UBS Emerging market equities

Focus on earnings growth in 2011
• Emerging equity markets have started the earnings season well and economic fundamentals in emerging economies remain strong. We reiterate our positive global view on emerging markets for 2011.
• We emphasize the importance of earnings growth this year, and identify countries with good earnings growth track records and a favorable medium term outlook.
• Inflation-fighting measures in individual countries -- above all, in China -- may induce some brief setbacks but, with the country's structurally high growth outlook and current attractive valuation, we stick to our favorable long-term outlook on Chinese equities.

Review
Although their performance has been somewhat muted so far in the New Year, emerging markets have still gained 4% over the past month, led by Financials, up 6.4%, and Industrials, up 5.2%. Eastern Europe performed well, with the Czech Republic rising by 8.8% and Russia by 6.6%. Asian stock markets have suffered from rising inflation and increasing tightening measures by local central banks. Indian and Indonesian stocks were down by 9.6% and 6.6% in USD terms.

Outlook
We expect inflation fears and central bank policy to drive the market's direction over the near term. As a result, Chinese equities are likely to remain volatile in the short term, as long as further tightening measures can surprise market participants. However, as the domestic market is already down by 15% since November, and was a laggard over the course of 2010, we tend to regard this as a possible entry opportunity for long-term investors. In addition, we have added Taiwan to our list of preferred markets as is likely to benefit from a stronger acceleration in US growth. Indonesian stocks are overvalued, in our view, and offer an unattractive risk reward profile.