The year ahead

After a strong performance in 2006, what do experts predict for the FA100 in 2007?

The FinanceAsia 100 experienced its fair share of volatility in 2006 but generally stayed on an upward trajectory after a decidedly flat and inconsistent performance in 2005. The index crossed the psychological barriers of 1,500 and 1,600 in quick succession only to be brought back to the ground by a mid-year correction in regional equity markets.

The index's volatility in 2006, which mirrored many regional indices, was forecast in our FA100 guide of 2005. At the end of 2005, several economists and strategists projected that markets were in for a bumpy ride in 2006 in light of an uncertain US interest rate cycle, a possible slowdown of the world's largest economy and issues such as high oil prices. For the most part, it now appears that they were right.

Using this crystal ball model, FinanceAsia again spoke to several analysts and strategists to get a feel for what may happen in the region in 2007 and how these macroeconomic factors would influence the FA100. In a nutshell, the experts we interviewed all reached the same conclusion, that 2007 will be a good, if not great year for the nine economies represented on the FA100.

"Our GDP forecasts will be down on 2006 and there will be a clear dispersion of growth in Asia next year," says Markus Rosgen, managing director and regional head of Asia-Pacific equity research at Citigroup. "Regional equity markets have experienced two years of strong price and earnings performance, but now we're encouraging a move to value rather than momentum."

Stewart Paterson, who is head of Asia-Pacific strategy at Credit Suisse adds: "We're cautious on Asian growth in 2007, as the external environment will be pretty stale. The economies of Europe, Japan and the US will grow by less than 2% in real terms in the first half of 2007 and this will likely effect Asian markets."

Of the strategists and analysts asked to provide 2007 forecasts, the vast majority believed that the biggest threat to Asia in 2007, and in turn the FA100, would come from external issues. Foremost, a slowdown in the US next year, which is widely predicted, and is expected to take some of the wind out of the region's exports. With this in mind, strategists and analysts have suggested, as in previous years, that domestic plays are a better bet for success in 2007. As a large number of FA100 constituents primarily derive income for their home markets, strong consumption and domestic demand in Asia could easily take the index up a few more notches next year.

"We are still bullish on the domestic sector and like sectors such as financials, telecommunications and transport," says Eddie Wong, chief regional strategist at ABN AMRO. "Domestic demand is still very well supported and even if the US economy slowed to 2%, the strength of demand is strong enough to cushion a moderate downturn. They will still be our core holdings of 2007, waiting for the market to fully price in a possible slowdown in the US."

Adds Citigroup's Rosgen: "It is very unlikely that any Asian downturn would be triggered by events in the region. A soft landing of 2.5%-2.8% in the US could easily be minimised by domestic demand, of which we like financials, consumer and telcos."

Aside from the likelihood of sluggish US growth, Asia's fortunes will be tied to the Chinese economy. With speculation that further currency appreciation could be just around the bend and the ongoing talk from numerous economists and banks that its economy is overheating, China has the ability to sway the fortunes of every economy in Asia, if not the world, and impact the direction of the FA100.

Although these are pressing issues for China and the rest of Asia, the strategists and analysts that we spoke to remain relatively positive on non-Japan Asia's largest economy, despite cautious observations such as from Paterson.

"We remain very cautious on China primarily due to valuation concerns," says Credit Suisse's Paterson. "Valuations will be driven by a higher currency."

Sector-wise, the strategists and analysts again like domestic demand-driven stocks like financials and telecommunications in China, but all admit that signs have emerged that the economy is experiencing a very moderate downturn.

Some economists have also expressed concern about India. In 2005, economic growth for the world's second most populated nation topped out at 7.5%. Projections for 2006 will likely result in a larger number.

In the first quarter of 2006, India's economy grew by 9.15% and the momentum continued throughout the year with third quarter GDP growth climbing to 9.2% year-on-year fuelled by sharply rising consumer credit and government spending, leading banks to forecast between 8.5% to 9.0% for the year.

According to some economists and equity strategists, this spiraling growth rate combined with the fact that headline inflation is outpacing government estimates is cause for concern. Indeed, it may become more pronounced in 2007, despite the Reserve Bank of India's (RBI) decision to hike rates several times this year.

"India, along with China, is clearly overheating and in this market it is difficult to know whether it is under control," says ABN's Wong. "The country's banking system has loan growth of 30%, high property prices and although the RBI has started to take action to cool the economy it will be important to see how aggressively they tackle the situation before a bubble forms."

Adds Rosgen: "India will underperform against the region in 2007, but sectors like software and outsourcing-related business will continue to perform well."

But there will also be some bright economic spots in the region.

The economies of ASEAN have been earmarked by several economists and strategists as likely strong performers in 2007, as they would be less sensitive to a US slowdown and are more domestically-focused.

However, the overwhelming verdict we heard was that South Korea and Taiwan appear on track to be two of the strongest economies in Asia next year. If this speculation turns into reality, a strong Korea and Taiwan would likely bode extremely well for the FA100, which comprises of a more than 30 constituents from the two countries.

According to the strategists and analysts, these two markets may struggle in the early stages of 2007, but will generally outperform as the year unfolds.

After a year of underperformance, Korea is expected to become more attractive due to its attractive PE ratio compared to markets like China and India – as well as because of increased equity allocations from the national pension fund.

"We think it is difficult to bet against Korea in 2007 and it will start the year very cheap compared to the region," says Credit Suisse's Paterson.

Taiwan too appears to be on the radar screens after a forgettable 2006, with strategists and analysts believing that the economy will improve in 2007.

"After the initial correction to Asian markets, which we expect in the first quarter of 2007, Taiwan will likely be one of the best performing markets in Asia," says ABN AMRO's Wong. "The bottom of domestic demand has occurred in Taiwan and if the market corrrects in the first quarter amid a slower US economy, it would be a great opportunity to accumulate."

If these predictions are anything to go by, 2007 will be solid but not spectacular. This may suggest a relatively flat year for the FA100 not unlike 2005.