Equity Strategy Stay focused on North Asian cyclicals

India, Indonesia and the Philippines are the three markets facing the biggest challenge from this perspective, albeit this risk is somewhat priced in already.

04 Jun 2020

Source: UBS Estimates

This bar chart shows the change in budget balance as both a percentage of domestic credit and as a percentage of GDP for several Asian locations.

A combination of recovery potential and balance sheet strength

Over the coming months, we think individual market performance is likely driven by the interaction of 1. Export recovery as global lockdowns ease (manufacturing looks more promising than tourism), 2. The scope for domestic recovery, 3. Macro balance sheet strength and 4. micro balance sheet strength and how these relate to what’s already priced-in. Our preference remains to be focused on a global manufacturing recovery (read cyclicals) and we continue to prefer balance sheet strength (both macro and micro).

Despite looking good on many of these issues, we cut China to underweight

We're cutting our long-standing overweight on China to underweight. First in and first out of the COVID-19 lockdowns, the recovery is more advanced than the rest of the region, but so too, given the outperformance are relative P/E valuations which are now trading in the 83rd percentile of the past decade. While listed China disproportionately benefits from trends such as offline-online, a 29ppt credit to GDP expansion is unlikely to help bank valuations, and while it may be right to shrug off trade tensions, there is nothing in the price if these tensions shift from rhetoric to action.

Our preference remains north Asia cyclical markets: Korea, Japan

We've been arguing cyclical valuations look compelling versus defensives and as activity recovers this should augur well for north Asia's export markets. We continue to overweight the inexpensive, cash generating cyclical markets of Korea and Japan, best placed in our view to benefit as the global lockdown gradually eases. Taiwan still looks very expensive to us, and we remain underweight. We close out our underweight on Australia taking it back to neutral (we like materials) and lift Singapore to overweight (generally benefits from an improving cycle, attractive valuations, capacity for domestic recovery and sound balance sheet).

South Asia inexpensive but too many unknowns

While valuations look compelling in parts of south Asia, outperformance is path dependent on a number of difficult to assess variables market to market – lockdowns easing too early and will investors worry about the fiscal bill given past perceived macro vulnerabilities (India, Indonesia, The Philippines)? When will global travel/tourism resume (Thailand)?  If we get clarity on these issues, there is considerable upside to many of these equity markets, but for now, we have greater confidence in backing a manufacturing recovery as global lockdowns ease, than taking a firm view on domestic recovery in south Asia.

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