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UBS Investment Research
Asia Equity Strategy
S overeign ratings, weak macro and Asia
S&P rating downgrade : limited fundamental impact
We see limited fundamental impact from S&P’s move on the US sovereign rating
for Asia. The Fed has reaffirmed the risk weighting of US government securities,
and we think most financial institutions are largely prepared for this from a
liquidity perspective. Japan’s experience (though not the world’s reserve currency)
showed equity, fx and bond markets largely unchanged in response to sovereign
downgrades. This is sentiment negative, but we don’t expect major dislocation.
But it comes on the back of weak economic data
Economic data has been weak, though the ISM New Orders is still a long way
above levels associated with recession. Our economists stick with their soft-patch
view. The bad news is that Asian equities do not appear to be pricing in a recession
– we see at least 15% downside in this event, based on past data. The good news,
we see upside of 25% to more normal valuation levels. At the sector level, Asian
Tech is pricing in more risk of a recession than Materials.
Silver lining for Asia – inflation and monetary headwinds likely to ease
Weak economic data should lessen inflation pressures short-term, and reduce
tightening risks in China and India in our view. We think monetary headwinds
which have acted as a drag on performance are likely to ease. We remain
overweight India and China (monetary headwinds easing and valuations/estimates
reflecting a growth slowdown, especially in India) and stay underweight Korea and
Taiwan which look more vulnerable to the global slowdown. Easing
inflation/policy headwinds should help Asian markets relative to global markets in
our view.
S&P’s decision to downgrade US government debt to AA+ on Friday evening,
coming on the back of troublesome data, is the focus here. What are the
implications for Asian equities? We look here at four issues: 1) S&P’s
downgrade of US sovereign debt, 2) the economic data 3) potential monetary
policy shifts in Asia ex Japan, 4) where sentiment currently is.
Summary
1. We see limited fundamental fall-out from S&P’s downgrade. Firstly, the
short-term ratings have not changed, which would have been more of a problem.
Secondly we think most US based financial system players are already
somewhat positioned for this risk, and the Fed has reaffirmed that there is no
change in the risk weighting of US Treasuries for banking organisations. Three,
as we show, there was little impact to financial assets from Japanese
downgrades (albeit the Yen is not the world’s reserve currency). Four, although
we think fundamentally there should be limited impact, sentiment in financial
markets is clearly fragile, and this is not positive news. Fragile sentiment and
uncertainty about how money markets respond is likely to lead to short-term
weaker markets. We would not, as it stands today, see this as long-lived, given
Japan’s experience.
2. This is coming on the back of last week’s tricky economic data. Our
economists’ base case remains that the US is in a soft-patch, not heading for
recession. The ISM New Orders and consumer spending data can be jumpy and
the former is still way above levels associated with recession (normally sub 40).
Meanwhile Friday’s employment report suggested that incomes and
employment are not falling off a cliff. Nevertheless, Asian equities are not
pricing a recession in, in our view. Currently, equities are pricing in the fear of a
recession, but not an outright recession. In the event that data does take a turn
for the worse there is still 15% downside in our view. However, that is matched
by 25% upside potential to a more normal environment if growth data stabilises.
Although the market is going to be very data dependant from here, this skew
presents opportunities. We would at the moment focus more on sectors and
stocks which are already at valuation levels consistent with recession, avoiding
those that are not. Sector wise, we think Asian Tech is more reflecting a
recession than Materials. Stock screens are on pages 12-15 showing what is
most pricing in a recession, and those that are not.
3. The biggest delta here in Asia ex Japan is likely to be shifts in perception both
on inflation and monetary policy. We think the external weakness and risks
make it highly likely that China is done with monetary tightening. We believe
the market already largely thinks the same, but we should expect more
commentary to this effect. The bigger delta in terms of investor positioning and
thinking is in India where tightening faces a good chance of being over. The
RBI has explicitly commented in their last monetary report that external
weakness and lower commodity prices might cause them to reassess the path of
rate hikes. We are overweight India (and China) precisely because we think
monetary headwinds which have caused both markets to underperform are
coming to (or are at) an end and slowing growth in both is largely priced in to
estimates and valuations (especially in India). We think these external events
over the last week in the US underpin this. Our country overweights – India and
China, versus underweights in Korea and Taiwan (global growth slowing) are
unchanged but we think underpinned by recent data and events. This another
way of saying that we see reasons for Asia ex Japan to outperform other parts of
the world with inflation fears and tightening receding here.
4. Sentiment though very fragile, is now at very low levels. Although from such
levels, markets are vulnerable to bad news, they are equally very vulnerable to
the upside to positive monetary action or statements. With the Fed meeting this
week and central banks now cutting rates, or undertaking other expansionary
measures (e.g. the SNB cutting rates, the BOJ intervening in the FX markets and
stepping up asset purchases) liquidity at the margin could well improve. This
bears watching. Equity markets are not alone in recognising the world’s
problems. Concerted policy action to overcome some of the last weeks’
challenges could have a major positive impact in our view given where
sentiment currently is.
Bottom line, we would focus in relative terms on India and China, our preferred
overweights, relative to Korea and Taiwan. Among cyclicals at the sector level,
Tech looks to be pricing in recession more so than Materials.
1. S&P’s rating downgrade
S&P’s move is clearly in the short-term bad for sentiment. But ultimately it
should not have major implications for equities beyond sentiment, in our view.
The key things we identify to think about here are 1) short-term ratings have
been left unchanged. This had the capacity to be far more serious had money
market funds no longer been able to hold US Treasury bills. This has not
happened, and so we see little money market fund problems arising. 2) the
Federal Reserve in its role as bank regulator announced on Friday that for
banking organisations, there will be no change in Treasuries and quasi
government debt asset risk weightings. This is hardly a surprise, but reaffirms
that there should be no need for financial institutions to reduce holdings of US
government securities. 3) It is not a major shock that S&P has downgraded their
rating of US government debt, albeit the timing comes against the backdrop of
fragile confidence. Our US financial colleagues have contacted many financial
institutions (banks, insurance companies, exchanges, brokers) to understand
their preparedness for such an event. The bottom line is that from a liquidity
perspective, we expect little major negativity, especially as the Fed has reaffirmed
no need to take haircuts on Treasury securities (see their note ‘How
Financial Firms Positioned Themselves for S&P’s Downgrade’ dated 6th August
2011).
Moreover, turning to Japan and looking at how assets performed in the
immediate aftermath of Japan losing it’s AAA (or equivalent ratings) from
agencies in the past reveals that markets there were little moved by these events.
S&P, Moody’s and Fitch all moved their ratings at different times, and these
rating changes came at different market points as well – September 1998, a few
days before the worst point for equity markets in the Asian financial crisis (Fitch
downgrade from AAA to AA+), February 2001 a few weeks after markets
started fretting more seriously about a US recession (S&P downgrade from
AAA to AA+) and a surprise Fed rate cut, May 2009 (Moody’s downgrade from
AAA to AA2), in the middle of the global cyclical recovery post the global
financial crisis.
Table 1 shows how assets performed around this. We show how, 1 month and 1
day before, along with 1 day after, 1 week and one month after, equities
performed, in absolute and relative terms, along with how Japanese financials
performed, how the Yen behaved and how Japanese bond yields moved.
Now for sure, there are differences between Japan and the US. For a start,
Japan’s debt is largely self-funded. Secondly, the Yen is not the world’s reserve
currency. But it does show that market behaviour was orderly.
However, for Asian equities in the current environment, S&P’s move is clearly
sentiment negative. There may be some dislocation – the very fear of this in its
own right is likely to keep markets nervous for a short-time. We will be
watching the commercial paper and Libor markets for signs of stress, though
expect the Fed will keep liquidity well supplied.
Beyond a likely sell-off partly on fear of dislocation (which we think will not
happen) and fragility of confidence in markets, we see limited fall out from the
downgrade.
Turning to sectors that might be most affected, we see the property stocks as
being most impacted from a potential move up in market rates and, from a
sentiment perspective, vulnerable. Although US Treasury yields and BAA
credits are already at very low levels, these act as a proxy for Cap rates for
property businesses. Fundamentally however, we think the stocks are pricing in
higher rates as it is. In our view, rates suggests that these stocks already have a
lot of comfort room in the even that US long rates did back up substantially as a
result of S&P’s moves
2. Weak economic data
We have all year believed that enthusiasm toward global growth was misplaced
and a slowdown inevitable (please see our note, From the Fear of Double Dip to
the Fear of Double Boom, January 6 2011). The soft patch, still our global
economists’ base case, is being severely challenged by markets given data this
last week. We have moved full circle in twelve months from fear of double dip
to the fear of double boom, back to fear of double dip.
How worried should we be by the data over the last week? Although the ISM
New Orders data and consumer spending data have a) been weak in absolute
terms and b) much weaker than expected, these are not without precedent in the
past. Moreover, specifically for the ISM New Orders index, recessions are more
associated with levels below 40, not just below 50 (where we ended up last
week).
Globally, our economists continue to believe that the soft patch, albeit one with
more risks attached given the data last week, is the most likely outcome. Andy
Cates, in his “Macro Keys” note of 4 August highlighted five supports for soft
patch, not hard landing: 1) not all data is actually bad, with housing data better
and global data surprising to the upside 2) Japan supply chain disruption turning
around, possibly acting as a positive in the second half 3) inventory levels that
are not high and the balance with new orders better 4) lower oil prices, 5) loose
global financial conditions. For a fuller explanation of the reasons, please see
Andy Cates’ note “A soft patch or something more sinister?” 4 August 2011.
Last summer we published analysis showing how Asia had performed in
different phases of the economic cycles, along with average valuations and
performance data. We looked at five phases – ‘normal conditions’,
slowdowns/fears of recessions, actual recessions, financial crises and recovery
phases. We repeat this here. Chart 3 shows the performance of Asian equities
and various phases of the cycle. Table 2 shows how Asian equities have
performed in these various different phases along with valuation data.
Summary of our Strategy View
We remain positive on Asia ex-Japan equities in 2011. Earnings growth
forecasts look achievable and valuations look attractive, especially relative to
other assets. Over the past couple of months, investor focus has increasingly
shifted from inflation to slowing growth. We are sanguine that the Asian
economies are slowing, not crashing, but these macro turning points could still
be unnerving. Our 2011 year-end MSCI Asia ex-Japan index target is 670, based
on 13.7x forward PE, in line with the long-term average.
Our key country picks are India, where we think policy headwinds may peak
and earnings risks are now beginning to be reflected in estimates, and China,
which we see as a market that should benefit from falling inflation. We have
underweight positions in Korea and Taiwan as we think slowing global growth
will remain a headwind. We are neutral Thailand to reflect the increasing
political uncertainties due to the upcoming elections. The ASEAN markets, in
general, look least at risk from a growth slowdown and can benefit from
inflationary fears subsiding. We are neutral on those markets due to their
relatively expensive valuations.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Asia Equity Strategy
S overeign ratings, weak macro and Asia
S&P rating downgrade : limited fundamental impact
We see limited fundamental impact from S&P’s move on the US sovereign rating
for Asia. The Fed has reaffirmed the risk weighting of US government securities,
and we think most financial institutions are largely prepared for this from a
liquidity perspective. Japan’s experience (though not the world’s reserve currency)
showed equity, fx and bond markets largely unchanged in response to sovereign
downgrades. This is sentiment negative, but we don’t expect major dislocation.
But it comes on the back of weak economic data
Economic data has been weak, though the ISM New Orders is still a long way
above levels associated with recession. Our economists stick with their soft-patch
view. The bad news is that Asian equities do not appear to be pricing in a recession
– we see at least 15% downside in this event, based on past data. The good news,
we see upside of 25% to more normal valuation levels. At the sector level, Asian
Tech is pricing in more risk of a recession than Materials.
Silver lining for Asia – inflation and monetary headwinds likely to ease
Weak economic data should lessen inflation pressures short-term, and reduce
tightening risks in China and India in our view. We think monetary headwinds
which have acted as a drag on performance are likely to ease. We remain
overweight India and China (monetary headwinds easing and valuations/estimates
reflecting a growth slowdown, especially in India) and stay underweight Korea and
Taiwan which look more vulnerable to the global slowdown. Easing
inflation/policy headwinds should help Asian markets relative to global markets in
our view.
S&P’s decision to downgrade US government debt to AA+ on Friday evening,
coming on the back of troublesome data, is the focus here. What are the
implications for Asian equities? We look here at four issues: 1) S&P’s
downgrade of US sovereign debt, 2) the economic data 3) potential monetary
policy shifts in Asia ex Japan, 4) where sentiment currently is.
Summary
1. We see limited fundamental fall-out from S&P’s downgrade. Firstly, the
short-term ratings have not changed, which would have been more of a problem.
Secondly we think most US based financial system players are already
somewhat positioned for this risk, and the Fed has reaffirmed that there is no
change in the risk weighting of US Treasuries for banking organisations. Three,
as we show, there was little impact to financial assets from Japanese
downgrades (albeit the Yen is not the world’s reserve currency). Four, although
we think fundamentally there should be limited impact, sentiment in financial
markets is clearly fragile, and this is not positive news. Fragile sentiment and
uncertainty about how money markets respond is likely to lead to short-term
weaker markets. We would not, as it stands today, see this as long-lived, given
Japan’s experience.
2. This is coming on the back of last week’s tricky economic data. Our
economists’ base case remains that the US is in a soft-patch, not heading for
recession. The ISM New Orders and consumer spending data can be jumpy and
the former is still way above levels associated with recession (normally sub 40).
Meanwhile Friday’s employment report suggested that incomes and
employment are not falling off a cliff. Nevertheless, Asian equities are not
pricing a recession in, in our view. Currently, equities are pricing in the fear of a
recession, but not an outright recession. In the event that data does take a turn
for the worse there is still 15% downside in our view. However, that is matched
by 25% upside potential to a more normal environment if growth data stabilises.
Although the market is going to be very data dependant from here, this skew
presents opportunities. We would at the moment focus more on sectors and
stocks which are already at valuation levels consistent with recession, avoiding
those that are not. Sector wise, we think Asian Tech is more reflecting a
recession than Materials. Stock screens are on pages 12-15 showing what is
most pricing in a recession, and those that are not.
3. The biggest delta here in Asia ex Japan is likely to be shifts in perception both
on inflation and monetary policy. We think the external weakness and risks
make it highly likely that China is done with monetary tightening. We believe
the market already largely thinks the same, but we should expect more
commentary to this effect. The bigger delta in terms of investor positioning and
thinking is in India where tightening faces a good chance of being over. The
RBI has explicitly commented in their last monetary report that external
weakness and lower commodity prices might cause them to reassess the path of
rate hikes. We are overweight India (and China) precisely because we think
monetary headwinds which have caused both markets to underperform are
coming to (or are at) an end and slowing growth in both is largely priced in to
estimates and valuations (especially in India). We think these external events
over the last week in the US underpin this. Our country overweights – India and
China, versus underweights in Korea and Taiwan (global growth slowing) are
unchanged but we think underpinned by recent data and events. This another
way of saying that we see reasons for Asia ex Japan to outperform other parts of
the world with inflation fears and tightening receding here.
4. Sentiment though very fragile, is now at very low levels. Although from such
levels, markets are vulnerable to bad news, they are equally very vulnerable to
the upside to positive monetary action or statements. With the Fed meeting this
week and central banks now cutting rates, or undertaking other expansionary
measures (e.g. the SNB cutting rates, the BOJ intervening in the FX markets and
stepping up asset purchases) liquidity at the margin could well improve. This
bears watching. Equity markets are not alone in recognising the world’s
problems. Concerted policy action to overcome some of the last weeks’
challenges could have a major positive impact in our view given where
sentiment currently is.
Bottom line, we would focus in relative terms on India and China, our preferred
overweights, relative to Korea and Taiwan. Among cyclicals at the sector level,
Tech looks to be pricing in recession more so than Materials.
1. S&P’s rating downgrade
S&P’s move is clearly in the short-term bad for sentiment. But ultimately it
should not have major implications for equities beyond sentiment, in our view.
The key things we identify to think about here are 1) short-term ratings have
been left unchanged. This had the capacity to be far more serious had money
market funds no longer been able to hold US Treasury bills. This has not
happened, and so we see little money market fund problems arising. 2) the
Federal Reserve in its role as bank regulator announced on Friday that for
banking organisations, there will be no change in Treasuries and quasi
government debt asset risk weightings. This is hardly a surprise, but reaffirms
that there should be no need for financial institutions to reduce holdings of US
government securities. 3) It is not a major shock that S&P has downgraded their
rating of US government debt, albeit the timing comes against the backdrop of
fragile confidence. Our US financial colleagues have contacted many financial
institutions (banks, insurance companies, exchanges, brokers) to understand
their preparedness for such an event. The bottom line is that from a liquidity
perspective, we expect little major negativity, especially as the Fed has reaffirmed
no need to take haircuts on Treasury securities (see their note ‘How
Financial Firms Positioned Themselves for S&P’s Downgrade’ dated 6th August
2011).
Moreover, turning to Japan and looking at how assets performed in the
immediate aftermath of Japan losing it’s AAA (or equivalent ratings) from
agencies in the past reveals that markets there were little moved by these events.
S&P, Moody’s and Fitch all moved their ratings at different times, and these
rating changes came at different market points as well – September 1998, a few
days before the worst point for equity markets in the Asian financial crisis (Fitch
downgrade from AAA to AA+), February 2001 a few weeks after markets
started fretting more seriously about a US recession (S&P downgrade from
AAA to AA+) and a surprise Fed rate cut, May 2009 (Moody’s downgrade from
AAA to AA2), in the middle of the global cyclical recovery post the global
financial crisis.
Table 1 shows how assets performed around this. We show how, 1 month and 1
day before, along with 1 day after, 1 week and one month after, equities
performed, in absolute and relative terms, along with how Japanese financials
performed, how the Yen behaved and how Japanese bond yields moved.
Now for sure, there are differences between Japan and the US. For a start,
Japan’s debt is largely self-funded. Secondly, the Yen is not the world’s reserve
currency. But it does show that market behaviour was orderly.
However, for Asian equities in the current environment, S&P’s move is clearly
sentiment negative. There may be some dislocation – the very fear of this in its
own right is likely to keep markets nervous for a short-time. We will be
watching the commercial paper and Libor markets for signs of stress, though
expect the Fed will keep liquidity well supplied.
Beyond a likely sell-off partly on fear of dislocation (which we think will not
happen) and fragility of confidence in markets, we see limited fall out from the
downgrade.
Turning to sectors that might be most affected, we see the property stocks as
being most impacted from a potential move up in market rates and, from a
sentiment perspective, vulnerable. Although US Treasury yields and BAA
credits are already at very low levels, these act as a proxy for Cap rates for
property businesses. Fundamentally however, we think the stocks are pricing in
higher rates as it is. In our view, rates suggests that these stocks already have a
lot of comfort room in the even that US long rates did back up substantially as a
result of S&P’s moves
2. Weak economic data
We have all year believed that enthusiasm toward global growth was misplaced
and a slowdown inevitable (please see our note, From the Fear of Double Dip to
the Fear of Double Boom, January 6 2011). The soft patch, still our global
economists’ base case, is being severely challenged by markets given data this
last week. We have moved full circle in twelve months from fear of double dip
to the fear of double boom, back to fear of double dip.
How worried should we be by the data over the last week? Although the ISM
New Orders data and consumer spending data have a) been weak in absolute
terms and b) much weaker than expected, these are not without precedent in the
past. Moreover, specifically for the ISM New Orders index, recessions are more
associated with levels below 40, not just below 50 (where we ended up last
week).
Globally, our economists continue to believe that the soft patch, albeit one with
more risks attached given the data last week, is the most likely outcome. Andy
Cates, in his “Macro Keys” note of 4 August highlighted five supports for soft
patch, not hard landing: 1) not all data is actually bad, with housing data better
and global data surprising to the upside 2) Japan supply chain disruption turning
around, possibly acting as a positive in the second half 3) inventory levels that
are not high and the balance with new orders better 4) lower oil prices, 5) loose
global financial conditions. For a fuller explanation of the reasons, please see
Andy Cates’ note “A soft patch or something more sinister?” 4 August 2011.
Last summer we published analysis showing how Asia had performed in
different phases of the economic cycles, along with average valuations and
performance data. We looked at five phases – ‘normal conditions’,
slowdowns/fears of recessions, actual recessions, financial crises and recovery
phases. We repeat this here. Chart 3 shows the performance of Asian equities
and various phases of the cycle. Table 2 shows how Asian equities have
performed in these various different phases along with valuation data.
Summary of our Strategy View
We remain positive on Asia ex-Japan equities in 2011. Earnings growth
forecasts look achievable and valuations look attractive, especially relative to
other assets. Over the past couple of months, investor focus has increasingly
shifted from inflation to slowing growth. We are sanguine that the Asian
economies are slowing, not crashing, but these macro turning points could still
be unnerving. Our 2011 year-end MSCI Asia ex-Japan index target is 670, based
on 13.7x forward PE, in line with the long-term average.
Our key country picks are India, where we think policy headwinds may peak
and earnings risks are now beginning to be reflected in estimates, and China,
which we see as a market that should benefit from falling inflation. We have
underweight positions in Korea and Taiwan as we think slowing global growth
will remain a headwind. We are neutral Thailand to reflect the increasing
political uncertainties due to the upcoming elections. The ASEAN markets, in
general, look least at risk from a growth slowdown and can benefit from
inflationary fears subsiding. We are neutral on those markets due to their
relatively expensive valuations.
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