HSBC's view for 2006 is that all is lined up for another good year...and China could be the surprise re-rating.
The bank's overview is positive: It argues that the key drivers of Asian equity markets point at a continuation of the bull market that began in spring 2003. HSBC also takes the view that interest rates are unlikely to rise much further. And it buys into analysts' forecasts that earnings will grow 11% this year (and another 10% in 2007). It expects 5.3% real GDP growth for Asia ex Japan in 2006, roughly the same as last year.
The bank also argues that despite all the strong fundamentals, valuations in Asia ex Japan are still reasonable: prospective PE is 11.8 times, which HSBC reckons is cheap compared to global markets on 14.5 times and cheap compared to Asia's history (the five-year average PE is 12.5 times). The bank also notes that sovereigns look stronger than last year, with no real-estate bubbles and most countries running current account surpluses.
Of course, there are risks, such as a slowdown in US consumption, but also a squeeze on margins caused by higher commodity prices, an upside surprise for inflation, or political instability.
In general, however, the bank's outlook is rosy.
But predictions must have some unexpected turns, so HSBC is betting on China for the surprise. HSBC argues that the mainland is poised for a re-rating similar to that of India, Korea and Japan last year. It carefully admits upfront that there are worries about Chinese stocks, given cases of poor corporate governance and lack of transparency over what assets large listed state companies actually own.
But the bank ticks off some up-sides: Valuations are cheap (PE is 10.7 times), the economy should continue to grow at around 9% (arguing that there will be a shift from investment-led growth to consumption) and HSBC takes the view that the authorities have made some progress in cleaning up the A-share market and non-tradeable shares. It recommends consumer-oriented stocks, energy companies and utilities, including: Sinopec, Beijing Datang and China Shenhua Energy.
HSBC is also bullish on "cyclical, high-beta countries". And so, it continues to like Taiwan. Valuations, after all, remain cheap. For example, HSBC points out Taiwan offers a dividend yield of 4.4% versus a 10-year bond yield of 1.8%.
It also likes the looks of Korea, forecasting real GDP growth of 5.1%, as exports and consumption fuel the economy. HSBC forecasts the KOSPI will reach 1,600 by year-end. In both countries HSBC recommends buying old-economy cyclicals, and "slightly more tentatively" tech.
Japan is another standout. The bank's view is that while valuations may be stretched, the momentum of economic growth will remain strong. HSBC sees the TOPIX at 1,800 by year-end. The bank continues to like financials, real estate and cyclicals such as machinery in Japan.
So what's the worry?
HSBC has lowered Thailand from overweight to neutral on the grounds that the credibility of Prime Minister Thaksin's government continues to decline and a political crisis cannot be ruled out. The bank does not buy into a strong recovery in the property market in Hong Kong this year, and sees trade disappointing after an artificial boost prior to textiles quotas last year.
It expects Indonesia's growth to slow to only 4% after last year's rate rises and argues that the Philippines remains beset by political uncertainty.
The bank says the tough call is India. While it notes that the fundamental story is highly attractive with economic growth likely to stay well above 7%, the valuations cause concern. With a forward PE of 16.1 times it is almost the highest among emerging markets anywhere and expensive even relative to developed markets. And so, the market is vulnerable to any downward surprises. That said, it would buy banks and infrastructure stocks, but forecasts the Sensex index ending the year roughly unchanged.
And so the predictions are in.
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