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UBS bullish on Asian equities although warns GDP growth may slip in the first half of 2011
In light of realistic earnings forecasts combined with attractive valuations in the region, UBS Investment Bank remains positive on Asian equities in 2011. However, analysts warn that GDP growth may drop below trend in the first half of 2011, before picking up in the second half of the year.
In light of the abundant liquidity in Asia, growth is becoming less of a concern and with the credit cycle set to improve, we believe that Asia could re-rate from its current discount to its historical average PE, and potentially achieve a premium. We therefore remain positive on Asia ex-Japan equities in 2011 and have a year-end MCSI Asia ex-Japan index target of 670, based on 13.7 times forward PE, said UBS Asian Equity Strategist, Niall MACLEOD.
Asia will not be immune from the global socio-political situation caused by slow economic growth and high unemployment. However, while tensions caused by exchange rates and capital flows are likely to increase, a full-blown trade war, which would disproportionately affect the region given its dependence on global trade, is remote.
Nonetheless, there is an elevated risk that Asia's market valuations could become stretched if fuelled by excessively loose monetary policy. Inflation, sharply higher US bond yields, and government intervention will also continue to pose risks, he added.
Currently, UBS recommends investors overweight the stock markets of China, Hong Kong and India, have neutral positions in Korea and Taiwan and underweight the more expensive and smaller markets of Malaysia, the Philippines and Indonesia.
Duncan WOOLDRIDGE, Chief Asia Economist at UBS Investment Research, expects Asia ex-Japan GDP growth to drop below trend next year to 7% against 8.8% in 2010.
Our main assumptions are that exports will begin to slow next year, which will impact economic growth. In addition, China will continue to normalise its monetary policy as it lowers credit growth and increases interest rates, he said.
However, we also believe that while regional growth will start on weaker note through the first half of next year, it will finish stronger through the second half. While markets can deal with this weaker growth, higher inflation is a potential problem. But there are good reasons to believe that inflation will stabilize at around 4.2% next year versus 4% in 2010.
First, much of the increase in Asia's inflation rate is due to increasing food prices caused by poor weather. We believe that this will improve over time. Second, we believe that slower economic growth by 1Q 2011 will stymie core inflation. With weaker growth and stabilizing inflation predicted for next year, interest rate hikes are likely to be less than expected in 2011. Weaker exports will also make exchange rate appreciation less palatable and we expect most central banks to continue to smooth the pace of appreciation in their currencies, continued Wooldridge.
We remain concerned about inflation in the longer term given that rates remain close to historical lows, but believe that it is some way off due to the factors cited above, he added.
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