UBS Sees MSCI Asia ex-Japan and TOPIX at 790 and 2,100 Respectively End-2018

From Neal McLeod and team at UBS:

« Our base case: a benign growth and policy backdrop…
We’re forecasting global growth to stabilise at 3.8% (China to slow from 6.8% to 6.4%), the export rebound to slow somewhat, inflation to pick up modestly, the Fed to hike rates three times by end 2018 (from now), US Treasury yields to grind higher to 2.7%, Asia ex Japan currencies to be flat (in equity market cap terms) versus the USD and the Yen to weaken to 122.

…points to less exuberance but still positive returns from equities
This backdrop suggests that Asia ex Japan earnings will grow again in 2018, but unlike 2017’s 10% upward revision, we think as the cycle slows sequentially, the pace of revisions will dissipate. We expect earnings growth to be broadly in line with current consensus 12% forecast. Earnings in Japan (consensus forecasts +8%) have some upside in our view. Valuations for Asia ex Japan are in line with longer-term averages, both in absolute terms and relative to government bonds. Our base case is that these multiples hold, leaving returns in the hands of earnings (as they were in 2017) and FX.
We see some modest upside to valuations in Japan. Our 2018 MSCI Asia ex Japan and TOPIX index targets are 790 and 2100 respectively.

The key themes we think will matter
Within the market, we think defensives will continue to lag, but given the relative valuation catch-up among the cyclicals, a peaking cycle and gradually rising bond yields, we think the financials look slightly more interesting now versus the cyclicals. We also expect growth to struggle versus value with a rising yield environment, though still think high growth stocks (generally Chinese internet stocks) that can grow into their multiples look more attractive than ‘quality growth’ that has re-rated with limited EPS upgrades. We think the cash return story will matter again– which should also help SOEs perform better. Finally, the region is gradually shedding its capex parsimony of the last few years – Chinese capex in particular has rebounded. We think capex beneficiaries will likely keep performing well, which should help Japanese exporters. »

Korea, Japan and Indonesia are the sweep spots.