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Asia Market Strategy
STRATEGY
2009 outlook
Asian Six Factor Valuation Indicator
-60
-40
-20
0
20
40
60
80
Sep 73 Sep 83 Sep 93 Sep 03
6 factor Asian v aluation indicator
-51% 1974 lows -50% 1982 lows
-52% 27 Oct,
now -49%
Source: Datastream, Credit Suisse estimates
■ A deep and long recession appears to be priced in. In December last
year, it was difficult to get excited about markets, as our Asian Six Factor
Valuation Indicator was around 15% overvalued. This time around, the Asian
Six Factor is at 50% undervalued. We have only seen this degree of
undervaluation twice previously – December 1974 and December 1982.
1974 and 1982 were both periods of deep and long global recessions. While
markets have been undervalued for a while now, we believe that there are
three potential catalysts in 2009 for a sustainable 30% rally – fiscal stimulus,
quantitative easing by the Fed and a bottoming in global IP.
■ How to play the rally – China and banks. Our preferred plays are China
and banks. We like China because of valuations and policy flexibility. Both
the H and A shares are trading at one-fifth of last year’s highs, and China
has room to move on both the monetary and fiscal policy fronts given the
large current account surplus, FX reserves, fiscal surplus and slowing
inflation. History favours banks, as they performed best in the three months
after the lows in 1974 and 1982, as well as after the last five major lows.
After China and banks, we also like Korea, as we think the won is oversold
as are materials stocks, particularly those trading close to trough valuations.
■ What to avoid – “crowded” trades starting to see EPS downgrades. We
believe that a lot of investors are hiding in “crowded” trades, such as
Chinese, Indian and Korean consumer staples, Hong Kong utilities, as well
as Korean telecoms and utilities, as they believe earnings in these sectors
are more defensive in a severe global recession. But with these sectors now
trading at P/B versus ROE premiums that are at record highs, we believe
that sectors such as Chinese and Korean consumer staples (which are
starting to see consensus EPS downgrades) look potentially vulnerable.
Three key themes for 2009
Our three key themes for 2009 are:
(1) A deep and long recession appears to be priced into Asian equities.
(2) Our preferred ways to play the rally are China and banks.
(3) What to avoid are “crowded” trades, particularly those starting to see consensus EPS
downgrades.
Our Asian Six Factor Valuation Indicator includes historical P/E, historical price-to-cash
flow, historical dividend yield, P/E adjusted by inflation, price-to-cash flow adjusted by
inflation and earnings yield adjusted by bond yields. Our Asian Six Factor has now moved
to 50% undervalued. Figure 5 illustrates that we have only seen this degree of
undervaluation twice before – in December 1974 and December 1982.
The historical dividend yield (DY) has risen to 4.8%. While this is still well below the 6.7%
seen in 1982 and the 9.1% seen in 1974, we highlight that inflation and bond yields
currently are significantly lower than in 1974 and 1982.
We do concede that our Asian Six Factor has been indicating that Asia is cheap since
5 September, when we reached the 25% undervalued “buy” signal. We also find investors
to be sceptical of any earnings-based valuation measure, such as historical P/E, given the
large downgrades to consensus EPS, which we also believe are likely to continue.
Even if we go back to basics and look at the biggest corrections in Asia ex. Japan since
1970, the current correction from the high to the low at 65% is already the third biggest.
The only two corrections that were bigger were the 86% correction in 1974 and the 70%
correction in the Thai SET Index in 1998.
We believe that there are two key differences between 1974 and the current situation. One,
inflation was above 20% then and generally markets tend to trade on lower P/E multiples
when there is high inflation, as the quality of earnings tends to be poorer. Two, the only
two Asian markets in 1974 were Singapore and Hong Kong. These two markets had
exports greater than 100% of GDP – not a great combination when global IP fell by 10%.
In other words, there was no China, India or any element of Asian domestic demand
growth or infrastructure spending.
The SET’s 70% fall in 1998 was largely because Thailand was one of the worst affected
countries during the Asian financial crisis, with credit losses/NPLs amounting to 30% of
GDP.
The current degree of undervaluation and the size of the decline suggest that we are due
for a strong rebound in Asian markets in 2009. The last two times Asia fell to 50%
undervalued, it rose by 74% in the first three months after the 1974 low and by 36% after
the 1982 low. Figure 7 also highlights that the average rally in the first three months after
all the big corrections since 1970 was 36% in the first three months.
We believe the key risks to our call for a strong rebound in 2009 are continued forced
selling driven by redemptions from both hedge funds and long only investors.
Figure 9 highlights that since our data starts in 2000, US hedge funds have seen the two
largest months in terms of redemptions in September (US$30 bn) and October (US$40 bn).
Figure 10 highlights that for equity mutual funds, October was also the biggest month ever
for redemptions as a percentage of market capitalisation, and the data starts in 1984.
The next question is what are the potential catalysts for a rally? While we have had many
bear rallies in 2008, we believe potential catalysts are a large fiscal stimulus, quantitative
easing by the Fed and a bottoming of global IP.
For a bottoming in global IP, we are watching the BDI (Baltic Dry Index), US ISM and the
OECD Composite leading indicator. Figure 11 highlights that the OECD leading indicator
fell by 4.1% in the year to September 2008. This fall is already bigger than the falls seen in
the 2001 recession and equal to the biggest falls seen in the 1990 recession. Credit
Suisse’s Global Strategist, Jonathan Wilmot, suggests that the global IP/OECD leading
indicator could bottom in the next couple of months.
Figure 12 highlights that historically, Asia has bottomed one month prior to the low in the
OECD leading indicator, and the average rally was around 30%. More significantly, Asia
ex. Japan has rallied 10 out of 10 times in the 12 months after the last 10 troughs in the
OECD leading indicator.
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