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Asian Equity Strategy Economics – Markets – Strategy Potential downside risk to growth forecasts? Simply, if forecast 2008 CPI is subtracted from long term nominal GDP growth to determine the implied real GDP growth, 2008 growth forecasts look high compared to the implied growth forecasts. Fig. 3: Implied real GDP growth, derived from paring off 2008 inflation from long term potential nominal growth LT potential growth 2008 forecast (1) (2) (3) (4) (3) - (4) (%) China 8.2 3.8 12.3 6.5 5.8 10.0 -4.2 Singapore 5.1 2.2 7.4 6.0 1.4 5.1 -3.7 Indonesia 5.7 5.2 11.3 10.3 1.0 5.9 -4.9 Hong Kong 4.1 3.0 7.3 5.0 2.3 4.7 -2.4 Thailand 4.7 3.2 8.1 6.4 1.7 4.7 -3.0 Korea 4.2 2.8 7.1 3.7 3.4 4.5 -1.1 Taiwan 4.2 2.0 6.2 3.4 2.8 4.1 -1.3 Malaysia 5.3 2.3 7.7 4.5 3.2 5.5 -2.3 India 8.1 4.8 13.2 6.8 6.4 7.7 -1.3 Source: Consensus Economics Inc. for LT growth forecasts, DBS Fig. 4: Downside risks spreaded out in all Asia markets. Countries with stronger fiscal position should have the ability to pump prime and policy flexibility to manage risks if needed % % 12 10 8 6 4 2 0 Indonesia Real GDP Singapore CPI China Nom. GDP Thailand Hong Kong DBS CPI forecast Malaysia * Implied GDP growth Taiwan Consens us GDP growth forecast India Korea Downside risks to growth Implied* Consensus GDP forecast Difference Source: Consensus Economics Inc., DBS. * Implied from long term nominal potential growth minus 2008 inflation forecasts 0 -1 -2 -3 -4 -5 -6 Fig. 5: Table of inflation 2005 2006 2007 2008f 2009f US 3.3 3.2 2.9 3.5 2.3 Japan -0.3 0.2 0.1 0.8 0.2 Eurozone 2.2 2.2 2.1 3.0 2.1 Indonesia 10.5 13.3 6.3 10.3 7.2 Malaysia 3.1 3.6 2.0 4.5 2.0 Philippines 7.7 6.3 2.8 9.0 4.8 Singapore 0.5 1.0 2.1 6.4 2.8 Thailand 4.5 4.6 2.2 6.4 2.8 China 1.8 1.5 4.8 6.5 4.5 Hong Kong 1.0 2.0 2.0 5.0 4.0 Taiwan 2.3 0.6 1.8 3.4 2.4 Korea 2.8 2.2 2.5 4.6 3.0 India* 4.4 5.4 4.3 6.8 4.9 Source: DBS. Up / down arrows denote revisions made since last quarter Fig. 6 : Table of real GDP growth GDP growth, % YoY 2005 2006 2007 2008f 2009f US 3.2 3.3 2.2 2.0 2.6 Japan 1.9 2.4 2.0 1.5 2.1 Eurozone 1.6 2.9 2.6 2.0 2.0 Indonesia 5.7 5.5 6.3 6.0 6.3 Malaysia 5.0 5.9 6.3 5.1 6.0 Philippines 4.9 5.4 7.3 5.4 6.0 Singapore 7.3 8.2 7.7 6.0 6.8 Thailand 4.5 5.1 4.8 5.0 4.7 China 10.4 11.1 11.9 10.0 9.0 Hong Kong 7.1 7.0 6.4 5.2 4.7 Taiwan 4.2 4.9 5.7 5.0 5.4 Korea 4.2 5.1 5.0 4.6 5.0 India* 9.0 9.6 9.0 8.6 8.6 Source: DBS. Up / down arrows denote revisions made since last quarter Countries with pro-growth policies and strong reserves and budget balance can afford to pump-prime the economy to sustain growth, others might not be able to do that. As such we now prefer the developed markets of Hong Kong, Singapore, Taiwan, and Korea, where fiscal positions are stronger and downside risks to economic growth forecasts are more benign. Emerging markets in ASEAN are least favored. 58
Economics – Markets – Strategy Asian Equity Strategy Fig. 7: Table of policy rate forecasts current 3Q08 4Q08 1Q09 2Q09 US 2.00 2.00 2.50 3.25 4.00 Japan 0.50 0.50 0.50 0.75 0.75 Eurozone 4.00 4.25 4.25 4.25 4.25 Indonesia 8.50 9.25 9.25 9.25 9.25 Malaysia 3.50 4.00 4.00 4.00 4.00 Philippines 5.25 5.75 6.00 6.00 6.00 Singapore* 1.44 1.31 1.52 1.94 2.31 Thailand 3.25 3.25 3.75 3.75 3.75 China 7.47 7.47 7.74 8.01 8.28 Hong Kong* 2.15 1.95 2.35 3.05 3.70 Taiwan 3.50 3.75 3.88 3.88 3.88 Korea 5.00 5.00 4.75 4.50 4.50 India 8.00 8.25 8.25 8.25 8.25 Source: DBS. Up / down arrows denote revisions made since last quarter. First published for 2Q09 figures. * 3- month interbank rate used. Current as of June 11. Fig. 8: Table of exchange rate forecasts current 3Q08 4Q08 1Q09 2Q09 Japan 107 106 107 108 109 Eurozone 1.55 1.52 1.49 1.46 1.43 Indonesia 9,319 9,500 9,600 9,700 9,800 Malaysia 3.27 3.30 3.35 3.40 3.45 Philippines 44.4 45.0 47.0 45.0 45.0 Singapore 1.37 1.38 1.40 1.42 1.44 Thailand 33.1 33.5 34.0 34.5 34.9 China 6.92 6.80 6.75 6.70 6.65 Hong Kong 7.81 7.81 7.83 7.84 7.85 Taiwan 30.4 30.5 31.0 31.5 32.0 Korea 1,025 1,075 1,100 1,075 1,075 India 43.1 43.0 43.5 42.5 42.5 Source: DBS. Up / down arrows denote revisions made since last quarter. First published for 2Q09 figures. Current as of June 10. Grappling with Oil Having said that, rising inflation particularly from higher energy prices, will have a varying impact on the economies in Asia. Countries that are still subsidizing fuel prices including Indonesia, Malaysia and India have cut subsidies by 28.7%, 40% and 10%, respectively (average, depending on fuel category). This does not bode well for the inflation trend to soften soon in these countries. Interest rates are likely to rise, whilst fear of social instability and the potential for further subsidy cuts will dampen sentiment. This comes at a time when the political scenes in these countries are becoming less stable. Indonesia and India will hold their general elections next year, while Malaysia's ruling party just lost its 2/3 majority win in the last elections and political upheaval is budding. Most importantly, these three countries run large budget deficits that if left unchecked coupled with ballooning subsidies because of higher oil prices, could lead to rating downgrades. We now have underweight recommendations for these three countries. Dollar rebound Secondly, with the pause in the US monetary easing cycle, the USD might not weaken as much as in the first half this year. And some Asian currencies may find difficulty strengthening. Hence, there are threats of higher Asian interest rates if currencies cannot help tame inflation. We have pencilled in more rate hikes or brought forward the rate hikes for some. The only country for which we still have a rate cut forecast is Korea. Our modelling suggests that a weaker currency and lower interest rates are positive drivers for Korea's 12-month forward return. Hence, in line with a positive outlook to the growth scenario, we are raising Korea to Neutral from Underweight. (See section on Korea) Rising bond yields Thirdly, bond yields are expected to rise from here as the bond market starts to price in rate hikes. We expect the US 10-year bond yield to rise to 5% from 3.8% currently. The implications for equities are that equities will be deemed expensive in a rising interest rate environment, but our stress test suggests that the bond / earnings yield relationship is still within the one standard deviation band. Fig. 9: US / Asia ex-Japan earnings yield ratio - proforma at US 10-year bond yield = 5% 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 (x) 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Source: DBS, Datastream, Bloomberg Equities expensive Equities cheap 59
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