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2H 2017 Investment Outlook: More Earnings Upgrade Ahead July 17, 2017
In this article, we provide a quick review on our calls made back in 4Q2016, and share some of our insights to investors on what we see in the second half of 2017.
Author : iFAST Research Team


2H 2017 Investment Outlook: More Earnings Upgrades Ahead

It has been a fruitful first half in 2017 as both equity and bond markets on aggregate posting positive returns year-to-date. Global equity markets, as represented by the MSCI AC World Index, posted a 10.3% return, while in the global fixed income markets, the JPMorgan Global Aggregate Bond Index delivered returns of 4.2% over the period. Breaking down the equity markets regionally, we saw that the developed markets, while posting positive gains year-to-date, have generally lagged behind emerging markets. The US equity market, represented by the S&P 500 Index, emerged the better performer in the developed markets space, registered an 8.3% increase in the first half. Over in emerging markets, Asian countries including Korea, India, Hong Kong and China led the pack. Among the markets under our coverage, China H (as represented by MSCI China) and Asia (as represented by MSCI Asia ex Japan) were among the strongest performers, delivering 24.5% and 21.6% returns during the period.

In the fourth quarter of last year, we labelled 2017 as a “Year of Inflexion” as we expected global especially emerging economies had bottomed out and markets’ earnings growth will get back to the positive territory. We also predicted EM and Asia will see upward rerating of valuation under the earnings upward cycle. At the mid-point of the year, it would be great to have a quick review on our calls made in 4Q 2016 which are mostly trending in the correct direction so far.

Quick Review: Our Calls Made in 4Q 2016

MSCI EM (+17.1%); MSCI Asia ex Japan (+21.6%)

  • We were at the inflexion point for earnings upgrades and re-rating of valuation;

  • Since peaking in 2011, the emerging markets earnings suffered from a five-year downgrade until June 2016, where we started to see upward revisions in earnings forecast;

  • Emerging markets have underperformed developed markets by around 40% from its post-2008 global financial crisis peak in May 2011. This situation was reversing as we saw more earnings upward revisions in emerging markets than developed markets since June 2016;

  • We were bullish on the considerable upward re-rating potential which would lead to superior performance in emerging markets including Asia over the next two years.

MSCI China (+24.5%); Hang Seng Index (+16.1%)

  • The economic recovery was in sight;

  • After contracting for 55 consecutive months, China’s PPI deflation was expected to come to an end in 2016. It was positive to corporate earnings, especially for those upstream sectors;

  • Industrial destocking cycle this time around lasted for 22 months and was likely to take a turn for better moving forward. With the economy starting to pick up steam and inflation expectation was back on the radar, we expected a restocking cycle to begin;

  • The earnings upward revision cycle might have just begun and it was reasonable to see more earnings upgrades in Chinese stocks moving forward;

  • We believe Hong Kong and China’s market will be seeing a valuation rerating in the coming 1-2 years.

[Returns in local currency terms, excluding dividends. Return period: 30 December 2016 - 30 June 2017]

Limited Room for Further Valuation Rerating for Some Markets in 2H 2017

Table 1: YTD Performance vs Valuation/Earnings Revision

Markets Year-to-date Performance Valuation Multiple Expansion (Change in 2017 Estimated PE) Earnings Revision (Change in 2017 Estimated EPS)
Global 9.01% 4.80% 4.02%
US 7.33% 7.42% -0.08%
Europe 3.74% 4.25% -0.49%
Japan 4.81% 1.56% 3.20%
Emerging Markets 16.39% 6.71% 9.07%
Brazil 1.76% -7.59% 10.12%
Russia -15.84% -9.59% -6.91%
Asia ex-Japan 20.89% 8.94% 10.97%
China H (HSML 100) 15.44% 13.11% 2.05%
China H (MSCI China) 23.93% 17.05% 5.87%
China A 9.71% 13.17% -3.06%
Hong Kong 16.32% 10.41% 5.35%
Korea 17.02% 2.25% 14.44%
Taiwan 12.10% 10.32% 1.62%
India 16.06% 25.70% -7.67%
Malaysia 7.83% 5.81% 1.92%
Indonesia 10.50% 16.34% -5.03%
Singapore 11.30% 10.77% 0.48%
Thailand 2.06% 2.48% -0.41%
Source: Bloomberg, iFAST compilations. Returns in local currency terms, excluding dividends. Return period: 3 January 2017 - 30 June 2017.
  • Market performance can be decomposed into the contributions from the valuation multiple expansion and earnings growth;

  • As shown in Table 1, most of the major markets’ year-to-date performances have been driven by an expansion in the valuation multiple, with India, Hong Kong, China and Indonesia among those receiving the largest rerating while Russia, Brazil and Latin America suffering from multiple contractions;

  • Some markets have risen on the back of strong earnings upgrades. Table 1 highlights Asia, Emerging Markets, Brazil, Korea and Singapore to be associated with the biggest upgrades to 2017 estimated consensus EPS year-to-date. However, earnings downgrades were seen in seven of the markets above including U.S and Europe while the revision for the rest was not significant; earnings upgrades across the board were not as large as what we saw in valuation expansion; 

  • Given the magnitude of the rally year-to-date which was mainly driven by the upward rerating in valuation multiples, we think select markets will find it difficult for their already stretched valuation multiples to materially expand further;

  • Two major regional markets that we believe will face such a particular scenario are the US and Europe equity markets, which apart from seeing rather stretched valuations, are also facing monetary policy normalisation and an end of further easing measures respectively, both of which are expected to eventually result in lesser liquidity down the road.

Earnings Growth to be the Key Determinant for the Market Performance in 2H 2017

Table 2: Forecast EPS Growth and Forecast P/E

Market Forecasted EPS Growth (%) Forecasted P/E(X)
2017EG 2018EG 2019EG 2017PE 2018PE 2019PE
MSCI World 16.45 10.17 9.69 16.6 15.0 13.7
US 10.10 12.02 10.33 18.6 16.6 15.1
Europe 11.32 9.26 9.16 15.7 14.4 13.2
Japan 9.01 9.34 8.86 17.4 15.9 14.6
MSCI Emerging Market 26.59 9.24 9.85 12.5 11.4 10.4
Brazil 35.28 10.82 20.97 11.7 10.6 8.8
Russia 4.86 12.21 7.36 6.4 5.7 5.3
MSCI Asia ex-Japan 23.35 11.03 8.58 13.5 12.2 11.2
China (HSML100) 12.81 10.79 10.49 10.1 9.1 8.2
China A (CSI 300) 9.26 12.25 11.95 14.0 12.4 11.1
Hong Kong 14.22 8.59 9.38 12.2 11.3 10.3
Taiwan 14.22 7.28 7.79 14.7 13.7 12.7
Korea 30.56 8.09 4.93 10.2 9.5 9.0
India 14.09 22.88 6.78 19.1 15.5 14.6
Singapore 5.38 7.70 6.54 14.6 13.6 12.7
Indonesia 15.23 15.17 7.96 16.8 14.6 13.4
Malaysia 8.29 5.99 7.39 16.2 15.3 14.2
Thailand 5.85 10.93 9.76 15.4 13.9 12.7
Source: Bloomberg, iFAST compilations. Data as of 30 June 2017.
  • As room for further rerating in valuation multiples are increasingly limited, earnings are expected to be the key determinant of the market performance in the second half. As at end June 2017, almost all of the markets that we cover are expected to record robust earnings growth in the coming two years;

  • Sorted by EPS growth in 2017, Brazil tops 2017E EPS growth at 35.3%, followed by Korea (30.6%) and Emerging Markets (26.6%) and Asia (23.4%). 12 out of 18 markets above are expected to record a double-digit earnings growth in this year;

  • With the exception of U.S, Europe and select ASEAN markets, we are not yet at materially elevated valuation levels. Robust earnings growth in coming years will help to push markets’ valuation back to an even cheaper level whilst driving market indices higher.

More Earnings Upgrades to Come after 1H Earnings Announcement

FIGURE 1: Global GDP growth and corporate profits.
  • In 1H 2017, Emerging Markets and Asia have received the largest earnings upgrades. As at end June 2017, Asia ex Japan (represented by MSCI Asia ex Japan) saw a 7th consecutive month of earnings upgrades. It was the third time since 2001 that we saw a string of upgrades (the other two were in 2004 and 2009), thanks largely to Korea which saw its current estimated earnings upgraded by more than 14%! China H and Hong Kong also saw upward revision of 5.8% and 5.4% respectively while the rest of the Asian markets only received modest revision;

  • We believe there is still room for further upgrades in the current cycle. Historically, world nominal GDP growth has a high correlation with the earnings growth of global equities (represented by MSCI AC World Index). As global economies are recovering and the world’s nominal GDP growth is accelerating, we believe 1H earnings generally surprised to the upside. More earnings upgrades can be expected especially after strong earnings data comes out following the interim earnings season;

  • The same pattern can also be observed in China A and H non-financial stocks as indicated by their high correlation between revenue growth and nominal GDP growth as well as the correlation between profit margin and PPI. The estimated earnings for 2017 of H-shares (represented by Hang Seng Mainland 100 Index) have been revised up by 2.1% while A-shares (CSI 300 Index) has been downgraded by -3.1%. In view of a firmer economic backdrop for China, we expect some upgrades to come especially after the 1H earnings beats.

North Asia Will See Another Wave of Earnings Upgrade In 2H 2017

FIGURE 2: Global Semiconductor Sales (3-Month Average).
FIGURE 3: Korea’s Earnings Trend.
FIGURE 4: Taiwan’s Earnings Trend.
  • On a year-to-date basis, Taiwan, South Korea and Japan all have received upgrades to their estimated earnings, with South Korea equities leading the pack with a 14% upward revision;

  • Global Semiconductor Sales is a pro-cyclical sector and tends to overshoot on both the upside and downside. Chip sales has started to recover since 3Q2016 and the recovery is expected to gain more momentum as manufacturers tend to attempt to time the cycle by ramping up production when future demand is expected to be strong. The World Semiconductor Trade Statistic estimates the growth of semiconductor by end 2017 is at 11.5%. We think further upside can be achieved and these figures are expected to point to further positive earnings results of relevant markets for 2Q and 3Q 2017;

  • Most of Taiwan and South Korea’s earnings upgrade comes from the upward revision in the outlook for the semiconductor business, with related companies’1Q earnings mostly beating market estimates.

Table 3: TSMC Estimated Earnings.

  2014 2015 2016 2017 2018 2019
Q1 Mar 21% 65% -18% 35% 2% 24%
Q2 Jun 15% 33% -8% -5% 23% 29%
Q3 Sep 47% -1% 28% -2% 15% 23%
Q4 Dec 78% -9% 38% -1% 8% 22%
Year 40% 16% 9% 5% 10% 12%
Calendar Year 40% 16% 9% 5% 10% 12%
Source: Bloomberg, iFAST compilations. Data as of 30 June 2017..
  • On Taiwan’s side, 2Q has been a hard time for TSMC because of inventory adjustment from Chinese customers, which analysts believed would end in 3Q, while the company is confident in bringing back positive growth in earnings from 3Q. Market seems to be bit too conservative on their 2H earnings estimation, leading to relatively low earnings forecast for the company and even the whole Taiwan market (Table 3);

  • As major Chinese mobile phone manufactures released their popular model in June and iPhone cycle start to feed into related companies’ earnings in 3Q, it is possible for us to see earnings upgrade for Taiwan and South Korea equities in the second half, while expectations are low for Japanese equities to receive another wave of earnings upgrade within the period.

What Should Investors Do?

  • We believe that it still remains appropriate for us to remain overweight equities vis-à-vis bonds at this juncture, after considering where we are in the various economic cycles, current market valuations as well as monetary policy at this juncture and what lies ahead of them in the future;

  • However, we would advise investors to reduce the magnitude with which they over weight equities vis-à-vis bonds in their asset allocation. From a previous 10% overweight in equities vis-à-vis bonds at the start of the year, we think investors could look to reduce this to a 5% overweight position to recognise that equity valuations have broadly risen across the board thus far in 2017;

  • We continue to prefer the faster growing and yet, more attractively valued regions of Asia ex Japan and emerging markets. Both regions continue to trade at a discount to our estimated fair PE ratios, indicating that they continue to remain undervalued despite having turned in a sterling performance in 1H 2017;

  • Although we do not think the bull market is over at this juncture, investors are advised to be more selective where they allocate their capital to as well as the product which they utilise. Active management will be increasingly important as valuations head higher and the need to separate the wheat from the chaff becomes greater;

  • While we have not expounded on bonds in this article, we continue to remain defensively positioned across all fixed income segments given that yields have at best continued to remain at unattractive levels, or, in certain segments such as US high yield and emerging market bonds, we’ve seen both yields as well as spreads head lower, making them even less appealing to us at this juncture. With low yields contributing to interest rate risk amidst the threat of an end of an era of ultra-easy monetary policy lurking in the background, a defensive position in fixed income is warranted in our opinion.


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