Pricing in a recession, but not a financial crisis. Figure 1 highlights that Asia Pacific ex Japan price-to-book has now dropped to 1.52x, close to the 2001 recession level of 1.4x. We believe Asia is already pricing in a recession as ROE in 2001 was around 8–9% versus 14% currently (Figure 15). We estimate that ROE could fall to 12% in the event of a mild recession such as in 2001. Figure 16 highlights that gearing has halved from a high of 47% in 1998 to 23% in 2011E. Our target for the MXASJ (MSCI Asia ex- Japan) for year-end 2012 is 527 (15% potential upside).

Structural ROE stories. The well-known structural growth stories are Astra International, BCA, Belle, Genting, HDFC, Hengan, ITC, Samsung Engineering, Sands China, TCS and Tencent. But all these stocks are trading at substantial premiums to the region. So, instead we suggest stocks with a rising ROE trend such as Keppel, COLI, Cheung Kong and TSMC and stocks gaining market share such as Kia and Hyundai Motors.

Trough valuations stories. We define trough valuation stories as those where the absolute price-to-book is at 2008–09 lows and trade at a discount on our price-to-book versus ROE valuation model. Among the Top 100 stocks by market capitalisation, trough valuation stories include COLI, China Mobile, Bank of China, CCB, ICBC, CNOOC, Cheung Kong, Sun Hung Kai, UOB, BHP, Rio Tinto, POSCO, Hyundai Heavy, LG Electronics and LG Display.

Global equity strategy

There are now signs of modest growth re-acceleration in the US. Yet, leading indicators are consistent with a recession in Europe. We believe that the recovery will be sub-trend, as there is still considerable excess leverage in developed economies(though good balance sheets in the emerging economies, 50% of global GDP, and the corporate sector help). We think there will be renewed monetary easing, as policymakers try to limit the economic impact of the required de-leveraging.

We are benchmark equities: global earnings momentum is poor and there is still considerable negative tail risk in Europe. We are also worried about the planned tightening of fiscal policy in Europe and the US in 2012. However, equities are abnormally cheap relative to bonds and equities are a hedge against inflation risk (with more QE to come).

Our preferred region is the UK, although on a structural basis (i.e., longer term) we are also overweight Non-Japan Asia. We are underweight the US on valuation concerns and Continental Europe on weaker economic and earnings momentum.

Key investment themes: GEM consumer (luxury goods, premium cars, consumer staples), index-linked bond proxies (regulated utilities), defensive cyclicals (software), and quality growth. We are underweight cyclicals.

Source: Asia Equity Strategy: 2012 Outlook, 2 December 2011