Earnings recovery to underpin Asian equity markets in 2013, says Goldman's Maasry

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EARNINGS of companies in Asia excluding Japan are expected to rebound from next year after stagnating in 2011 and 2012, paving the way for shares in the region, particularly cyclical counters, to move higher. But the outperformance by Southeast Asian markets against the rest of the region over the last seven years is likely to end in 2013, as stocks in China, South Korea and India are seen offering better value.

That, in a nutshell, is what Caesar Maasry, Goldman Sachs' regional strategist, has been telling the investment bank's clients in the lead-up to the New Year. He believes markets in Asia will generally fare better than those elsewhere — Goldman Sachs forecasts a return of 14% for the MSCI AC Asia Pacific excluding Japan (MXAPJ) Index in 2013 — as economic conditions and corporate profitability across the region improve.

"What has plagued Asian equities over the last few years? We haven't had earnings growth. In 2011, it was 0%. This year, it looks like it's going to be only 2% or 3%," says Maasry. But prospects from next year should be better as profit margins are expected to rise, he lets on. "One of the reasons we think profit margins might expand is a little bit less inflation, a little less cost input to corporates."

That projection is premised on Goldman Sachs' belief that oil prices will stabilise and pull back in the coming years as a result of an expected increase in global supply with the discovery of shale oil in the US. Also, while economies in the US and Europe may not be out of the woods yet, equity markets tend to be forward-looking, Maasry says. "We think over the course of next year, markets will price in a better growth profile at the macro level. That's going to drive markets."

Goldman Sachs expects earnings in Asia to increase 13% next year and 14% in 2014. As such, Maasry says investors will start to move out of defensive plays to cyclical stocks. "The theme for next year is going to be a switch from yield to growth."

Beyond the next couple of years, the longer-term earnings outlook for Asia hinges on the sustainability of profit margins, which in turn will depend on pricing power, the investment bank adds. For that, companies will have to build up their intellectual property and branding, it says.

SEA markets to underperform

In terms of geographical allocation, Goldman Sachs' top picks are China, South Korea, India and Singapore, which is the only Southeast Asian market it favours. The remaining markets in Southeast Asia could very well underperform the rest of the region as they have already moved up substantially over the years on the back of favourable domestic economic prospects.

Indeed, current valuations of the Philippine market, for example, are among the priciest in the world. "Foreigners have already allocated a lot of assets in the Philippines. Valuations are extremely expensive," says Maasry. If it turns out as Goldman Sachs projects, 2013 will mark the first year since 2005 that the MXAPJ outperforms Southeast Asian markets.

"Developed-market institutional investors who have the bulk of the capital in the world are looking at Asian markets and saying 'Where is growth changing? Where is growth becoming more positive?' The answer to that question was Southeast Asia for the last couple of years and it will turn to North Asia next year," Maasry says.

"From an absolute return perspective, Southeast Asia will still be a good investment. But in the relative context, if you're talking to a portfolio manager looking at the region or to a hedge fund, we would look outside Southeast Asia," he adds. "It's been a great investment for seven years, but we think other areas are a little bit more attractive."

Favourite markets

The Singapore market offers better value for investors seeking exposure to the region, though, he says. With the exception of Singapore, markets in Southeast Asia are within 5% of their respective peaks reached during the rebound from the global financial crisis.

By Goldman Sachs' estimates, earnings in Singapore are reasonably correlated with the region's growth, but the market trades at a 40% discount to the average book value of the Thai, Philippine, Indonesian and Malaysian markets. On a price-to-earnings basis, Singapore trades at a 3% discount to the average of these four markets. The bank projects earnings growth of 7% next year and 14% in 2014 for the Singapore market.

Its positive call on China is also based partly on valuations, which it finds attractive at current levels as the market had underperformed the rest of Asia in recent years. Moreover, Goldman Sachs believes Chinese stocks will stage a marked recovery in 2013 as it expects the country's GDP to rebound and expand 8.1% next year and 8.4% in 2014, driven by a pick-up in exports, domestic consumption and local infrastructure investment. Its forecast for China's GDP this year is growth of 7.6%. Along with the improved economic backdrop, earnings of Chinese companies are also expected to recover.

South Korea, meanwhile, will be a prime beneficiary of a pick-up in global economic growth, according to Goldman Sachs. The country's continued investment in R&D and brand building has also helped protect corporate profit margins, which should facilitate earnings growth of 18% next year and 15% in 2014.

As for India, catalysts for stocks include a recovery in domestic economic activity, lower inflation and the likelihood of more government reforms, which should bode well for businesses. The "delta of growth" in India is strong, with the economy forecast to expand 6.5% in 2013 and 7.2% in 2014 from 5.4% this year, says Goldman Sachs. It adds that the improvement in the global macro environment will be particularly beneficial for the country as Indian companies tend to borrow extensively offshore.

What to avoid

On the flip side, the bank has an "underweight" call on Australia and Taiwan, in addition to some of the Southeast Asian markets. It sees the economic cycle in Australia slowing and business investments declining, with GDP potentially expanding by 2.7% in 2013 following projected growth of 3.5% this year. Taiwan is also not seen as attractive as the market has already priced in a recovery in earnings. Makers of technology components in Taiwan also appear to lack sustainable bargaining power as their products tend to have low intellectual-property content.

In terms of sectors in Asia, the bank advocates starting 2013 with transportation, real estate, insurance, and information technology. It is "neutral" on metals and mining, capital goods, and banks, and has an "underweight" view of consumer staples and utilities.

With Goldman Sachs' generally bullish view on Asian equities, Maasry expects increased participation from institutional investors next year. "There's a ton of cash on the side lines, whether in the form of deposits or bonds, especially among developed-market institutional investors. That will be allocated much more into equities next year, in our view, than it has been this year."

This story first appeared in The Edge Singapore weekly edition of Dec 24-31, 2012.

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