Credit Suisse Asia Equity Focus 2011 outlook of Asian equity markets stays positive

Focus on inflation and growth themes in Asia for 2011
Global equity markets kick-started 2011 on a strong note with a broad-based rally extending across major stock markets. On the first trading day of the New Year, the Euro Stoxx 50 rose 1.7%, the S&P 500 surged 1.1% and the MSCI Asia ex-Japan gained 1.4%, driven by growing investor optimism towards a global growth reacceleration, as suggested by latest strengthening of key global leading indicators.

The softening of China's December headline PMI to 53.9 from 55.2 in November and the moderation of the PMI input price index to 66.7 in December from 73.5 in November was welcomed by the markets, as investors expected monetary tightening in China to curb inflationary pressure and engineer a soft-landing in the Chinese economy. In our view, the latest softening of the China PMI reflects the positive effects of the monetary tightening measures launched by Beijing over the past few months. The decline in the December PMI input price index should help to ease overheating fears in the market.

We reiterate our constructive view on Asia's economic growth outlook in 2011 and our strategic overweight position in the Asian equity markets for the next 6–12 months. Our base-case scenario calls for a policy-induced soft landing in Asia in 2011, as the Asian central banks have accelerated their monetary normalization
actions to mitigate inflation and asset bubble risks. We believe the positive macro backdrop, favorable liquidity outlook after the second round of quantitative easing (QE2), positive earnings cycle and attractive valuations are the key drivers that support our constructive view on Asian equities this year. We expect QE2 to put downward pressure on the USD, driving global asset reallocation from low-yielding USD assets into higher-yielding assets like equities, commodities and real estate, including Asian equities. Notably, after 22
consecutive months of net inflows, US municipal bond funds recorded USD 7.7 bn outflows in November alone. US equity fund flows entered positive territory in November and are expected to overtake bond fund flows in December.

We expect Asian equities will benefit from the global asset reallocation from safe-haven USD assets into risky assets in the coming year. Over the past 20 years, Asian equities have delivered a strong performance during four periods of substantial USD weakness in 1994–1997, 1999–2000, 2004–2007 and 2009. The Asian earnings cycle continues to stay positive as we enter the 20th consecutive month of consensus earnings upgrades after earnings hit the trough in April 2009. Our forecast 2011 earnings growth of 16.1% for the MSCI Asia ex-Japan (down from 29% in 2010E) and 17.5% for the MSCI Asia Pacific (down from 52.9% in 2010E) is largely in line with the normal growth rates in previous mid-cycle slowdown phases. Based on IBES earnings estimates, the MSCI Asia ex-Japan and MSCI Asia Pacific are trading on a 12-month forward P/E of 13.1x and 13.9x respectively, representing an 11% and 33% discount to their mid-cycle valuations. Our DDM-based 12-month base-case index targets suggest aggregate weighted average upside potential of 19% for the MSCI Asia ex-Japan and 14% upside potential for the MSCI Asia Pacific in the next 12 months from current levels.

To position in the rising inflation environment and rate-hiking cycle in Asia, we recommend that investors focus on the inflation and growth themes for 2011: 1) the winners of asset price inflation, especially property developers, which are our favorite inflation hedge, as they will benefit from the low interest rate environment, a weaker USD, and QE2-driven liquidity inflows into the Asian real estate market; 2) Asian consumption plays, which will benefit from rising inflation expectations and strengthening Asian currencies as the purchasing power of Asian consumers will be enhanced; 3) commodity stocks, which offer an attractive inflation hedge and will benefit from global growth reacceleration in 2011 and the QE2-driven liquidity inflows into commodities; and 4) Asian high-yielding stocks, which offer an attractive investment vehicle for yield-seeking investors to gain exposure to the Asian markets at a controlled risk. Our Asia Pacific top 25 high-yielding stocks basket offers an average 2011E dividend yield of 5.3%, a 2011E P/E of 13.3x and attractive average upside potential of 20% in the next 12 months.