CIO WM Research

8 May 2013

Asia Pacific equities

A comfortable but unconvincing victory in Malaysia
Asia ex-Japan equities performed well in April after a poor showing
in the first quarter. We expect this outperformance to continue given the market's still-attractive valuations and good growth prospects.
Kelvin Tay, Regional CIO, Southern APAC, UBS AG kelvin.tay@ubs.com Cheryl Chian, analyst, UBS AG cheryl.chian@ubs.com

Fig. 1: Equity market performance Total returns in USD

-20% -10% China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Asia ex-JP EM World Year to date return (%)
-0.1% -5.2% -2.6%

0%

10%
6.0% 7.3% 5.9% 2.1% 7.8% 2.0%

20%

30%

South Korea and India remain our Most Preferred markets, while Singapore is Least Preferred. South Korea has done well since the easing of tensions with North Korea and the stabilization of the yen. In India, sharply lower gold and oil prices have boosted sentiment. Although Malaysia's recent elections have removed a major
overhang with the victory of the ruling coalition, greater challenges lie ahead given the racial and socioeconomic divide that emerged after the vote. We do not expect Malaysia's outperformance to last, and thus maintain our Neutral rating on the market. After a poor showing in the first three months of 2013, Asia ex-Japan equities (AxJ) performed well in April relative to developed market equities. Can this outperformance continue? We have previously highlighted that a strong US Dollar Index (DXY) has always negatively affected the performance of AxJ equities, and indications are that the DXY has peaked and begun to stabilize (see Fig. 4). Although MSCI AxJ has risen from the early April low of 1.58x price to book value (P/BV) to the current 1.6x, it is still trading at a significant discount to the 2x P/BV of MSCI World, offering better growth prospects and value than developed market equities. We made strategic changes to our AxJ strategy in early April, with the key changes being a downgrade of China to Neutral, and an upgrade of Malaysia to Neutral and of India to Most Preferred. We also kept our Most Preferred rating on South Korea, leaving Singapore as our only Least Preferred market. The performance of these markets has been largely in line with our expectations so far (see Fig. 5).

13.9%

3.9% 8.8% 6.9% 7.2% 7.0% 4.0% 4.8% 4.6% 11.5% 4.7% 2.1% 5.2% 4.1% 4.8% 11.8% 24.4%

1-month return (%)

Source: Factset, MSCI, UBS, as of 6 May 2013

Fig. 2: Asian equity market performance MSCI Asia ex-Japan versus MSCI World; standardized to 100 in May 2010
150 140 130 120 110 100 90 80 May-10 May-11 May-12 Asia ex-Japan World May-13

Source: Factset, MSCI, UBS, as of 6 May 2013

This report has been prepared by UBS AG. Please see important disclaimers and disclosures that begin on page 6. Past performance is no indication of future performance. The market prices provided are closing prices on the respective principal stock exchange. This applies to all performance charts and tables in this publication.

Asia Pacific equities

India has been one of the best performers since we upgraded the market in early April, with MSCI India returning 7.7% as of 6 May and outperforming AxJ by 2.5%. Lower inflation suggests the Reserve Bank of India will have the capacity to ease policy rates further to stimulate the economy. The sharply lower gold and oil prices in recent months have also been positive for the Indian fiscal deficit and hence the Indian rupee. South Korea remains one of our two favorite markets. The combination of cheap valuations (with MSCI Korea currently trading at 1.1x P/BV) and easing political tensions in the Korean Peninsula has resulted in a recovery of both the stock market and the Korean won over the last month. The stabilizing of the Japanese yen to 9899 per US dollar has also helped Korean equity sentiment. However, we believe these are still early days for Korea's market outperformance, and we maintain our Most Preferred rating. Although MSCI Singapore is near its five-year highs, the market has underperformed MSCI AxJ over the last few weeks as risk appetite returned to the Asian equity markets. Being a more defensive market, Singapore tends to outperform during periods of risk aversion. It did so starting February, when jitters over Europe took hold, despite poor manufacturing and export numbers from the Singapore economy. However, when positive US data, receding concerns over Cyprus, and the easing of tensions between North and South Korea in April led to a recovery in risk appetite and a surge in AxJ market performance, Singapore underperformed. Impact of BN's win on Malaysia We upgraded Malaysia to Neutral in early April as we felt that the stock market had largely priced in a victory by the ruling Barisan Nasional (BN) coalition, but with a lower majority than in the previous general election. The election results are in line with our view: BN won with a majority 60%, lower than the 63% in 2008, based on a historically high voter turnout of 80%. However, the outcome was above the market's expectation of an even lower majority for BN. This is likely to be positive for both the Malaysian ringgit and the stock market over the short term (see Fig. 6), as it removes a significant overhang that has plagued the market for much of the last 12 months. That said, one crucial fact is that BN lost the popular vote, polling in only 46.5% compared to the opposition's 49.9%. The election also exposed critical rifts in the Malaysian population, with the society split between racial and socioeconomic fault lines. BN secures legitimacy comfortably, but not convincingly Given the unconvincing but nonetheless comfortable margin by which the BN coalition secured political legitimacy (there were widespread allegations of vote-rigging, vote-buying, and electoral fraud), Prime Minister Najib Razak may face some challenges to his leadership in the coming months, although a change in the stewardship of UMNO, one of the coalition's three parties, led by Razak, is unlikely. Over the next three months, we would look out for the formation of a new cabinet, the timing of the next UMNO general assembly, and announcements on economic priorities as possible market movers.

Fig. 3: Asia ex-Japan country preferences

Current most preferred markets India Korea
Source: UBS, as of May 2013

Current least preferred markets Singapore

Fig. 4: DXY performance A strong negative correlation between the US dollar and MSCI Asia ex-Japan market performance
120 110 100 90 400 80 70 60 1997 300 200 100 1999 2001 200 200 200 200 2011 2013 DXY Index (LHS) MSCI Asia ex-Japan (RHS) 800 700 600 500

Source: Bloomberg, UBS, as of May 2013

Fig. 5: Relative market performance since early April USD total returns compared to MSCI Asia ex-Japan
3% 2% 1% 0% -1% -2% -3% -4% -3.3% Underperform -1.2% -1.1% -0.9% -0.8% Outperform 0.7% 0.7% 1.9% 2.0% 2.5%

Hong Kong

Philippines

Indonesia

Thailand

China

Malaysia

Singapore

Korea

Source: Bloomberg, UBS, as of 6 May 2013

UBS CIO WM Research 8 May 2013

Taiwan

India

Asia Pacific equities

Short-term outperformance expected... With the election results exceeding market expectations, we believe MSCI Malaysia is likely to outperform its regional peers over the near term, as the Malaysian market has been a laggard over the past 12 months and is therefore likely to play catch-up. Indonesia, Thailand and the Philippines have all rallied sharply this year and therefore, in terms of valuations, Malaysia is now rather attractive on both 12-month-forward P/E and P/BV terms relative to its neighboring markets. Furthermore, over the short term, there could be a rotation of capital from some of these markets to Malaysia to take advantage of the lower valuations and the removal of the biggest uncertainty that was hanging over the market. The win for BN suggests a continuation of the Economic Transformation Program, which is the government's cornerstone investment program, and the Iskandar Development Project. These should continue to support GDP growth. Likewise, the backlog in potential IPOs and government infrastructure projects is likely to be cleared in the months ahead, while foreign direct investments are likely to reverse the outflows experienced over the last few months, when the political uncertainty was at its peak. ...but Malaysia likely to struggle over the medium term The bigger question is whether this positive run will be sustainable on a long-term basis. While the election results are clearly positive for the Malaysian capital markets, outperformance on a sustained basis may be difficult, as the long-term challenges are pretty significant, despite all the short-term positives. For example, the election laid bare the fact that the Malaysian society has become increasingly divided. The incoming administration will have to deal with a Malaysia that has become polarized along racial lines, as made evident by BN's loss of Chinese voters to the opposition and the swing of Malay voters to UMNO, as well as along social lines, with urban voters rooting for the opposition and the rural poor sticking with BN. There are also the tricky issues of the loss to the opposition of Gelang Patah, a key area in the Iskandar Development Project, and the implementation of promised populist measures in the run up to the election that will shift the focus back to the fiscal deficit. Although the election results have removed a major overhang on the Malaysian market, our view is that the medium- to long-term challenges are now greater in light of the racial and socioeconomic divide that the election has thrown up. We do not expect the market's current outperformance to last, and therefore maintain our Neutral rating on Malaysia.

Fig. 6: Malaysia outperformed on election results Positive performance may not be sustained in the longer term
110 108 106 104 102 100 98 96 94 92 90 Dec-12

Jan-13 Feb-13 Asia ex-Japan

Mar-13 Apr-13 Malaysia

Source: Factset, UBS, as of 6 May 2013

Fig. 7: 12-month-forward price-to-earnings ratios MSCI Malaysia vs. Indonesia, Thailand, Philippines
22 20 18 16 14 12 10 8 6 4 May-08 May-09 May-10 Philippines: 12-m forward PE Thailand: 12-m forward PE May-11 May-12 Indonesia: 12-m forward PE Malaysia: 12-m forward PE May-13

Source: Factset, UBS, as of 3 May 2013

UBS CIO WM Research 8 May 2013

Asia Pacific equities

Fig. 8: Market valuations and ratings as of 3 May 2013

12-month Forward P/E Country China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Asia ex-Japan Price/Book Value Current 1.6x 1.4x 2.6x 4.0x 1.1x 2.1x 3.7x 1.6x 1.9x 2.5x 1.6x 5-yr Historical 2.1x 1.4x 2.8x 3.8x 1.3x 2.1x 2.6x 1.6x 1.8x 2.0x 1.7x Market rating Neutral Neutral Most Preferred Neutral Most Preferred Neutral Neutral Least preferred Neutral Neutral N/A YTD performance -2.6% 7.3% 2.1% 13.9% -5.2% 8.8% 24.4% 7.0% 4.8% 11.5% 2.1%

Relative to Relative to Earnings 5-yr Relative to Relative to Current ROE Historical Region Growth Historical Historical Region -18.4% 1.6% -3.9% 16.6% -15.1% 3.0% 45.3% 8.8% -8.5% 17.6% -7.2% -19.2% 36.1% 25.5% 32.7% -27.7% 30.2% 87.5% 28.2% 27.6% 11.9% NA 10.9% 5.6% 13.1% 13.0% 21.1% 5.4% 8.4% -1.8% 27.2% 13.6% 13.7% 9.1x 15.3x 14.2x 15.0x 8.1x 14.7x 21.1x 14.5x 14.4x 12.6x 11.3x 11.2x 15.1x 14.7x 12.8x 9.6x 14.2x 14.6x 13.3x 15.7x 10.7x 12.2x -24.8% -0.9% -8.8% 5.9% -12.5% 1.7% 40.9% 1.7% 6.3% 27.7% -7.4% -3.5% -15.1% 59.6% 150.0% -30.4% 29.9% 126.2% 1.1% 15.6% 57.7% NA 14.7% 8.4% 15.5% 21.7% 12.7% 13.1% 14.8% 10.2% 11.9% 17.3% 12.8%

Source: Factset, MSCI, UBS, valuations as of 3 May; year-to-date performance as of 6 May.

Fig. 9: Economic growth forecasts Real GDP; % change y/y

2010 China Hong Kong India Indonesia Malaysia Philippines Singapore South Korea Taiwan Thailand Asia ex-Japan
Source: Thomson Reuters, UBS, as of 30 Apr 2013

2011 9.3 4.9 6.2 6.5 5.1 3.9 5.2 3.7 4.1 0.1 6.7

2012 7.8 1.4 5 6.2 5.6 6.6 1.3 2 1.3 6.4 5.7

2013F 8 4 6.5 6.3 5.5 6.3 2.5 2.8 4 6 6.3

2014F 8 4.5 7 6 5 5.6 4.5 3.5 4.2 4.5 6.5

10.4 6.8 9.3 6.2 7.2 7.6 14.8 6.3 10.8 7.8 8.9

UBS CIO WM Research 8 May 2013

Asia Pacific equities

Fig. 10: Inflation forecasts CPI; % change y/y

2010 China Hong Kong India Indonesia Malaysia Philippines Singapore South Korea Taiwan Thailand Asia ex-Japan 3.3 2.3 9.7 5.1 1.7 3.8 2.8 2.9 1 3.3 4.4 2011 5.4 5.3 8.1 5.4 3.2 4.7 5.3 4 1.4 3.8 5.3 2012 2.6 4.1 8.2 4.3 1.7 3.1 4.6 2.2 1.9 3 3.7 2013F 3 4 7.4 6 2.7 3.5 3.5 2.2 1.4 3.2 3.9 2014F 4 4.1 7 5.5 3.8 4 2.8 2.6 1.6 3.1 4.3

Source: Thomson Reuters, UBS, as of 30 Apr 2013

Fig. 11: Interest rates in %

30-Apr-13 CNY 3M Shibor CNY 10Y Gov HKD 3M Hibor HKD 10Y Gov INR 3M T Bill INR 10Y Gov IDR 1M SBI yield IDR 10Y Gov MYR 3M Klibor MYR 10Y Gov Phibor 3M T Bill PHP 10Y Gov SGD 3M Sibor SGD 10Y Gov KRW 3M CD KRW 10Y Gov Taibor 3M CP TWD 10Y Gov THB 3M Bibor THB 10Y Gov
Source: Thomson Reuters, UBS, as of 30 Apr 2013

6 months 4.2 3.7 0.4 1.2 8.5 7.5 5.1 5.7 3.2 3.7 3.5 4.5 0.4 2.1 3 3.2 1.1 1.3 3.2 3.8

12 months 4.2 3.7 0.5 1.4 8.5 7.7 5.1 5.7 3.5 3.8 3.5 4.8 0.4 2.1 3.3 3.5 1.4 1.5 3.2 3.8

End 13 4.2 3.7 0.5 1.3 8.5 7.6 5.1 5.7 3.4 3.8 3.5 4.7 0.4 2.1 3.2 3.4 1.3 1.4 3.2 3.8

3.9 3.4 0.4 0.9 8.5 7.8 4.9 5.5 3.2 3.4 0.5 3.5 0.4 1.4 2.8 2.8 0.9 1.2 2.9 3.4

UBS CIO WM Research 8 May 2013

Asia Pacific equities

Appendix

Terms and Abbreviations

Term / Abbreviation Description / Definition Term / Abbreviation Description / Definition

A CPI GDP

actual i.e. 2010A Consumer price index Gross domestic product

bn E NV

p.a. Shares o/s WMR y/y or YOY

Per annum (per year) Shares outstanding UBS Wealth Management Research Year-over-year; year on year

P/BV UP CIO

Billion expected i.e. 2011E Neutral View: The stock is expected to neither outperform nor underperform the relevant benchmark nor significantly appreciate or depreciate in absolute terms. Price to book value Underperform: The stock is expected to underperform the sector benchmark UBS WM Chief Investment Office

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Asia Pacific equities

Appendix
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