MicroStrategy:Beyond Brexit,back to Asian fundamentals;where to from here?

Brexit creates yet another layer of uncertainty for equities

    ‘Brexit’ complicates investor calculus as the focus over the next several months is likely to shift to the economic impact on global demand; disinflation and financial conditions (see our views). However eventually Asian investors will need to focus on the underlying fundamentals. How do they stack up?

    The downdraft in Asian earnings continues although the pace has moderated somewhat. Whilst consensus 2016E EPSg expectations are modest at 2% (ex-resources at ~1%), the key issue is 2017E where consensus expects EPSg of 11-12% (ex-resources at 10%). For 2017E, expectations across most markets appear extended to us and as investors focus on 2017, these expectations are likely to disappoint. Downside risks are likely to come from macro volatility; sluggish growth; shift in currencies, particularly the pace of USD appreciation and volatility in commodity prices. Earnings expectations in India and Indonesia appear excessive to us; sector wise Financials’ earnings are likely to disappoint. Whilst 2016 earnings estimates look reasonable (and there could be upside in some markets), a new downgrade wave is likely later in the year.

    Asian equities appear to be trading at ‘ex-risk’ multiples

    The key concern is that Asia-ex multiples have expanded despite a weak earnings backdrop and risks from global macro-cross currents and related volatility. MXASJ trades at 12x PE whilst ex-resources, ex-financials PE is 16x - both higher than post-2010 averages. For equities to move higher, we need further multiple expansion and/or improvement in fundamentals. Both seem unlikely at this stage, in our view. That said, in a scenario of globally coordinated public sector actions, multiples and equities are likely to receive support.

    Growth remains scarce and should remain highly valued

    The overall earnings backdrop remains challenging with limited growth. Macro cross-currents and a rise in volatilities imply Asian equities will likely remain choppy; stock selection remains critical. Our preference remains with companies that have a history of revenue and earnings growth and are expected to deliver superior earnings. We believe ‘premium’ multiples attached to quality growth are justified given scarcity of growth elsewhere. Despite the ‘trash rally’ earlier in the year, relative valuation of ‘Quality’ vs. ‘Value’ remains at historically high levels.

    For Value or Cyclicals to outperform, we need a robust recovery in economic growth rates and/or profitability. Unfortunately, we find little conviction in calling for a broad-based rebound in global/Asian earnings growth rates given our over-arching views of sub-par economic growth rates, secular productivity stagnation and a long grinding cycle.

    We highlight 15 stock ideas from MQ Asia ex Japan analytical coverage of more than 850 stocks where our analysts expect superior earnings growth over the next 2 years. The list trades at a forward PE of 18x; with expected earnings CAGR of ~30% (‘15-17E) with all stocks having a PEG of less than 1. What we like about this set of stocks is that most of them have been able to avoid earnings downgrades; are generally domestically focused and therefore should face lower risk premia from the externalities. We also highlight our flagship ‘Quality & Stability’ portfolio, which continues to perform well, despite volatility (up 200bps YTD and ~27% since launch in March 2013).