Macquarie Regional strategy: Skating on Thinner Ice

MacQ regional strategist Daniel McCormack flags the deterioration in the risk/reward trade-off for Asian equities. Asian markets have enjoyed a very strong run recently, with MSCI Asia ex Japan up 44.7% since the local trough in early March. At 1.7x P/BV, 8.7x P/CF, 16.1x trailing earnings and 15.6x forward earnings, Asia ex Japan is now pricing in fairly rapid recovery in final demand. Indeed, with a long-run forward PER average of 13.1x, markets are effectively saying that analysts’ earnings forecasts are currently 19% too low. Key risks:

1. Restocking has given demand a short-term boost in recent months, with the 2009 earnings growth forecast for Asia ex Japan moving up from -12.7% at the end of March to -4.7% at the end of May. But for this trend to continue, final demand now needs to come through in a meaningful way.

2. The latest news here is disappointing. So far there are no tangible signs of a turnaround, either in the US or Europe . Moreover, the outlook is challenging, with bank credit still very constrained, interest rates and gas prices having moved up appreciably, and US fiscal policy likely to be less of a support to income growth in 2H09. Indeed, there are early signs that the recent positive news flow on earnings may be coming to an end and possibly reversing, with our earnings revisions indicator for Asia ex Japan turning down in recent weeks.

Staying Overweight in Indonesia
Within regional context, Macquarie research re-iterates Overweight stance on Indonesia with an increased country weighting to 1.0 from 0.5 previously. Indonesia offers third-strongest economic growth in the region with a forecast GDP growth of 3.5% in 2009 and 5.5% in 2010, behind only China and India . The market trades on 12.4x forward earnings, or 22% below its long-run average of 15.9x, which is third-cheapest in the region. Key positive catalysts would be the accelerating domestic demand (e.g. strong month in May for motorcycle and automotive unit sales), stable and improving politics (presidential election on 8 July should be peaceful yielding predictable outome), and cheaper and easier financing for the consumers (a strong come back in bank lending appetite). Top five stock picks by Macquarie research are Astra International (10.5x P/E for FY10), BCA (11.3x), Bank Mandiri (10.3x), Indocement (11.1x), and PGAS (9.2x).