Economics Markets Strategy - the DBS Vickers Securities Equities ...

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Asian Equity Strategy Economics – Markets – Strategy Asian Equity: Between the devil and the deep blue sea • Our base case scenario of a very weak first quarter but no recession is slowly being panned out, but markets have overstated recession fear and risk appetite remains very low. With US recession risks fading we recommend a portfolio shift towards more beta • We expect some volatility in the short term as the shift from US growth fears to inflation fears is expected to drive up US bond yields and strengthen the USD. Soaring oil prices adds to these fears. While US growth fears have somewhat subsided, fear of higher inflation in Asia dampening growth and driving up interest rates are turning the table around to a US recovery and Asia slowdown story. However a mild slowdown in Asia need to be seen in the context of a high base in recent years and still above potential growth levels for most countries • In view of new Asia headwinds of higher oil prices, inflation and interest rates , we now prefer the developed markets of Singapore, Taiwan, Hong Kong and Korea, where fiscal positions are stronger and downside risks to economic growth forecasts are comparatively lower. Emerging markets in ASEAN as well as India run the risks of policy missteps, weak fiscal position and political uncertainty undermining investors' confidence • We are overweight in Singapore, Taiwan and China-H; benchmark weight in Hong Kong and Korea; and underweight in Malaysia, Thailand, Indonesia, and India Fig. 1: Regional GDP growth 12 10 8 % China India ASIAN EQUITY Note: The weightings which we refer to in our Equity Strategy outlook are not necessarily consistent with the equity “weightings” being used in our Asian Tactical Asset Allocation. The latter refer to specifically constructed benchmarks for asset allocation purposes. 6 4 2 0 Asia (8) US Japan EZ 2003 2004 2005 2006 2007 2008f 2009f Source: DBS. Asia (8) includes countries of Hong Kong, Singapore, Malaysia, Thailand, Indonesia, Philippines, Korea and Taiwan. Simple average is taken. Joanne Goh • (65) 6878 5233 • joannegohsc@dbs.com 56

Economics – Markets – Strategy Asian Equity Strategy Mildly positive We are raising the outlook for Asian equities from a cautious stance in the second quarter to mildly positive as it becomes more apparent that the US will avoid recession. Risk appetite remains very low as depicted in shrinking trading volume and foreigners' net sell position since early 2006. 1Q08 US GDP data is an important sign that recession fears were overstated; our analysis also finds that inflation fears might be overstated this time. Rising oil price remains the biggest risk right now, but has varying impact on the economies of Asia. New fed fund forecast; US non-consensus GDP growth reiterated DBS economics maintains its projection of 2% US GDP growth for 2008 that is implied from first quarter growth of 0.9%, 1.5 in Q2, 2.5% in Q3 and 2.75% in Q4. Our economist has removed the last rate cut forecast for the year and added two rate hikes in 4Q08, and more rate hikes to 4.5% in 2009 as US interest rate normalisation takes its course after drastic rate cuts by the Fed in the past nine months. Between the devil and the deep blue sea The implications for Asia equities are that US growth slowdown will be less than mostly feared but interest rates are set to rise. We recommend a portfolio shift towards more beta to growth with a focus on managing interest rate risk in Asian countries. Volatility in the short term In the short term, volatility in the US bond markets and USD could spill over to the equities market, as the shift in mindset from growth fears to inflation fears are driving up US bond yields and strengthening the USD. Soaring oil prices have added to these fears. Our view is that inflation fears could be overstated, just as were recession fears at the beginning of the year. The Fed rate hikes we have pencilled in are premised on the rates being normalized after the pre-emptive cuts in the past 9 months. Hopeful of a second half recovery We are hopeful of a second half Asian Equities market recovery premised on:- 1. US economic growth of c. 2% in the second half; rapid rate cuts and stimulus package to provide stability and save the US from drifting into recession; 2. Asian domestic demand should hold up in the face of external weakness, underpinning economic and earnings growth in the region; 3. Valuation becoming attractive again after three years of multiple expansion; and 4. Asia's comparatively stronger growth should continue to attract funds flow into the region. Macro environment deviates The macro environment in Asia envisaged in our base case scenario in our 2Q strategy, however, has deviated on three fronts. We now make our allocation changes in response to lower external risks and rising concerns on the domestic macro front. Inflation overshoot Firstly, inflation has overshot on the upside. However, core inflation remains low, whilst higher energy and food prices are driving headline inflation. Asian equities will find relief later as headline inflation starts heading south. While the timing of when inflation will start coming off is difficult to predict, consensus expectations of around July (generally expected due to the year-on year effect) may be slightly too optimistic, probably by a quarter. We do not think inflation risks will be extended beyond next year nor will higher inflation pose a significant threat to Asia's growth, barring the unpredictable movement of oil prices. DBS Economics has raised inflation forecasts for 2008 for most Asian economies, but growth forecasts remain largely intact. Fig. 2: Higher food & energy prices are driving up inflation % 200 150 100 50 0 -50 -100 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Food Commodities Source: Datastream, IFS Crude Oil 57

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