The Asian FLASH

March 2012

Asia 2012 Outlook: A Year of Promise

The Global Economic Picture Appears to be Improving We retain our relatively positive view on Asian markets and economies for 2012. We think that the world will generally be healthier in 2012 than it was in 2011, although we do recognize that uncertainty about the outcome of the Eurozone sovereign debt crisis continues to pose a significant risk and will likely keep markets volatile. Nonetheless, we expect governments to act rationally and do not expect the situation to spin out of control. We are cautiously optimistic about developments in the US economy which should be supportive of Asian trade.

Scott Davidson Research Director

Asias Economic Environment is Reasonably Healthy We think that the Asian economic environment remains attractive. While we expect that economies will gradually slow, with some tapering off of exports, and rising currencies, our optimism arises from the likelihood that Chinas economy will probably be stronger than most expect, intra-Asian trade should remain fairly solid (Charts 1 & 2), and domestic consumption should be relatively resilient with nearly full employment in much of the region (Charts 3 & 4).
Chart 1: Asian exports by destinations (As of end Dec 2011) Chart 2: Koreas exports by region (US$bn)

Chart 3: Consumption in Asia

Chart 4: Unemployment rate as of 31 Dec 11

Absolutely Dedicated to Investment in Asia

The Asian FLASH

March 2012

Inflation which was a significant risk in 2011, although by no means out of the picture, especially given the strength of oil prices, should be less of an issue in 2012 as food prices are coming down and weather conditions have been somewhat calmer, at least, thus far, this year (Chart 5). With inflation easing in much of Asia, governments and central banks are in the fortunate position of being able to undertake more monetary easing and, if need be, to introduce stimulatory measures in case the global economy becomes more unsettled (Chart 6).
Chart 5: Consumer Price Inflation YoY (%) Chart 6: Central Bank Interest Rate (%)

Monetary easing and stimulatory measures are possible because unlike much of the rest of the world, Asian countries posses strong balance sheets with massive foreign reserves and generally solid fiscal positions (Chart 7 & 8).
Chart 7: FX Reserves (US$ bn) Chart 8: Prudent Fiscal Policy in Asia

Source: Credit Suisse, CEIC

Absolutely Dedicated to Investment in Asia

The Asian FLASH

March 2012

While currencies are likely to rise, given the strength of Asian economies, they will also add to the possible pressure on exports from an unstable global economy. On the other hand, stronger currencies can also attract fund inflows (Chart 9).
Chart 9: Asian Currencies Appreciation vs US Dollar

Valuations, although not as appealing as at the beginning of 2012, still remain rather attractive (Chart 10).
Chart 10: MSCI Asia Pacific ex Japan and China 12m forward PE relative to MSCI USA 12m forward PE

Elections and Leadership Changes will Matter in 2012 Elections and leadership changes will be important factors this year and, while they do pose risk, we expect that the results should be more positive than negative and should generally help to alleviate some uncertainty. In January, Taiwans President Ma Ying Jeou of the Koumintang Party was re-elected which should help to sustain improving relationships with China. In Malaysia, an anticipated election may lead to short term government stimulus measures and ultimately more infrastructure projects. China, where a change in leadership is well underway, but will be officially announced later in the year, should allow the government to introduce more proactive policies. An election will also occur in Korea. In this case, we see it as a possible negative as the government is likely to introduce voter friendly, but possibly business unfriendly, measures in the lead up to the election. In India, the ruling Congress Party experienced disappointing results in the recently concluded state elections which is likely to result in a delay in much needed reform measures.

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The Asian FLASH

Country Views:

March 2012

China should have a Good Year In 2011, Chinas market performance was disappointing, but this year we think that the environment is more attractive. Although investors remain nervous about China because of issues in the banking and property sector as well as concerns about the pace of growth, there are clear signs that the tightening policy which was imposed to ease inflation and control property price speculation is being relaxed and that the feared hard landing is unlikely to materialize. Valuations are very attractive, so we think that China is an appealing market. Hong Kongs performance often goes hand in hand with Chinas. A better outlook for China is positive for Hong Kong as Hong Kong benefits from Chinese tourism, plus, the Hong Kong government has offered some stimulatory measures in its Budget package. Taiwan Edges Out Korea We think that Koreas economy is in a reasonably good shape, but we have a preference for Taiwan over Korea. While both markets have some of the same characteristics, we are concerned about possible counterproductive policy initiatives that have been and are likely to be implemented in the period leading up to the Korean Presidential election later this year. On the other hand, Taiwan is likely to benefit from improved relations with China which should support its domestic economy and signs of an improved global economy enhances the prospects of greater demand for its very important technology sector. Southeast Asia is Expensive, but the Macro Environment is Resilient Southeast Asian markets were the outstanding performers in 2011, so we are cautious about Southeast Asian markets in 2012 from a valuation perspective, but the fundamentals are generally strong and in some cases improving with rising domestic consumption, better corporate governance and likely progress in long delayed infrastructure programs. Indonesia and the Philippines both benefit from young populations, mineral resources, robust domestic consumption and signs of an improved political environment. However, Indonesia may face some risks from a reduction in fuel price subsidies and, hence, rising inflation. Malaysia is a more defensive and inward looking market, and may benefit from pump-priming in the period leading up to the general election. Meanwhile, political risk has heightened ahead of the general elections and the quality of Prime Minister Najibs win will be crucial for the market. Despite massive flooding in Thailand in 2011, the political environment has calmed following the election of former Prime Minister Thaksins sister, Yinluck Shinawatra, as the new Prime Minister. Additionally, the economy should see a significant uplift in response to flood recovery measures including more stimulus and infrastructure rebuilding efforts. Singapore, the only developed market in Southeast Asia, may see some slowing this year on softer exports, but we expect that tourism should continue to underpin growth and, so far this year, the property sector has offered appealing returns, despite the imposition of more restrictive anti-speculation measures in 2011. Possible Delay in Reforms Dampens Outlook for India After being the weakest Asian market in 2011, we were becoming more positive about India in 2012. Inflation seemed to be heading down. Monetary easing seemed likely. Plus, a host of important policy initiatives which could help to transform the economy and open the market were under serious discussion. However, our more positive view was contingent upon the results of the recently completed state elections and the upcoming FY 2013 Union Budget due on March 16 2012. Unfortunately, the governing Congress Party performed poorly in the recent state elections. As a result, policy reforms may be further delayed and there are concerns that the Congress Party may resort to more populist measures, including looser fiscal policy, ahead of the 2014 national election. Meanwhile, the Union Budget will likely dictate the future direction of the market. Indias economy is very sensitive to oil prices, and the sharp upward movement in oil prices poses another risk. Consequently, we have become somewhat more discouraged about the outlook for India this year and will take a wait and see attitude and a more defensive stance.
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The Asian FLASH

March 2012

Commodities should Underpin Growth in Australia and New Zealand Australias overall economy is reasonably healthy with a strong financial system and an enormous resources sector. However, the country has been suffering from a two-speed economy with the domestic economy experiencing relatively lackluster performance as sentiment was dampened by external global economic events, an unpopular government, massive floods in early 2011 which weighed on the economy for the entire year, and a strong Australian dollar which poses headwinds for a number of sectors. While the domestic oriented economy is likely to remain under pressure, the resources and related sectors should do well if the developed world and China remain relatively healthy or grow more than expected. New Zealands economy has struggled to emerge from the financial crisis and suffered a set back from the earthquake in Christchurch in September 2010, another major quake in February 2011 and continuing aftershocks, but there are signs that the rebuilding from the earthquake should accelerate this year, dairy prices are rising again, the property sector is improving and sentiment may be turning around. Theme and Sector Preferences Absolute Asia AM has a thematic approach to investing. In terms of themes and sectors, we continue to favor domestic consumption oriented stocks on rising wealth throughout the region. Infrastructure is appealing due to plans by China along with South and Southeast Asian governments to increase their budget allocations to major projects and recently completed and upcoming elections may provide a catalyst as will ongoing recovery efforts following natural disasters in Thailand, New Zealand, and Japan. We still like resources and energy stocks, including gold, as well as mining service companies and believe that despite the uncertain global economic environment, Chinese demand and a possible US recovery, good valuations and M&A activity should provide the impetus for these stocks to perform well. We are turning more positive about technology, as signs of a US recovery materialize, and within technology we prefer Taiwanese companies exposed to the Apple supply chain. Risks to Outlook We see seven potential risks to our rather optimistic outlook. First, we expect that the biggest challenge may be another year of market volatility if Europe cannot demonstrate clear steps to resolve its massive financial issues and if the US recovery fails to gain traction. Second, investors may have to worry about ongoing Middle East tension and the possibility of substantially higher oil prices which could threaten growth in a number of emerging Asian countries. Third, we think that investors may be wary of re-entering the China market aggressively until more loosening measures are announced and there is more clarity about the health of its property sector and the overall pace of growth. Fourth, Asian countries whose markets have performed well in the last two years, particularly in Southeast Asia, appear to be fairly valued by historical standards and investors may worry about the extent of additional upside in those markets. Fifth, picking the right sector may be challenging since a number of important sectors in Asia, such as technology and property may continue to face some policy headwinds. Sixth, elections in the region represent opportunities as well as threats if candidates who oppose reforms or other market friendly measures win or if strong governments do not emerge. Finally, this is also an election year in the US and investors may have to worry about the impact if US politicians call for Asian countries to restrict their exports and allow their currencies to appreciate.

Absolutely Dedicated to Investment in Asia

The Asian FLASH

March 2012

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