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Bull market in Asia in mature stage

Value investing advisable

THE bull market in Asia ex-Japan equities is in the mature stage, says Markus Rosgen of Citi Investment Research, and he advises investors to switch from momentum investing towards value.

In the value space, Mr Rosgen, Citi’s chief Asian strategist, favours large cap stocks which he says have only just begun to outperform. The sectors with more value support are semiconductor, banks and utilities. Those with the least value are software, healthcare, industrials and the consumer space.

Up till now, the playground for momentum plays has been the mid-cap space, he says in a Nov 19 report. ‘The alpha trade has been to go long mid/small caps and short the index against it as a hedge, effectively shorting large caps. This has stopped working and given them higher ROE, higher margins and the fact that large caps are free cash flow-to-sales positive … will serve them well in this time of increased economic uncertainty’.

In his report, Mr Rosgen debunks the notion that in the Asia ex-Japan equities space, it’s different this time. Asia, he says, is now trading at valuation premiums to the MSCI World index. The last time this occurred was in 1988.

In terms of price-to-book value, Asia last traded at a premium from 1993 to 1995 when Asian ROEs were superior to the developed markets. This time, valuations in Asia are superior but ROEs are inferior.

The decoupling theme, he says, has become a global consensus ‘among a large enough pool of investors to frighten me’. ‘The more recent the investor is to Asia, the stronger the view is held. The longer an investor has been involved with Asia, the higher the degree of scepticism.’

Trade linkages, he says, are stronger after 2000 than at any time over the last 20 years. ‘This makes decoupling hard… Far from rising, consumption share in GDP has fallen as export and investment shares have risen. Nor, regrettably, has the Asian consumer ever behaved counter cyclically. Finally, stock markets themselves are the most correlated they have been over the last 30 years.’

Reviewing the changes in the sectoral composition of Asia ex-Japan markets, he finds that while the weights have changed significantly, the difference in PEs between 1975 and today is just 0.9 multiple points. Over the period, the difference averages just 0.3 PE points.

While investors may believe that valuations have changed dramatically over time, the statistical tests on Asian multiples show that valuations are mean reverting. In addition, buying high PE stocks since 2000 has not led to outperformance. On a 12-month basis, buying stocks with PEs of over 30 times results in negative returns.

‘The bottom line is that we do not deny that things change over time as far as market composition and perception of actual or implied risk; they clearly do. What one finds is that investors have a tendency to over-emphasise or extrapolate changes and thus overpay for the perceived change.’ He adds: ‘… excessive growth expectations are now in the price of Asian equities with 44 per cent implied earnings growth for the region and in excess of 60 per cent for China and India’.

China’s market cap to GDP ratio stands at 123 per cent today. The ratio for Japan in 1990 was 150 per cent, and that of the US in 2000 was 131 per cent. But GDP per capita in Japan in 1990 was 10 times larger than China currently; and in 2000, the US’ ratio was 14 times larger. ‘If China continues to grow nominal GDP at 12 per cent per annum, it would take 20 years to reach the Japanese GDP per capita set in 1990 when valuations were comparable. It would take 23 years to reach the same level of GDP per capita as the US in 2000 when market cap to GDP was similar.’

 

Source: Business Times 28 Nov 07

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