There are plenty of concerns and headwinds for Asian markets, but the Swiss bank argues that forces at work mean that it prefers equities (with some caveats) in China, Indonesia and Thailand. It is less keen on South Korea and Malaysia, while it sees opportunities for Japanese equities to recover.
UBS continues to smile on Chinese, Indonesian, and Thai equities at a time when it nevertheless argues that downside risks to Asian markets have risen in the near term, such as in China’s real estate market.
Setting out its positioning in Asia, the Swiss bank noted that the region’s equity and high yield bond benchmarks have fallen by almost 19 per cent and 22 per cent, respectively, this year.
Among the red lights flashing on investment dashboards is a “mortgage boycott,” as homeowners hold back payments rather than start making payments on real estate before projects are finished. Delays to projects have rattled confidence that they will be completed. Homeowner protests have reportedly affected developments in 24 of China’s 31 provinces.
A stronger US dollar and recession risks in the US and Europe are also headwinds for Asia.
However, balance of payment positions, and real effective exchange rates are in a “decent shape” for economies such as Indonesia and Thailand, UBS notes. And it argues that China should recover in the second half of 2023, enabling the region to grow above 4 per cent for 2022. China can use fiscal policy to boost growth, while Indonesia has strong earnings' momentum and Thailand has experienced an international travel recovery, so it should benefit from domestic reopening.
The bank, however, is less optimistic about South Korea and Malaysia, marking the countries as its least preferred equity markets.
South Korea is a “barometer of global growth and international trade,” which is likely to come under pressure, though its valuation has cheapened considerably, UBS said. However, It said that Malaysia, which has among the weakest earnings momentum in the region, is facing political uncertainty.
Within the fixed income field, the bank said it prefers Asian investment grade names offering 4 per cent yields for not more than five years. Within the IG category of bonds, it prefers A/AA-rated issues with less than a five-year duration offer value. It is "very selective" in choosing high-yield debt and prefers select commodity players and non-China names.
“For China, the tail risk has clearly increased following the mortgage boycott. We think the current situation should still be manageable, as local and central governments are serious about ensuring the resumption of project construction. Social instability is the last thing policymakers want before the 20th Party Congress later this year,” UBS said.
“Any continued rise in systemic risks will be very painful for other Asian economies as well, as China is a key trading partner and regional FX anchor. Our call is for China to outperform the rest of Asia, which can work in a relief rally or market correction,” it continued.
After falls in Asia ex-Japan equity prices this year, these equities have fallen to an “attractive” price-to-book level of 1.27 times, but the earnings outlook is uncertain due to slowing global economic growth. UBS said it has cut its 2022 earnings growth estimate for Asia to 4.6 per cent.
“We favour quality companies with a solid free-cash-flow dividend coverage ratio and a robust capital ratio for banks. The outlook for a further rise in yields is also a key consideration; we recommend investors to limit exposure to Asian emerging markets (particularly India and the Philippines) given the risk of further rate increases due to the inflationary backdrop and given their balance-of-payment issues,” UBS said.
The bank noted that the Yen is “still on the backfoot” versus the dollar, trading in “an elevated 135 to 140 range versus the US dollar.” A weaker Yen should, however, benefit Japanese exporters.
UBS noted that blue-chip Japanese companies have been buying back shares actively during 2021. As the pandemic had restricted Japanese companies from buying back shares while their earnings recovered. They now have excess cash at hand and are ready to buy back shares.
Japanese equity valuations have fallen; for example; the Nikkei 225’s P/E ratio is still near a 10-year low, and UBS thinks the downside from there is limited.
“Given the low valuations, solid earnings, and high dividend yields, we expect share prices to rebound for select sectors,” it said.