BT: Room for optimism in equities (14 Feb 2007)

Room for optimism in equities

The opportunities that lie in Asia and emerging markets outweigh the risks, Deutsche Bank believes. GENEVIEVE CUA reports

CENTRAL banks may fret about complacency in equity markets given the strong returns of the last few years, but Deutsche Bank Private Wealth Management's chief Asian strategist Marshall Gittler says there is good reason for optimism, particularly over Asia and the emerging markets.

'We can look with confidence. Valuations look reasonable; they're quite cheap relative to earnings growth. In most countries, the likelihood is that growth will surprise on the upside. I believe the opportunities will outweigh the risks.'

He reckons the global economy is entering an era akin to post-World War II, as the integration of emerging markets into the world economy spurs a rise in productivity. Emerging Asia and the Eastern European bloc together are expected to result in a doubling of the workforce.

Add in their high savings rates, low real interest rates and sluggish wage growth, and the scenario could be one of a 'disinflationary economic boom', says Mr Gittler.

Mr Gittler is telling clients to overweight equities, in particular Asia and emerging markets. He also tells clients to invest in global themes and not to get caught up in sheer geographical allocations. 'Themes cut across the whole world. There are some great themes globally.' These include global warming, which covers companies involved in developing alternative energy, for instance; water and agri businesses. Infrastructure is another theme with legs.

There are distinctions that he sees between investing in Asia against Latin America and the EMEA bloc (Eastern Europe, Middle East and Africa), and these have a bearing on the risks. Asia, he says, is a secular growth story. Latin America and EMEA are seen as 'cyclical growth stories with a secular element'.

Since 2004, Latin America and EMEA have outperformed Asia, thanks to rising commodity prices, and credit spreads have gone way down. This, however, implies that Latin America and EMEA are vulnerable to weakness in the commodity markets. Commodity stocks make up some 17 per cent of Asia's capitalisation compared to nearly half for the two other regions.

Price earnings and price-to-book multiples in Asia are similar to the rest of emerging markets, but earnings per share growth is 'significantly better and we expect the secular story to carry on'. The return on investment in emerging Asia is also far above the cost of borrowing, unlike in Latin America.

Asia is trading at a PE multiple of 13 times on expected 2007 earnings, on the back of EPS growth of 15 per cent. On expected 2008 earnings, PE drops to 12 times with EPS growth remaining at 15 per cent. Latin America's PE on 2007 earnings is about 12 times, on EPS growth of 21 per cent. On 2008 earnings, PE drops slightly to 11 times, but EPS growth is relatively weaker than Asia at 6 per cent. Mr Gittler is positive about China and India, but adds that India is currently overvalued.

Investors, however, should brace themselves for volatility. BCA Research said in a Feb 7 note that global share prices are technically overbought and it cannot rule out a short term correction. 'Current market conditions are indicative of some froth in select equity markets, but not the kind of euphoria that typically marks a major peak in share prices. Therefore any pullback will likely prove to be another bull market correction.'

In any case, a pullback is not expected to be as severe as that of last May/June. This is partly because softness in the global industry sector is already known and should not be a major drag on emerging markets' performance. Foreign holdings, while elevated, are also not at frothy levels as they were last year. Based on BCA's analysis, markets like China H shares, India, Mexico and Argentina are in overbought territory; and Taiwan, Korea and Thailand are undervalued.

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