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Asia Equity Strategy
N eutralising Defensives v Cyclicals
Asian equities are pricing in recession, not financial crisis
At 1.5x price to book and 9.4x forward earnings, we think Asian equities are now
pricing in a recession. Given where leading indicators are, we would be positive on
equities if this was the only major risk. However European events are likely to
prove binary for risk assets in the coming weeks, dictating which way we go. Asian
equities are not priced for a financial crisis (we think that means close to 1x book),
but nor is any respite from Europe’s woes priced in either.
Key message: start paring back cyclical underweights
We have been negative on cyclicals for most of the year based on softer leading
indicators and expensive relative valuations to defensives. The valuation case has
now mostly disappeared (see chart). Though the catalyst for getting overweight
cyclicals – rising leading indicators – is not in place, given relative performance
and valuation we want to pare back this underweight to neutral. Tech (which we
moved neutral in late July) and Industrials (Capital Goods, Transportation) are our
preferred cyclicals, as they appear to be pricing in recession in terms of their
relative multiples. Among defensives, we prefer Utilities and Telecoms.
Country changes: Korea, Taiwan to neutral from underweight
Our neutral view on cyclicals means we take our underweight in Korea and Taiwan
back to neutral. We stick to our overweights in India/China, where we expect
lower inflation to lead to less policy headwinds. By default we end up underweight
the expensive markets in ASEAN where believe many investors have been hiding
as India and China have underperformed and the world economy has softened.
In the sell off of the last few weeks, Asian equities have retraced to levels that
we now believe reflect the risk of recession. Although leading indicators are not
pointing to an outright recession at the moment, there is considerable risk priced
into valuations at 1.5x book, in line with previous recessionary valuation
troughs. What is not being priced in is a global financial crisis, brought about by
events in Europe. To this, there is still considerable downside in our view to
around 1x price book from 1.5x today. Our economists’ base case is that an
imminent and disorderly default of Greek debt will be avoided for now, the
EFSF will likely be passed and this might provide some temporary relief to risk
assets (especially many of the markets that have sold off on liquidity concerns
over the last month, and Asian fx). However everything is very binary on events
that unfold in the next few weeks. Though we want to be positive, especially
given that growth risks alone seem embedded in share prices to a large extent,
the reality is that markets are likely to be very event driven in the short-term.
The key message from us today is intra market: that is we want to close out the
overweight defensive/underweight cyclical bias that we have had in place since
mid February. Relative Price/book multiples of cyclicals versus defensives have
retraced from very high levels at the start of this year toward levels getting on
for those that we saw during the depths of the global financial crisis. The
relative P/B ratio between these groups tends to move in tandem with leading
economic indicators as it has again this year (see the chart on the front page).
We think many cyclical sectors (particularly Tech, which we warmed up to in
late July, and Industrials) are now at relative multiples that are pricing in
recession. For choice we would still be wary of expensive cyclicals. Among the
defensives, we think Utilities and Telecoms look best, more expensive consumer
defensive sectors to us look overowned and expensive. As leading indicators
remain soft and have yet to turn up, we still think it is too early to turn bullish on
the cyclicals in aggregate, but we no longer believe it is right to persist with an
outright bearish view.
Our strongest conviction lies in these relative sector calls right now over
countries, however given our preference to neutralise our negative cyclical call,
we take Korea and Taiwan back to neutral. Our preference is to focus on those
markets where we believe inflation fears will fade and policy headwinds with
them – China and especially India which we moved overweight at the start of
last quarter. By default this leaves us moving underweight the expensive
markets in the ASEAN, which have performed well and become even more
expensive in the absence of reasons hiterhto to be buying China, India, Korea or
Taiwan. With the outlook for policy looking better in our minds for the former
two, and the negative cyclical case looking priced in for the latter two, we would
expect the relative outperformance of ASEAN markets to fade into year end
though a short-term bounce on the back of better European news looks likely
given their poor (fx related) performance over the last month.
We start with a summary of many of the general market indicators we look at –
earnings, valuations, sentiment/technicals, before going into greater detail on our
views based on more subjective thoughts.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Asia Equity Strategy
N eutralising Defensives v Cyclicals
Asian equities are pricing in recession, not financial crisis
At 1.5x price to book and 9.4x forward earnings, we think Asian equities are now
pricing in a recession. Given where leading indicators are, we would be positive on
equities if this was the only major risk. However European events are likely to
prove binary for risk assets in the coming weeks, dictating which way we go. Asian
equities are not priced for a financial crisis (we think that means close to 1x book),
but nor is any respite from Europe’s woes priced in either.
Key message: start paring back cyclical underweights
We have been negative on cyclicals for most of the year based on softer leading
indicators and expensive relative valuations to defensives. The valuation case has
now mostly disappeared (see chart). Though the catalyst for getting overweight
cyclicals – rising leading indicators – is not in place, given relative performance
and valuation we want to pare back this underweight to neutral. Tech (which we
moved neutral in late July) and Industrials (Capital Goods, Transportation) are our
preferred cyclicals, as they appear to be pricing in recession in terms of their
relative multiples. Among defensives, we prefer Utilities and Telecoms.
Country changes: Korea, Taiwan to neutral from underweight
Our neutral view on cyclicals means we take our underweight in Korea and Taiwan
back to neutral. We stick to our overweights in India/China, where we expect
lower inflation to lead to less policy headwinds. By default we end up underweight
the expensive markets in ASEAN where believe many investors have been hiding
as India and China have underperformed and the world economy has softened.
In the sell off of the last few weeks, Asian equities have retraced to levels that
we now believe reflect the risk of recession. Although leading indicators are not
pointing to an outright recession at the moment, there is considerable risk priced
into valuations at 1.5x book, in line with previous recessionary valuation
troughs. What is not being priced in is a global financial crisis, brought about by
events in Europe. To this, there is still considerable downside in our view to
around 1x price book from 1.5x today. Our economists’ base case is that an
imminent and disorderly default of Greek debt will be avoided for now, the
EFSF will likely be passed and this might provide some temporary relief to risk
assets (especially many of the markets that have sold off on liquidity concerns
over the last month, and Asian fx). However everything is very binary on events
that unfold in the next few weeks. Though we want to be positive, especially
given that growth risks alone seem embedded in share prices to a large extent,
the reality is that markets are likely to be very event driven in the short-term.
The key message from us today is intra market: that is we want to close out the
overweight defensive/underweight cyclical bias that we have had in place since
mid February. Relative Price/book multiples of cyclicals versus defensives have
retraced from very high levels at the start of this year toward levels getting on
for those that we saw during the depths of the global financial crisis. The
relative P/B ratio between these groups tends to move in tandem with leading
economic indicators as it has again this year (see the chart on the front page).
We think many cyclical sectors (particularly Tech, which we warmed up to in
late July, and Industrials) are now at relative multiples that are pricing in
recession. For choice we would still be wary of expensive cyclicals. Among the
defensives, we think Utilities and Telecoms look best, more expensive consumer
defensive sectors to us look overowned and expensive. As leading indicators
remain soft and have yet to turn up, we still think it is too early to turn bullish on
the cyclicals in aggregate, but we no longer believe it is right to persist with an
outright bearish view.
Our strongest conviction lies in these relative sector calls right now over
countries, however given our preference to neutralise our negative cyclical call,
we take Korea and Taiwan back to neutral. Our preference is to focus on those
markets where we believe inflation fears will fade and policy headwinds with
them – China and especially India which we moved overweight at the start of
last quarter. By default this leaves us moving underweight the expensive
markets in the ASEAN, which have performed well and become even more
expensive in the absence of reasons hiterhto to be buying China, India, Korea or
Taiwan. With the outlook for policy looking better in our minds for the former
two, and the negative cyclical case looking priced in for the latter two, we would
expect the relative outperformance of ASEAN markets to fade into year end
though a short-term bounce on the back of better European news looks likely
given their poor (fx related) performance over the last month.
We start with a summary of many of the general market indicators we look at –
earnings, valuations, sentiment/technicals, before going into greater detail on our
views based on more subjective thoughts.
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