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Potential for 10% to 15% gains on Asian equities, according to UBS

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While the more pessimistic investors in Asia and the US are suggesting that Asia is at peak cycle earnings, Sakthi SIVA, Managing Director and Head of Asian Equities Strategy at UBS argues that Asia is in fact at peak cycle EPS growth and sees the possibility for 10% to 15% gains.

The case for peak cycle earnings is based on four main assumptions: that Asian EPS, ROCE (Return on Capital Employed) and EBIT (Earnings before Interest and Tax) margins are already at new highs; most macro indicators including leading indicators, semiconductor sales, exports and industrial production appear to have peaked or are close to peaking; interest and other input costs such as oil, raw materials and unit labour are higher; and Capex to sales is expected to rise.

Siva commented: "We are not convinced by these arguments. While Asian EPS, ROCE and EBIT margins are at new highs, at the country level, this is only true in Korea and Thailand."

"While most macro indicators such as leading indicators appear to be peaking and have a reasonable relationship to Asian EPS, the closest correlation with Asian EPS growth is with property prices and bank credit growth which are only in the early stages of recovery," she added.

Countering the view on rising interest rates, Siva expects that there will be a modest rise in Asian rates over 2004-05. She further pointed out that, leverage has fallen significantly by one-third from the 1997 peak (and by two-thirds in previously highly leveraged Thailand).

"With other input costs such as higher commodity prices, we find that historically there has been a positive rather than inverse relationship between a rising CRB (Commodity Research Bureau) index and Asian EPS growth. This is because the environment in which the CRB index is rising is traditionally reflective of good growth and this offsets the impact of higher commodity prices at the macro level,"

"The last point we don't believe Asia is at peak cycle earnings is that Capex is still growing slower than sales using GDP as a proxy (6.6% capex in Asia ex-China versus 7% for GDP in the March quarter of 2004 YoY %), with China and Thailand as exceptions," she said.

"The implication for Asian equities, if we are at peak EPS growth, is that a modest gains of 10% to 15% are possible and we are positive on Asian equities. This is well proved with the situation in 1995 - 6, a period when Asian equities rose 10 - 15% despite decelerating Asian EPS growth and slowing OECD leading indicators," Siva concluded.

Hong Kong, 22 July 2004

Matthew McGrath (P) +852 2971 8200 (M) +852 9325 0166
Donna Chan (P) +852 2971 8792 (M) +852 9312 1311

Hong Kong, 22 July 2004