The firm has upgraded offshore Chinese equities to “most preferred” given the policy tailwinds and an expected macro turnaround, which should power earnings to grow in the teen this year.
“In our view, China’s earnings growth prospects will prompt valuation re-ratings. The MSCI China index’s current valuations (on a price/earnings basis) are trading below historical averages. This suggests that most of the regulatory headwinds have been factored into share prices,” Eva Lee, head of greater China equity at UBS Global Wealth Management, said in a report.
In the near term, the firm continues to favour cyclical sectors, including consumer durables and services, which are key beneficiaries of a macro recovery.
China’s consumption growth in 2022 is projected to rise as the country gradually lifts Covid-19-related restrictions, coupled with a strong macro recovery. At the same time, a more benign producer price inflation trend could result in stabilizing raw material costs and expanded profit margins for consumer staples companies, Lee said.
“Over the medium to long term, we think the higher-than-market average earnings potential for growth sectors, including the new economy, greentech, and intelligent infrastructure segments, will shine,” according to Lee.
An inflection point in terms of share price performance will likely come once the earnings trend shows stabilisation, which UBS expects to happen after the macro recovery in the second quarter of 2022.
Asia tech rebound
Tech stocks globally have declined by a mid-teen percentage this year amid concerns over the prospect of more aggressive Federal Reserve tightening, slower economic growth prospects, and geopolitical risks, Sundeep Gantori, equity strategist at UBS GWM, said.
“Despite a few high-profile misses, which we attribute mainly to idiosyncratic issues at a few companies, the good news is that we haven’t seen any significant signs of deterioration in global tech’s fundamentals,” Gantori said.
This is highlighted by strong overall positive earnings estimate revisions. He expects mid-teens earnings growth in 2022 for global tech and low teens in 2023, which follows 20% growth over the past few years.
The case for Asia tech is even more compelling, as earnings are stronger and valuations are more affordable.
“We expect a high-teen earnings rate on average for key tech markets in Asia this year, higher than their global peers. Structurally, we remain positive on foundational technologies such as artificial intelligence, big data, and cybersecurity,” according to Gantori.
The tech theme is expected to benefit from 10% addressable market growth over the next three years. Taiwanese and Korean supply chain names as well as select Indian IT leaders are well placed to ride these structural trends.
UBS GWM’s analysis of the risk scenarios suggest that the global tech sector may see a further derating of 6–8% based on rate considerations alone (assuming US real rates move toward zero).
This would put the sector on a forward P/E multiple of 22x (versus 23–24x currently), “which is attractive”. However, should tech company earnings suggest a significant deterioration in the earnings growth outlook, a further derating toward 20x forward P/E is possible, according to UBS GWM.
Meanwhile, in the base case, the stabilisation of valuations and solid mid-teens earnings growth should be reflected in share prices over the next 12 months.
