Russell Asia Market Commentary - …...Russell Investments // Your analysis of recent economic events and market movements /p4 March 11 // Market Outlook Market Outlook continuedThe

Andrew Pease Chief Investment Strategist, Asia-Pacific

Your analysis of recent economic events and market movements

March 2011

Russell Asia Market Commentary

Russell Investments // Your analysis of recent economic events and market movements /p2

March 11 // Table of contents

Table of contents

Market Outlook March 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

The slow motion recovery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

US outlook: from double dip to potential boom . . . . . . . . . . . . . . . . . . . . 5

China: slow motion slowdown . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Rest of Asia: Inflation pressures and policy tightening . . . . . . . . . . . . . . 6

Equity market valuation: broadly neutral . . . . . . . . . . . . . . . . . . . . . . . . . 6

Country ranking: Korea, India and China preferred; neutral on Singapore, Taiwan and Malaysia; Indonesia and Thailand least favoured . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Conclusion: upside remains in ageing recovery . . . . . . . . . . . . . . . . . . . 10

Asia ex Japan valuation chart pack . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Asia ex Japan valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Consensus forecast EPS trends by country . . . . . . . . . . . . . . . . . . . . . . 14

Currencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16


March 11 // Market Outlook

Market Outlook March 2011 › Global share markets

to post gains on profits growth

› US economic recovery to continue, but unemployment to decline only gradually

› Asia ex Japan share market valuation is neutral

› China inflation concerns offset good share market valuation

› Korea, India and China preferred; neutral on Singapore, Taiwan and Malaysia; Indonesia and Thailand least favoured

The slow motion recovery

Volatility is likely to be an ongoing theme of 2011 . The Middle East and Europe are the prime candidates, but last November’s North Korean missile tests provide a taste of what could be an eventful year for geo-politics .

As we write, in mid-March, the tragic events in Japan are at the front of mind for investors . We expect that the global economic and market impact of this event will be relatively modest over the longer term . Natural disasters rarely, if ever, have major intermediate, much less long-term, impacts on global economic growth rates or market results in the longer term . Usually, the uncertainty immediately following the event creates a sell off in the market directly affected, as we have seen in Japan . This has flowed on to other markets with more subtlety . This event neither fundamentally alters our moderately bullish outlook towards global equities, nor makes us more cautious on Asia ex Japan markets .

The uprisings in the Middle East have put oil prices firmly back on the radar . The WTI price has pushed up from an average US$80 over the second half of 2010 to over US$100 in early March . The usual rule of thumb is that every 10% increase in the oil price reduces global GDP growth by 0 .25% (although this is a conservative estimate given the declining oil dependence of the major economies) . Usually, the oil price has to double before it triggers a global recession . The price rises so far, if sustained, will probably knock around half a percent from global GDP growth – a significant amount, but not enough to derail the global recovery, especially in an environment where growth forecasts are generally being upgraded and inflation pressures are muted in the major developed economies . A sustained rise above US$120, however, would have a significant impact on economic growth, profits growth, interest rates and inflation . It would change our modestly bullish outlook towards global shares .

Rising oil prices will have larger impacts across Asia, where inflation pressures are already causing concerns . It is another reason for expecting that share market returns in Asia will probably lag those in the rest of the world this year .

The swings in investment sentiment over recent months have been remarkable . Last August, there were fears of a US double-dip and a meltdown in Europe . At the beginning of the year, economists were busily upgrading forecasts for global growth and analysts were coming up with ever more optimistic forecasts for share market returns, with some forecasting over 20% returns for the major developed markets . The surge in oil prices to US$100 and the Japan earthquake have shifted sentiment down again .

Throughout we have maintained a measured view on the prospects for growth and investment returns . We expect that global share markets can deliver returns in the high single to low double digit range . In particular, we think the S&P500 can finish the year at around 1,350 to 1,400 .

Central to our cautiously optimistic share market view is that the US economy will achieve growth of 3-3 .5% this year – close to the long-term trend growth rate but not enough to make sustained inroads into the unemployment rate . This should deliver reasonable growth in earnings per share (EPS) . The amount of spare capacity in the US means that the risks around our growth forecast are skewed to the upside (i .e . 4 .5% growth is more likely than 1 .5%), however, the US still faces a number of hurdles in terms of de-leveraging, mortgage foreclosures and government spending cutbacks (especially at the state and local government levels) .

Asian share markets ran hard during 2010, with the Russell Asia ex Japan index delivering a 22% return for the year, following the 79% gain achieved in 2009 . Valuations are no longer supportive (although they are not yet dangerously expensive), but the biggest issue is the inflation pressures across many regional economies . This is likely to trigger policy tightening across a range of countries with China at the head of the queue . The medium-term outlook for Asian markets still looks relatively benign, but 2011 could provide some challenges after two years of strong outperformance .



Market Outlook continued

The issue for share market returns is how much more profits growth is left in the US recovery and can the price-to-earnings multiple (P/E ratio) increase? EPS for the S&P500 rebounded by nearly 40% in 2010 . One of our favourite indicators of the US profit cycle, the Conference Board’s quarterly survey of CEO confidence, bounced back in the December quarter and suggests reasonable EPS gains are possible .

The bottom-up consensus estimates from the Institutional Broker Estimate Service (I/B/E/S) predict 15% EPS growth this year in line with some of the more optimistic sell-side market strategists .

A growth of 15% this year means that EPS would almost be back to its peak in inflation-adjusted terms by the end of 2011 . This would be a 50-month period to recover the previous earnings peak . This is slower than the 44-month recovery period in the post-tech-wreck earnings recession and faster than the 65 months to recovery after the early 1990s recession . The EPS downturn, however, was larger this time than previously . The tech-wreck saw a 20% decline in inflation-adjusted EPS and there was a 30% decline in the early 1990s . This time, real EPS fell by nearly 40% from September 2007 to September 2009 . Given the hurdles facing the US economy and the depth of the downturn, a return to pre-GFC EPS peaks this year would be remarkable .

Figure 1a: CEO Confidence and S&P 500 Trailing EPS

n CEO Confidence (advanced two quarters) n Annual EPS growth

1990 1995 20052000 2010

% EPS growth (yoy) CEO Confidence Index

SOURCE: I/B/E/S, The Conference Board

20

30

40

50

60

70

80

-40

-30

-20

-10

0

10

20

30

40

1985 1989 1993 1997 2001 2005 2009

SOURCE: I/B/E/S, Russell calculations

Figure 1b: S&P500: Real Trailing EPS

2010 US$ value

10-Year Average

20

40

60

80

100

Europe has been relatively quiet over the past couple of months and has taken a back seat to the Middle East . This, however, seems a temporary respite as there are no easy solutions to the Eurozone debt crisis and more bail-outs seem likely . Our main concern is that the policy response in Europe seems reactive rather than proactive – policy makers seem to act only when under threat of a crisis . We expect the euro to survive, but it is likely to be a messy and protracted affair as the highly indebted countries struggle with internal devaluation (i .e . wage cuts) and Germany counts the costs of financial rescues .

US outlook: from double dip to potential boom

Last August, the talk was of a potential US double dip as economic indicators faltered and the Fed moved towards a second phase of quantitative easing . Now, analysts are upgrading forecasts following a run of strong manufacturing indicators and improving labour market news . The forecast for 2011 economic growth from the Consensus Economics’ panel of economic forecasters has been revised up from 2 .4% last September to 3 .1% in March .

Russell’s chief economist, Mike Dueker, is wary about extrapolating the current run of positive economic indicators into booming growth . Similarly, he warned mid-last year that the run of weak data was likely to be temporary . Mike expects the monthly payrolls figures to average around 220,000 by mid-year, enough to make gradual inroads into unemployment – but he thinks this will be as good as it gets . The recovery from the financial crisis is likely to be drawn out and moderate, as households continue to pay down debt and banks work though mortgage foreclosures .



Furthermore, not all measures of the P/E ratio are low . The ‘Shiller P/E’ which is based on the average of inflation adjusted EPS for the previous ten years is at 17 times (based on the I/B/E/S measure of trailing EPS) .

Our expectation is that S&P500 returns this year will be mainly driven by earnings growth .

China: slow motion slowdown

The long-awaited China slowdown is yet to materialise . There were signs in mid-2010 that the economy was cooling as money supply growth slowed from its stimulus-driven peak in 2009 . The economy, however, accelerated over the final quarter of 2010 as exports strengthened and industrial production picked up . Inflation also stayed high, ending the year at 4 .6%, and was expected to accelerate further in early 2011 .

The debate on China is largely around whether the spike in inflation is temporary and will subside when food prices return to normal, or is a sign of an overheating economy that will force more aggressive tightening measures that create the risk of a sharp economic slowdown .

The ‘inflation is temporary’ view argues that over 70% of the increase in consumer prices last year came from higher food prices, largely because of weather-related declines in food production . This view sees inflation pressures moderating later in the year and only a gradual further tightening to come .

Figure 1e: China Money Supply: M2 Growth

1998 2000 2002 2006 20082004 2010

% Y/Y

SOURCE: Datastream

10

15

20

25

30

Figure 1f: China: CPI Inflation

2000 2002 2004 20082006 2010

%

SOURCE: Datastream

-2

0

2

4

6

8

10

Another challenge for forecasts of strong EPS growth is that broad measures of corporate profitability are already high as a share of GDP . Nominal GDP growth is unlikely to be higher than 5% this year given real growth of 3-3 .5% and inflation of no more than 1 .5% . The amount of spare capacity in the US economy means that profits can most likely grow at a faster pace than nominal GDP this year . We’re comfortable with EPS growth of around 8-10% this year – that is, we think profits can grow faster than nominal GDP, but the high profit share already makes us wary of forecasting faster growth .

The other issue for returns is the potential for P/E re-rating . Some of the more optimistic commentaries point to the potential for the P/E ratio to rise once investors become convinced that the US economy is no longer in danger of a renewed recession . A sustained rise in the trailing P/E multiple from its current 15 times to 16 times (close to the long-run average), would lift the S&P500 by nearly 7% .

We’re not so sure that P/E re-rating is likely . The risks of a renewed recession seem low and the amount of spare capacity means that the US economy can easily grow near or above trend for the next few years . There is, however, the issue of fiscal risk given the large and increasing public debt burden . We don’t think that markets are ready to signal the all clear and return to pre-GFC valuation benchmarks given the uncertainties over how the US (and other economies) will achieve sustainable debt and deficit outcomes .

Figure 1c: US: Pre-tax Profits as a Share of GDP

nTotal nDomestic

1970 1990198519801975 2000 20051995 2010

%

SOURCE: Federal Reserve

5

10

15

20

25

Figure 1d: S&P500: Trailing and Shiller PE

nTrailing P/E nShiller P/E

1985 1990 2000 20051995 2010

Times

SOURCE: I/B/E/S, Russell calculations

10

15

20

25

30

35

40




Above-trend economic growth and limited tightening measures suggest that inflation may remain on an upward trajectory during 2011, even if food price inflation moderates . According to J .P . Morgan, monetary conditions (calculated by weighting exchange rate moves and short-term interest rate changes) are still loose relative to historical averages . Rising inflation will keep pressure on authorities to tighten monetary conditions, which in turn will maintain upward pressure on currencies .

Equity market valuation: broadly neutral

Asia ex Japan has significantly underperformed the rest of the world over the past six months . The result is that some of the previous over-valuation relative to the rest of the world has started to unwind .

Figure 1h: Asia ex Japan Inflation

%

1999 2001 2003 2005 2007 2009 2011

SOURCE: Datastream, Russell calculations weighted by free-float market capitalisation

-1

0

1

2

3

4

5

6

7

Figure 1i: Inflation Rates

%

SOURCE: Datastream

IndonesiaMalaysiaThailandTaiwanSingaporeKoreaIndiaHongKong

China

n Jan 2010 n Jan 2011

0

5

10

15

20

The ‘overheating’ view is that cost-of-living increases will be incorporated into wage gains leading to a sustained increase in inflationary pressures . This will force the authorities into more aggressive monetary tightening (through reserve ratio increases and interest rate hikes) than currently anticipated .

The inflation trend over the first half of the year is going to be important . A continuing upward path could see investors start to worry about aggressive tightening and the risk of an economic slowdown later in the year .

Rest of Asia: Inflation pressures and policy tightening

2010 was the strongest GDP growth year for the region in over 15 years . GDP (weighted by market capitalisation) increased by 8 .9% (8 .3% for the region excluding China) . The forecasters surveyed by Consensus Economics expect growth to moderate to 6 .3% (5 .3% ex China) in 2011 and 6 .4% (5 .5%) in 2012 . Just about every economy is forecast to grow faster than the ten year average . The most notable exception is China, where the consensus view is that continued policy tightening will result in modestly slower growth over the next two years .

The most important issue across the region is inflation . Inflation is picking up in almost every country (the main exception being India where food price pressures have eased) . Again, as for China, the main questions being asked are how much of the inflation lift is due to food price pressures and how much is due to overheating pressures and accommodative policy settings?

Figure 1g: Consensus GDP Forecasts: March 2011

%

SOURCE: Consensus Economics

-4

-2

0

2

4

6

8

10

12

14

16

IndonesiaMalaysiaThailandTaiwanKoreaSingaporeIndiaHongKong

China

n 10-Year Average n 2010 n 2011 forecast n 2012 forecast




USD Return Russell Index – February 2011 Total Returns

Asia ex Japan China Hong

Kong India Korea Singapore Taiwan Thailand Indonesia Malaysia Global Developed

5 years p .a . 10 .8 16 .7 9 .6 11 .4 5 .2 12 .8 9 .4 15 .8 23 .1 18 .4 3 .6

3 years p .a . 1 .7 0 .7 2 .5 -4 .8 0 .3 5 .9 4 .7 10 .6 7 .3 8 .7 1 .0

1 year 22 .3 14 .2 21 .8 6 .9 27 .8 25 .9 28 .7 52 .9 37 .6 38 .7 23 .8

6 months 13 .1 9 .8 16 .7 -2 .6 19 .8 10 .2 22 .1 12 .3 13 .1 13 .0 27 .4

3 months 0 .1 -2 .9 -1 .5 -9 .3 5 .7 0 .5 5 .7 -2 .1 0 .3 5 .5 13 .9

1 month -3 .9 -1 .5 -3 .9 -2 .1 -6 .6 -4 .5 -8 .2 4 .5 5 .6 -2 .0 3 .6

SOURCE: Russell Indexes

The forward P/E ratio for the region has fallen to 11 .7 times in March from 13 times last November . It is now below the long-term average .

In March, Asia was trading on the same P/E ratio as the MSCI World Index, compared to a 7% premium last November .

We have constructed a composite value index (CVI) for the Asia ex Japan share market index to summarise the various valuation indicators into one index . The CVI equally weights two categories of equity market valuation: earnings-based measures and balance sheet measures . The earnings-based measures of valuation are the forward P/E ratio, the trailing P/E ratio and a P/E ratio based on the average of inflation adjusted earnings over the past five years . This is intended to capture ‘normalised’ or trend earnings . The balance sheet measure is price-to-book value (price divided by the value

Figure 1j: Forward PE: Asia ex Japan

Times

1987 1990 1993 1996 2008 20111999 2002 2005

SOURCE: I/B/E/S, MSCI

5

7

9

11

13

15

17

19

21

23

Figure 1k: Forward PE: Asia ex Japan Relative to the World

Ratio

1987 1990 1993 1996 2008 20111999 2002 2005


0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3


of net tangible assets) . The CVI gives equal weight to the earnings-based measure and the balance sheet measure .

The different measures are ‘standardised’ which means they are given a standard deviation of one and an average of zero . This is calculated on a rolling five-year basis, meaning that, at each point in time, the CVI is relative to the average and the standard deviation of the previous five years .

The CVI shows that Asia was around three standard deviations expensive in late 2007 and two standard deviations cheap in late 2008 . It suggests that present share market valuation is neutral .

Asia continues to experience a much stronger rebound in projected earnings per share (EPS) than the developed world . The level of 12-month-ahead expected EPS for Asia ex Japan is now 3% higher than the previous peak in 2008 . By contrast, EPS levels in the developed world are still 9% below their pre-crisis peak .

Figure 1l: Composite Value Index: Asia ex Japan

Standard deviations

SOURCE: Factset, MSCI, Russell calculations

1997 20092000 2003 2006

Shares cheap

Shares expensive

-3.0-2.5-2.0-1.5-1.0-0.50.00.51.01.52.02.53.03.5

Figure 1m: Forward EPS Levels: Asia ex Japan versus the World

Index, 2002 = 100

n Asia ex Japan n Developed World

1987 1990 1993 1996 2008 20111999 2002 2005


50

100

150

200

250

300




The strength in Asian EPS is impressive, but it also brings to the surface the question of sustainability . EPS grew by 43% in 2010 and the consensus of bottom-up analysts is for 14% growth in 2011 and 15% in 2012 . Are these estimates achievable after such a strong profits rebound?

One way to answer this is to look at price-to-book value (share price divided by the value of tangible assets less liabilities) . A high price-to-book value combined with a low P/E ratio can be a signal that a market or region is ‘over-earning’ – the available stock of tangible assets is producing a high level of EPS relative to history, making further gains difficult . Price-to-book value, at two times, is above the long-term average, although still well below the previous peak of near three times in 2007 . It suggests that Asia is not yet ‘over-earning’ .

In summary, Asia’s P/E multiple is slightly below the region’s long-term average and at a small discount relative to the World . Price-to-book value is above the long-term average and EPS growth expectations for the next twelve months look realistic . Our composite value index suggests that sharemarket valuation is neutral for Asia ex Japan .

Figure 1n: Price-to-book Value: Asia ex Japan

Times

1995 1999 20011997 2003 2005 2007 2009 2011

SOURCE: Factset

0.5

1.0

1.5

2.0

2.5

3.0

Country ranking: Korea, India and China preferred; neutral on Singapore, Taiwan and Malaysia; Indonesia and Thailand least favoured

For this report we have developed a more structured framework for assessing relative equity market valuation for each country . We have calculated composite sharemarket valuation indicators for each country based on the following three components:

1 . Price-to-earnings ratios – Based on both one-year ahead consensus EPS and

trailing EPS for the past 12 month .

2 . Price-to-book value .

3 . Price-to-book and price-to-earnings relative to the region .

There are two absolute measures of valuation (P/E ratios and P/BV) and one measure of relative valuation (P/E and P/BV for each country relative to Asia ex Japan) .

Again, the different measures are ‘standardised’ which means they are given a standard deviation of one and an average of zero . This is calculated on a rolling five-year basis, so that at each point in time, the CVI is relative to the average and the standard deviation of the previous five years . The CVI is the equally weighted average of the three measures .

The CVI is simply a tool for summarising the various sharemarket valuation metrics into one number . Other factors come into play when assessing whether a market is attractive or not . For example, a country might be cheap according to its CVI, but thematics, for example, rising inflation and likely policy tightening could make it unattractive for the time being . Equally, a relatively expensive market as indicated by the CVI may outperform for a period of time .

The chart above shows the composite valuation indicator for each in country in March and six months previously in September 2010 .

Figure 1o: Composite Valuation Indicator

Standard deviations

SOURCE: Factset, I/B/E/S, Russell calculations

ThailandMalaysiaHongKong

IndonesiaTaiwanSingaporeKoreaIndiaChina

n Mar 2011 n Sep 2010

-0.9

-0.6

-0.3

0.0

0.3

0.6

0.9

1.2

1.5



The best performing markets over six months to February 2011 have been Taiwan (22 .1%), Korea (19 .8%), and Hong Kong (16 .7%) . Taiwan and Hong Kong were moderately cheap last August and Korea was three-quarters of a standard deviation cheap . The worst performing market was India, which returned -2 .6% over the past six months . It was a quarter of a standard deviation cheap last August and is now over half a standard deviation cheap . The cheapest market is China, which returned 9 .8% over the past six months compared to 13 .1% for the region .

The most expensive markets last August were Indonesia, Malaysia and Thailand . These three delivered returns that were broadly in line with the region .

So where does this analysis lead us? Surprisingly, it makes us want to take a closer look at India, a market we have been cautious about for some time . India has been the worst performing market by a wide margin over the past one and three year as investors worried about the extent of policy tightening required to control inflation pressures, the widening current account deficit (now pushing beyond 3% of GDP), Reserve Bank of India (RBI) tightening and corruption scandals .

The good news is that inflation has eased, from 16% at the beginning of 2010 to 9 .3% in early 2011 . Most forecasters seem to think that it will continue to decline with the Consensus Economics panel predicting 7 .3% inflation for fiscal year 2011 (that is, the year to 31 March 2012) . The monsoons, as always, will be important for food price inflation . Fortunately, India’s official weather forecasters are predicting ‘normal’ monsoon conditions this year . This will significantly ease food price inflation pressures .

The RBI has lifted rates seven times since last March, but the policy rate, at 6 .5%, is still below the inflation rate and there is a risk that rates will be hiked a further two to three times . The other two risks are oil prices and the Rupee . Oil is a risk across the region and India is about average in terms of oil intensity (oil consumption per unit of GDP) . The specific risk for India is that more expensive oil will widen the current account deficit potentially putting downward pressure on the

Figure 1p: Oil Consumption % of GDP: 2010

% of GDP

SOURCE: UBS

ThailandTaiwanKoreaIndiaMalaysiaIndonesiaSingaporeChinaHongKong

0

1

2

3

4

5

6

7

8

Rupee and upward pressure on interest rates, especially if the RBI feels more pressured to slow overall inflation .

The current account deficit and high inflation mean that the Rupee is one of the few currencies in the region at risk of falling against the US dollar . Investors need to be aware that share market returns might be offset by currency losses .

The positives are that India’s growth profile is strong . Consensus Economics forecasts GDP growth of near 8 .5% for the next two years – a significant step up from the average 5 .6% growth achieved over the five-year period from 2000 to 2005 . This growth confidence is reflected in bottom-up consensus earnings, estimates of which have India’s EPS growing by 22% this year and 18% in 2012 .

The bottom line is that growth resilience, strong earnings, and good valuation have us warming up to India after a long period of underperformance . The risk is that it may be too early to move in yet given that the RBI hasn’t finished tightening and because of India’s vulnerability to rising oil prices . Also, the Rupee is one of the few regional currencies that has downside risk . However, India has the potential to be one of the bright spots in what may be a relatively lacklustre year for the region .

China is another market that stands out on valuation grounds and has underperformed . The risk with China is that the policy tightening phase is far from over and there are few growth scenarios this year that investors will find comforting . Stronger-than-anticipated growth will increase fears of inflation and more aggressive tightening . Weaker growth will leave investors wondering just how deep the slowdown will be and if the tightening was overdone . The most positive scenario would be an easing of inflation back towards 3% along with signs that wage pressures are abating amid a backdrop of GDP growth around 8% . This, however, is unlikely to be apparent before the second half of the year, and investors may need patience before China’s relatively attractive share market valuation is rewarded .

The other attractive market, according to our valuation indicator, is Korea . It has been one of the better-performing markets over the past year . The issue in Korea, like much of the rest of the region, is inflation which hit 4 .5% in January 2011, up from 2 .6% in mid-2010 . This is above the Bank of Korea’s (BoK) 2-4% target band . The BoK has lifted the base rate twice already this year, by 0 .5% to 3% . These rate increases followed last year’s hikes that lifted the rate from a record low 2% . More gradual hikes seem likely . Despite this, Korea still seems likely to remain an outperforming market . BoK policy is still accommodative, demand is strong for Korea’s tech, electronic and auto exports and bottom-up consensus forecasts for EPS growth of 11% this year and 13% in 2012 look realistic . Furthermore, the Won has room to appreciate, having gained less than 3% against the US dollar over the past year . It also looks to be one of the more under-valued currencies in the region with the Won sitting at 9% below its average for the past ten years in real trade-weighted terms .




The least attractive markets are Thailand, Malaysia and Indonesia . Thailand seems best avoided for the time being . A general election is likely by mid-year and has the potential to trigger another wave of city-based ‘yellow-shirts’ versus rural ‘red-shirts’ confrontation . It is the most oil-dependent economy in the region and macro policy right now is a confused mix of fiscal easing ahead of the election, increased subsidies on rice, electricity and diesel, price caps on other basic commodities, and central bank tightening to combat inflation (rates have been raised by 1 .25 percentage points to 2 .5% since last July with more expected) . The one positive for Thailand is that bottom-up earning expectations have been relatively stable for several months at 20% for 2011 and 16% for 2012 . But the combination of stretched valuations, political risk and the threat of rising interest rates leaves us comfortable on the sidelines .

Indonesia is another market that we are negative on . Valuation has improved over the past six months – our valuation indicator has recovered from almost one standard deviation expensive to now being half a standard deviation in the expensive zone . Indonesia has been one of the best performing markets in the region for the past couple of years despite consistently ranking as one of the most expensive markets . The positives are the strong growth outlook (most forecasters expect GDP growth of around 6% for the next two years) and potential for currency appreciation . The main negative, aside from valuation, is that the central bank has been slow to react to inflation pressures meaning it may be in catch-up mode later in the year . The combination of over-valuation and inflation pressures leaves us wary of Indonesia .

Malaysia is a challenging market on which to have a strong view at present . On one hand, it is expensive . But on the other, Malaysia is the only net oil exporter in the region, making it a winner from higher oil prices . Inflation is rising and the central bank, Bank Negara, is likely to respond with more tightening . Overall, we are neutral on Malaysia relative to the region .

Hong Kong is now around three-quarters of a standard deviation expensive on our valuation indicator after being moderately cheap six months ago . Mostly, this is due to Hong Kong having slower EPS growth than the rest of the region . The bottom-up consensus forecasts have EPS rising by 8% in 2011 compared to 13% across the rest of the region . We’re neutral on Hong Kong, with the market over-valuation offset by the supportive liquidity conditions provided by Hong Kong’s monetary board link to US monetary policy .

We’re also neutral on Singapore and Taiwan . Both are in the neutral zone for our valuation indicator . Inflation concerns are building in both countries and more monetary tightening is likely . Taiwan should benefit from the US recovery in tech demand and Singapore is likely to see monetary tightening reflected in further currency gains .

Overall, we’re left feeling fairly indifferent about country preferences . The markets we like come with reservations (currency and oil for India, timing for China) and most countries have an even number of positives and negatives . We’re cautious about Indonesia and have been for some time, but it continues to perform strongly . Thailand has political risk and poor valuation, but strong growth and earnings potential .

Conclusion: upside remains in ageing recovery

The pessimism of mid-2010 has given way to a strong sense of optimism as economists upgrade global growth forecasts and post bullish targets for share markets . We agree that share markets have upside, but we’re wary of some of the more bullish forecasts . In the same way that investors became too gloomy towards the middle of last year, there is a risk that positive economic news is being over-extrapolated .

Our expectation for a continuation of the moderate US economic recovery combined with reasonable, but not cheap valuations, leads us to a modest bias towards global share market exposure .

Share market valuation is, at best, neutral for Asia ex Japan, but rising inflation and worries about policy tightening mean that returns could lag behind the rest of the world this year . Within the region, Korea, China and India offer the best value while Thailand and Indonesia have the least upside .

Volatility is likely to be an ongoing theme in 2011, generated by market events such as government debt concerns and shifting views about monetary policy, and by geo-politics . As it has been in recent years, the challenge again this year will be for investors to maintain discipline amid potential large swings in market sentiment .


March 11 // Asia ex Japan valuation chart pack


Asia ex Japan valuation chart pack

The MSCI Asia ex Japan one year-ahead P/E ratio declined to 11 .7 times in March compared to around 13 times at the end of 2010 . The long-run average is 12 .7 times . During the global financial crisis valuation trough in November 2008, forward P/E was as low as nine times .

At 11 .7 times, Asia’s forward P/E ratio is roughly equal to the forward P/E ratio for the MSCI World Index .

Asia typically trades on an 18 .5% discount . The most expensive valuation for Asia ex Japan relative to the World was in October 2007, when with a forward P/E of 17 times, Asia traded at a 17% premium .

Figure 2a: Forward PE Ratio: Asia ex Japan

Times

1988 1990 1992 1994 1996 2008 20101998 2000 2002 20062004

SOURCE: I/B/E/S

5

7

9

11

13

15

17

19

21

23

Figure 2b: Forward PE: Asia ex Japan relative to the World

Times

1988 1990 1992 1994 1996 2008 20101998 2000 2002 20062004

SOURCE: I/B/E/S

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

Asia ex Japan was 2% more expensive in March relative to the Australian share market that was trading on 11 .5 times forward earnings . This is compared to a long-term average discount of 2% .

The consensus estimate for 2011 EPS growth in Asia ex Japan is 14 .3% . The consensus expects EPS to grow by 14 .8% in 2012 and 7 .5% in 2013 . The region has generated compound annual EPS growth of 14% since 2001 .

Figure 2c: Forward PE Ratio relative to MSCI Australia

Ratio

1988 1990 1992 1994 1996 2008 20101998 2000 2002 20062004

SOURCE: I/B/E/S

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Figure 2d: Forecast EPS Growth: Asia ex Japan

% ann growth forecast

n 2011 n 2012 n 2013

Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11

SOURCE: I/B/E/S

5

10

15

20

› Asia ex Japan forward P/E ratio is below the region’s long-term average

› The consensus estimate for 2011 EPS growth in Asia ex Japan is 14 .3%

› Based on a Composite Valuation Indicator, Thailand and Malaysia are the most expensive markets in the region

› China and India are the cheapest

› Every industry sector is trading at a P/E ratio premium compared to the World relative to the past ten years



Asia ex Japan valuation chart pack continued

Another way to view earnings momentum is to look at the level of expected EPS . It’s also useful for checking the message from the P/E ratio . The forward P/E ratio will look artificially low if it is based on an unrealistically inflated EPS level .

At US$46, the level of expected EPS is now 13% above the July 2008 peak . This represents a 106% increase relative to US$22 expected in March 2009 during the depth of the global financial crisis .

Based on the Composite Valuation Indicator, China and India are the cheapest markets in Asia ex Japan . China’s CVI declined from -0 .25 standard deviations in September 2010 to -0 .7 standard deviations in March 2011 . Thailand and Malaysia are the most expensive . Since August 2010, the CVI for Hong Kong moved from -0 .1 (being on the cheap side) to 0 .6 in March making it the third most expensive market in the region .

Figure 2e: Forward EPS Levels: Asia ex Japan

US$

1988 1990 1992 1994 1996 2008 20101998 2000 2002 20062004

SOURCE: I/B/E/S

0

10

20

30

40

50

Figure 2f: Composite Valuation Indicator

Standard deviations




n March 2011 n September 2010

-0.9

-0.6

-0.3

0.0

0.3

0.6

0.9

1.2

1.5

Now we turn to the components of the Composite Valuation Indicator . The relative value index for each country versus the Asia ex Japan region is based on the forward P/E ratio and P/BV for each country relative to the region . It shows that China and India are the cheapest and Thailand and Malaysia are the most expensive countries in the region .

The P/E ratio component of the index compares the forward and trailing P/E ratios of each country to the average for the past five years (in standard deviations) . Taiwan appears cheap on this measure whereas it is on the expensive side of the scale in the aggregate CVI .

Figure 2g: Relative Value Index

Standard deviations





-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

Figure 2h: PE Index

Standard deviations





-1.2-1.0-0.8-0.6-0.4-0.20.00.20.40.60.81.01.2




The final component of the Composite Valuation Indicator is price-to-book value (P/BV) .

The standardised measure shows that Taiwan is expensive on P/BV while India and China are on the cheap side of the scale .

India and Indonesia are expected to deliver the strongest EPS growth over the next twelve months . EPS growth expectations are still relatively modest in Singapore and Hong Kong . Over the past twelve months, Taiwan and Korea experienced the largest EPS rebound .

Figure 2i: P/B Index

Standard deviations





-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

Figure 2j: EPS Growth: Actual & Forecast – March 2011

%

SOURCE: I/B/E/S

SingaporeHongKong

MalaysiaThailandTaiwanKoreaChinaIndonesiaIndia

n Next 12 months n Last 12 months

0

20

40

60

80

100

The chart below shows the industry breakdown for Asia ex Japan relative to the World . It contains the relative forward P/E ratios, compared to the average for the past ten years . IT, for example, tends to trade at a low P/E ratio relative to the World . This is mostly because IT in Asia is more focused on lower value added manufacturing than higher value added software design . Health care and financials tend to trade at a premium to their counterparts in the developed world markets .

Relative to the ten year average, Asia’s IT sector is trading at a 23% premium . The health care sector is the most expensive while the financials sector is the least expensive trading at a 2% premium to the ten year average .

A price-to-book comparison for Asia’s industry sectors relative to the World shows that the Telecommunications, Energy, and Consumer Staples sectors are trading at a discount relative to the past seven years (when price-to-book data are available) . All the other sectors are trading at a premium .

Figure 2k: Relative Forward PE Ratios Asia ex Japan relative to the World*: March 2011


* adjusted for average discount/premium over past 10 years

IndustrialsFinancialsEnergyUtilitiesConsDiscret

ConsStaples

ITTelcosMaterialsHealthCare

%

0

10

20

30

40

50

6070

80

Figure 2l: Relative Price-to-book Value Asia ex Japan relative to the World*: March 2011


* adjusted for average discount/premium over past 7 years

Energy TelcosConsStaples

FinancialsUtilitiesITIndustrialsMaterialsHealthCare

ConsDiscret

%

-20

-15

-10

-5

0

5

10

15

20




Consensus forecast EPS trends by country

Figure 2m: Forecast EPS Growth: China

%

n 2011 n 2012 n 2013

Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11

SOURCE: I/B/E/S

5

10

15

20

Figure 2o: Forecast EPS Growth: Taiwan

%

n 2011 n 2012 n 2013


SOURCE: I/B/E/S

-10

0

10

20

30

40

50

60

Figure 2q: Forecast EPS Growth: Hong Kong

%

n 2011 n 2012 n 2013


SOURCE: I/B/E/S

-5

0

5

10

15

20

Figure 2n: Forecast EPS Growth: Korea

%

n 2011 n 2012 n 2013


SOURCE: I/B/E/S

0

5

10

15

20

Figure 2p: Forecast EPS Growth: India

%

n 2011 n 2012 n 2013


SOURCE: I/B/E/S

5

10

15

20

25

Figure 2r: Forecast EPS Growth: Singapore

%

n 2011 n 2012 n 2013


SOURCE: I/B/E/S

3

6

9

12

15




Figure 2s: Forecast EPS Growth: Malaysia

%

n 2011 n 2012 n 2013


SOURCE: I/B/E/S

0

5

10

15

20

Figure 2t: Forecast EPS Growth: Indonesia

%

n 2011 n 2012 n 2013


SOURCE: I/B/E/S

5

10

15

20

25




Currencies

Apart from Hong Kong (with a currency board), regional currencies, including the Chinese renminbi, have strengthened against the US dollar over the past year . The biggest gainers have been the Malaysian ringgit, up 11 .7%, and the Singapore dollar, which has increased 10 .6% over the 12 months to February 2011 .

Relative to the past ten years, real trade-weighted exchange rates are:

• highestinIndonesia,ThailandandSingapore.

• lowestinHongKong,KoreaandTaiwan.

Figure 2u: Currency Moves Against USD February 2010 to February 2011

%

SOURCE: Datastream

-10 -5 0 5 10 15

Hong KongEuroIndia

KoreaChina

IndonesiaTaiwan

ThailandJapan

SingaporeMalaysia

Figure 2v: Real Trade-Weighted Currencies versus 10-Year Average, February 2011

%

SOURCE: Datastream

Under-valued Over-valued

-20 -15 -10 -5 0 5 10 15 20 25 30 35 40

Indonesia

Thailand

Singapore

China

Malaysia

India

Taiwan

Korea

Hong Kong

Since June 2010, China has increased the rate of its official foreign reserves accumulation from US$323 billion per year to US$448 billion per year in December 2010 . The rate of accumulation in the rest of Asia was generally declining in the second half of 2010 . By the end of 2010, China’s total reserves stood at US$2 .85 trillion . Official reserves across the rest of the region were US$1 .8 trillion .

The US dollar has depreciated by 4% in real trade-weighted terms since September 2010 . At the end of February 2011, it was 14% below its long term average .

Figure 2w Asia: Official Reserves Accumulation

US$ billion annual growth

n China n Rest of Asia n Japan

1998 2000 2002 2004 2006 2008 2010

SOURCE: Datastream

-200

-100

0

100

200

300

400

500

600

Figure 2x: United States: Real Trade-Weighted Dollar

Real broad effective index

1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

SOURCE: US Federal Reserve, Datastream

80

85

90

95

100

105

110

115

120

125

130

Russell Investment Group Pte Ltd . 4 Shenton Way 28-01 SGX Centre 2 Singapore 068807 Tel . +65 6880 5900 Email ask_russellasia@russell .com www .russell .com/asia

This material does not constitute an offer or invitation to anyone in any jurisdiction to invest in any Russell product or use any Russell services where such an offer or invitation is not lawful, or in which the person making such an offer or invitation is not qualified to do so and it has not been prepared in connection with any such offer or invitation . This material is not intended for distribution to retail clients . Unless otherwise specified, Russell is the source of all data . Unless otherwise specified, all information contained in this material is current at the time of issue and to the best of our knowledge all information presented is accurate, however this cannot be guaranteed . Any opinions expressed are those of Russell Investment Group Pte Ltd and are not a statement of fact, they do not constitute investment advice and are subject to change . The value of investments and the income from them can fall as well as rise and is not guaranteed . You may not get back the amount originally invested . There is no guarantee that any target or projected figures will be met and this information is for illustrative purposes only . Any simulated figures and estimated figures are for illustrative purposes only . Any past performance figures are not necessarily indicative of future performance . Any reference to returns linked to currencies may increase or decrease as a result of currency fluctuations . Any references to tax treatments depend on the circumstances of the individual client and may be subject to change in the future . Copyright © Russell Investments 2011 . All rights reserved . This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments . It is delivered on an “as is” basis without warranty . Issued by Russell Investment Group Private Limited of 4 Shenton Way #28-01, SGX Centre 2, Singapore 068807, Registration No . 199901513K, which is a wholly owned subsidiary of Frank Russell Company, a Washington Corporation, United States of America which is in turn a subsidiary of The Northwestern Mutual Life Insurance Company of United States of America .

MKT/2617/0710 R_ASIA_MKT_Commentary_V1D6_1104

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