Excerpts from Credit Suisse’s excellent Asian Daily report dated June 9
Winter scene in South Korea. Photo by Leong Chan Teik
Asia Equity Strategy: Korea now the most undervalued market
Analysts: Sakthi Siva & Kin Nang Chik
Five reasons to OVERWEIGHT Korea.
* One, it has just become the most undervalued market in the region on our P/B versus ROE valuation model.
* Two, the current Korean discount of 17% is bigger than the average discount of 11% seen over the past five years.
* Three, net foreign selling in Korea was 0.7% of its market cap in May, second only to Thailand’s 1%.
* Four, it continues to have one of the strongest upgrades to 2010E consensus EPS of 6.9% in May.
* Five, we continue to believe that KRW looks cheap.
● The key risks to our OVERWEIGHT call are North Korea and a global double-dip, as Korea is still seen largely as a proxy for global growth.
And while US May employment report disappointed in terms of private sector employment, CS economists highlight that private labour income has grown 4.9% so far in the quarter – which they believe is still consistent with 4% US GDP growth in the current quarter and 3% in 2H10.
Why we stay overweight of equities
Credit Suisse analyst: Andrew Garthwaite
1) Double-dips are very rare – they have occurred just twice in the past 100 years, in 1920 and 1981. Yet, we have seen markets correct by 12% from their peak in the US. We find that 80% of the time the market has corrected by this amount, there has either been a recession or ISM has fallen below 48.
Despite the sharp fall in bond yields, cyclicals have only marginally underperformed. Could this be because the market is being sold off on ‘financial contagion concerns’ as opposed to clear signals that we are going to have a severe slowdown?
2) Global growth is solid – Global PMI new orders may be peaking, but they are consistent with GDP growth of 4.5–5%. Clearly, lead indicators are in the process of peaking, but there is a big difference between a modest rollover (our view) and a double-dip.
We continue to be impressed by some features of the global recovery:
1) Corporate FCF and corporate cash on the balance sheet are both at all-time highs;
2) Our model of US employment growth is still consistent with underlying monthly jobs growth of 200–250k; 3) US housing is recovering;
4) The probability of a soft landing in China has increased;
5) We believe that banks’ holdings of government securities are so low;
6) Finally, deflationary concerns have been overdone;
7) Finally, policy makers are well aware of the risks of deflation and know how to fight against it.
3) Earnings growth is still likely to be respectable: Our models point to 34% EPS growth this year and c.10% next year in the US (in the Euro-area we forecast 26% EPS growth this year). Remember, despite acute scepticism on earnings, earnings revisions remain strong and positive globally and in the US.
The critical issue to us is that the market is not explicitly or implicitly pricing in anything close to our EPS forecasts, let alone IBES consensus earnings numbers.
4) Valuation: Valuation is another way of saying that implicitly the market is not pricing in anything close to ours or IBES numbers. If we put in two-year forward IBES numbers and then return earnings to their long-run trend, we find that the equity risk premium is 6.2%.
If we use long-term trend EPS since 1900, we find that 12-month trailing trend reported earnings are $64.5 and on this basis the equity risk premium is 4.7% (almost exactly where it should be).
5) Credit is now back to fair value levels: We now find that the high-yield spread is discounting a default rate of 28% over the next five years, slightly higher than the long-run average of 25%. For the first time in six months, we believe credit appears reasonably valued.
6) Positioning: If we look at mutual fund or flow of funds data, we find that the equity share in total households’ assets is well below the historical norm. On flow of funds data, the weighting of equities relative to bonds is 15% below normal.
7) Only partial capitulation: We look at four main tactical indicators and one (the % of NYSE stocks trading above the ten-week MA) has shown capitulation (when it fell to just 8% on 20 May). Indeed, it has reached levels at which equities normally rally by around 7% in the subsequent month.
The other indicators are not giving strong near-term buy signals, but are consistent with a rise in equities over the next three to nine months. |
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