In its latest Asian investment weather forecast report, Merrill LynchÆs team of strategists from Hong Kong and Australia outline six of their most significant asset allocation changes in their model portfolio in June compared with April.
First, Thailand has jumped from the fourth-largest to the largest overweight. The allocation to Thailand, which was previously 0.6 percentage points over the benchmark, is now 2.8 percentage points over the benchmark. In April, ThailandÆs earnings revision ratio (ERR) was a weak 0.72 times, and it has since risen to a robust 1.21 times, giving it the highest ERR in the region. Thailand also has the highest consensus earnings per share (EPS) growth forecast of 42% versus the regional average of 15%.
Second, Indonesia has fallen from the largest overweight to the fourth-largest overweight. The allocation to Indonesia, which was 3.5 percentage points over the benchmark, is now 0.7 percentage points over benchmark. In contrast to Thailand, IndonesiaÆs ERR was a strong 1.52 times in April, but has since fallen to 0.59 times.
Third, the Philippines has risen to third-largest overweight at 1.8 percentage points above benchmark, from a modest underweight of 0.4 percentage point below benchmark. Its first quarter GDP growth was 5.2% and Merrill LynchÆs economists forecast full-year growth. Merrill LynchÆs composite valuation measure for the Philippines has also improved, making it the third-most attractive market in the region after Australia and Taiwan.
Fourth, Singapore has switched from third-largest overweight to mild underweight. The marketÆs ERR was 0.88 times in April, and has since fallen to 0.52 times. Economic growth featured positively in SingaporeÆs old score, and is now dragging it down. Earnings growth shows an improvement but is much less than the regional average.
Fifth, Taiwan was previously heavy underweight of 2.3 percentage points below benchmark, and has risen to a milder underweight of 0.6 percentage point below benchmark. Taiwan still has many negatives, but Merrill Lynch says they are not as pronounced as they were before.
Sixth, Korea was a mild underweight of 1 percentage point below benchmark, and has fallen to a heavier underweight of 2 percentage points below benchmark. GDP growth and a poorer currency forecast have dragged the marketÆs score down.
It terms of rankings, Merrill LynchÆs overweights from largest to smallest are Thailand, China, the Philippines, Indonesia, Pakistan, and Hong Kong. The firmÆs underweights from heaviest to lightest are Australia, Korea, India, Taiwan, and Malaysia.
In constructing the model portfolio, Merrill Lynch looks at five variables.
Three of those variables are based on estimates: the forecast change in each countryÆs currency versus the US dollar between now and the end of the year; a comparison between the most recent quarterly GDP reading, the Merrill Lynch economics teamÆs full-year GDP forecast; and the consensus Institutional Brokers' Estimate System (IBES) 12-month forward earnings forecasts.
The two remaining variables calibrate the model with realism: the ERR calculated by the Merrill LynchÆs Quantitative Research team; and a composite valuation measure of dividend yield, trailing P/E, forward P/E, P/cash flow and P/book value.
Merrill LynchÆs model contains no inflation variable because, going back 20 years, inflation and stock market performance in the region are positively correlated. However, as inflation has arguably become the most important and has become the highest profile of any variable within Asia-Pacific this year, Merrill Lynch introduced an oil sensitivity model. After all, oil is the most homogenous commodity across Asia-Pacific economies, and the most visible representation of the inflation threat.
The oil sensitivity model concludes that the markets least-impacted by rising oil prices are Malaysia, Hong Kong and China, while the most-impacted are the Philippines, Thailand and India.
Merrill Lynch notes that its new country allocation however appears to be in flagrant contrast to how a fund manager should be positioned, if the conviction is oil prices will keep rising. However, the firm notes that the impact of oil prices on a market is different from the overall call on that market.
Thailand, for example, is the only country in the region to show a positive correlation between the crude oil price and equities, Merrill Lynch says. With the crude oil price now up more than 30% in the second quarter of 2008, the firm says there have significantly been more earning upgrades than downgrades for Thailand.
Benchmark weighting versus the Merrill Lynch model weighting:
Hong Kong û 9.3% vs 7.9%
China û16.4% vs 18.2%
Malaysia û 2.6% vs 2.4%
Singapore û 5.1% vs 4.5%
Philippines û 0.4% vs 2.1%
India û 6.9% vs 6.2%
Australia û 28.6% vs 25.6%
Indonesia û 1.8% vs 2.5%
Thailand û 1.5% vs 4.3%
Taiwan û 12.4% vs 11.8%
Korea û 14.9% vs 14.3%
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