a monthly guide to investing in asia pacific financial ...ubs cio gwm december 2018 5 investing in...

Investing in Asia PacificA monthly guide to investing in Asia Pacific financial markets

2019 outlookChief Investment Office GWMInvestment Research

ab

Navigating turbulence

Editorial

Navigating turbulence05

Tactical views32 Macro

34 Asset allocation

35 Equities

36 Bonds

37 Currencies

2019

Key investment ideas12 China-US relations: Managing a new era of strategic rivalry

15 Trade tensions: The implications for businesses

18 Regional politics: The case for diversification

21 Technology: The tug of war – innovation vs. regulation

24 Asia real estate: Headwinds but no recessions

26 Search for yield: Stay safe

28 Japan: Be selective

This report has been prepared by UBS AG and UBS Switzerland AG. Please see important disclaimers and disclosures at the end of the document.

Please note there may be changes to our house view and tactical asset allocation strategies prior to the next edition of Investing in Asia Pacific. For all updated views, please refer to the most recent UBS House View: Investment Strategy Guide.

Contents

4 UBS CIO GWM December 2018

Investing in Asia Pacific

UBS CIO GWM December 2018 5


2018 has been a rougher year for Asia than we had foreseen – the region’s equity benchmark, the MSCI Asia ex-Japan (AxJ) Index, has fallen by more than 14% in USD terms (as of 30 November 2018). Escalating China-US trade tensions, deleveraging in China, and the desynchronization of global growth are largely to blame. And as later-cycle dynamics take hold, we think the risk-reward trade-off could become even more challenging in 2019.

As we detail in the pages that follow, we expect continued volatility as economic growth slows and as political risks challenge regional policy-makers and businesses alike. Still, we see opportunities and believe the environment remains navigable through selectivity, diversification, and a clear long-term investment plan.

Asia’s 2019 outlook is cloudedEconomic growth is slowing in Asia – we forecast 5.8% GDP growth in 2019 versus 6.2% in 2018 – but we don’t see the conditions commonly associated with an impending recession. Nevertheless, strategic concerns like a potential reconfiguration of global supply chains are clouding the region’s investment outlook.

The silver lining is that these risks and relatively benign inflation should keep Asian central banks mostly on hold. Lower oil prices and a weaker US dollar should help Asian assets in the second half of the year, but both could head higher in the short term.

China-US relations, the elephant in the room, will shape Asia’s fortunes in 2019 and beyond. A pivotal meeting between the US and Chinese presidents at the G20 Summit suggested relations may be thawing, with the US agreeing to postpone a planned escalation of tariffs till 1 March. This pause implies a willingness from both sides to reach a deal. But finding a mutually agreeable solution will not be easy, and conse-quently a breakdown of these talks remains a key risk for markets.

In the long run, the recent detente aside, we believe China-US relations have entered a new era of strategic rivalry on which the two economies could increasingly decouple. For individual firms, this splintering of supply chains could bring both positive and negative consequences, so the over-all impact is unknown at this stage.

EditorialNavigating turbulence

This year turned out to be rougher for Asia than expected

Selectivity, diversifi-cation and having a clear plan are key for 2019

China-US relations will continue to shape Asia’s fortunes



Valuations look unaligned with fundamentalsAsia’s beaten-down valuations offer an opportunity, in our view, as they reflect an earnings expansion well below our 6.6% forecast – the 1.4x price-to-book (P/B) ratio currently reflects negligible earnings growth. An expected step-up in Chinese policy support is helpful and solid corporate fundamentals should underpin dividends, which have historically helped to offset pick-ups in volatility.

In the weeks and months to come, a number of key events could alter our tactical positioning. Two standouts are the China-US relationship and communication from the Federal Reserve. Crucial elections in India, Indonesia, and Thailand also bear watching.

We remain positive on equities as a whole, but this view is contingent on China-US trade tensions not escalating further. In our regional strategy, within Asia we’re overweight China, South Korea, Singapore, and Indonesia and underweight Hong Kong, Taiwan, Malaysia, and the Philippines. We remain overweight JACI high yield (HY) versus JACI investment grade (IG) bonds for carry, and we’re long SGDTWD. (See page 39 for details.)

Note: 2018/2019 are forecasts. * Global: excluding Venezuela. ** Asia: excluding JapanSource: UBS, as of 26 November 2018

UBS economic forecasts

Global * Asia **

GDP

3.9%3.8%

3.6%

20182017 2019

Inflation

2.7%3.1%

3.2%

20182017 2019

GDP

6.2% 6.2%5.8%

20182017 2019

Inflation

2.2%2.7%

2.8%

20182017 2019

Look out for Chinese policy support and higher dividend payouts

We're positive on regional equities heading into the new year



Ideas for 2019 and beyond

Equities: Oversold financials and technology, secure dividend yields, and beneficiaries of China’s stimulus measures. Select financials and tech provide a good mix of growth and value exposure, while high-yielding stocks with strong balance sheets and a history of sustainable payouts, such as REITs in Singapore and Hong Kong, should be resilient. We also prefer companies linked to Chinese infrastructure and materials sectors, and firms with greater domestic market exposures like insurers and some regional banks.

Asia credit: HY still worth the risk. We expect Asia credit to generate about 3–4% total return in 2019. Yields are attractive – 5% for IG and 9% for HY – though we are highly selective on individual names. We prefer short-dated HY Chinese property developers, specific BBB rated issuers, bank Tier 2 debt, perpetuals with high step-ups, and select Chinese state-owned enterprises.

Asia FX: More pain before gain. We expect the region’s exchange rates versus the US dollar to end 2019 largely where they stand now. But it won’t be a straight line: we expect further weakness in the short run and then strength after the Fed indicates an end to the hiking cycle. The USDCNY pairing will follow its own path, however, gradually rising to 7.3 by end-2019 though the trade truce could keep it from breaking above 7.0 over the next couple of months.

Beyond 2019: Expect shifts in supply chains, secular growth in disruptive innovations, and a greater focus by corporations on environmental, social, and governance (ESG) issues. The disruption of supply chains is set to benefit Vietnam and to a lesser degree Thailand and Malaysia. Softer consumer demand and regulations remain near-term headwinds for tech-nology, but structural prospects in segments like gaming and biotech offer value for longer-term investors. Private markets are a good way to gain exposure to growth areas like artificial intelligence and health tech. Investors can also consider ESG leaders in Japan.

Mark Haefele Min Lan Tan Chief Investment Officer Head Chief Investment Office APACGlobal Wealth Management Global Wealth Management

We like oversold financials and tech, firms with secure yields and stimulus beneficiaries

Asia HY remains worth the risk

USDCNY to gradually rise to 7.3 by end-2019



Key investment ideas

China-US relations

Managing a new era of strategic rivalry

China-US relations are likely to get more complex and challenging, but a full-on Cold War is unlikely. Rather, we could see a long cycle of fight and talk over a broad range of issues and a gradual decoupling of the two economies. Beijing is hunkering down to stabilize the domestic economy, as substantial concessions are out of the question considering Japan’s trade war experience. see page 12

see page 15

see page 18

Trade tensions

The implications for businesses

A readjustment of Asian supply chains is expected to continue, with Vietnam, Thailand and Malaysia benefiting from increased FDI and rerouted Chinese M&A. While hard to estimate, corporate margins will likely fall and capex spending will eventually rise as supply chains reconfigure. Businesses with exposure to automation and Beijing’s ramp-up in R&D should benefit.

Regional politics

The case for diversification

China-US relations will likely dictate geopo-litical headlines and risk sentiment in the region over the coming years. Investors also need to keep watch on regional elections in India, Indonesia, Thailand and potentially Sin-gapore. Dramatic policy change (e.g. more reform) seems unlikely; if anything, a boost to fiscal spending is a potential upside risk.



see page 21

see page 24

see page 26

see page 28

Technology

The tug of war – innovation vs. regulation

The regulatory backlash in 2018 is unlikely to derail the long-term growth prospects of Asia’s innovative indus-tries. Regulations, in our view, are intended to prevent excesses and promote sustainable growth, and not to deter online business models. Near-term risks remain, but for longer-term investors, we see attractive oppor-tunities in public markets (biotech, gaming) and private markets (artificial intelligence, healthtech).

Asia real estate

Headwinds but no recessions

For Asian real estate, policy headwinds are likely to persist, but we don’t anticipate major price correc-tions in the next 12 months. In Singapore, prices should remain stable within a +/–2% range. In Hong Kong, prices could fall 10–15% after rising 130% over the past five years. In China, prices in higher-tier cities should stay flat, while those in lower-tier cities could fall 5–10%.

Japan

Be selective

We believe 2019 will mark the beginning of the end of Abenomics. We remain neutral on Japan’s equity market in our global tactical asset alloca-tion. Within Japan, we like select blue chips whose valuations are overly downtrodden versus fundamentals and companies involved in digital payments, and focus on longer-term themes like ESG leaders.

Search for yield

Stay safe

Investors should focus on safe-yield strategies in Asian bonds and stocks in 2019. We focus on instruments with low correlations to the market overall, and companies that historically exhibit a stable yield. We think this should help insulate investors against short-term volatility.



Asset class viewsAsset allocation

Bonds

Macro

Currencies

Equity

• Strategically diversified global portfolios offer the first line of defense amid heightened market volatility.

• Valuations of risk assets in Asia are attractive, but to generate returns we expect to be more flexible in moving between equities and bonds as well as in our relative value ideas in 2019.

• Select BBB rated bonds• Bank Tier 2 debt• Perpetuals with high step-ups• Shorter-dated HY China property• Select SOE names in Asia

• We expect Asian 2019 GDP growth to fall 0.4ppt to 5.8%.

• China will likely ease policy further in 1H19 in response to tariff-driven uncertainty.

• Monetary tightening in the rest of Asia should pause, while higher oil prices pose a moderate risk to a benign inflation outlook.

• Long SGD, short TWD• Long USD, short KRW• Long USD, short North Asian basket

(50% CNY, 25% TWD, 25% KRW)• Yield enhancement for local currency deposits

• Select financials and IT names• Beneficiaries of Chinese stimulus• Vietnam• High-yielding dividend stocks with sustainable

payouts



What we’re watching

Legend:

Budget

Elections

Other events

2019

Jan Japan Late Jan, BoJ meeting

Feb

India

Thailand

Central govt FY20 budget

Between Feb-May, general elections

Mar

China

India

National People‘s Congress

Between Mar-Apr, parliamentary elections

Apr

Japan

Indonesia

Japan

China

ASEAN

1 Apr, nationwide local elections

17 Apr, presidential and parliamentary elections

Late Apr, BoJ meeting

China Politburo meeting

Summit

May

Philippines

Thailand

13 May, congressional, regional and provincial elections

Government budget 2019–20

June Japan 28–29 June, G20 meeting in Osaka, Japan

July

Japan

China

1 July, Upper House election

Late Jul, BoJ meeting


Aug

Indonesia

Philippines

Singapore

Korea

16 Aug, government budget 2020

State of the Nation Address and Budget 2020

National day rally

Between Aug-Sep, government budget 2020

Sep Vietnam Between Sep-Nov, government budget 2020

Oct

Indonesia

Japan

China

Malaysia

26 Oct, New Indonesia cabinet announced

Late Oct, BoJ meeting


Federal budget

Nov

Japan

ASEAN

APEC

Fall, constitutional referendum

Summit

Summit

Dec China Mid-December, Central Economic Conference


2020 (Select events)

Jan Taiwan General election

Apr Korea Legislative election



China-US relations are in uncharted waters and are likely to get more complex and chal-lenging in the years ahead. The base scenario we foresaw was a long cycle of fight and talk over a broad range of economic and security issues. The recent G20 meeting between president’s Xi and Trump and the pause in tar-iff escalation is a point in case. Still, a compre-hensive rollback of tariffs looks elusive at this stage. The US currently maintains tariffs on a total USD 250bn worth of Chinese imports, has ratcheted up the pressure by tightening foreign investment in 27 critical tech sectors (including semiconductors, aircraft and biotech) and has introduced “poison pill” clauses in the new USMCA trade deal, implicitly targeting China.

China has responded with retaliatory tariffs of 5–25% on USD 110bn worth of US goods, nearly 70% of total US imports. Despite the recent truce, a gradual decoupling of the two

economies and supply chains splintering along regional lines seems the most likely outcome in the long run. A full-on cold war in trade or security still remains only a tail risk, in our view, given the economic ties and cultural inter-dependencies of the two countries.

Hunkering down to ensure domestic stabilityBy most accounts, Beijing has miscalculated the severity of the US trade conflict as well as the effect deleveraging would have on the private sector and local government infra-structure spending. China has since reversed course and shifted to policy easing in late July, and further measures – relating to state-owned enterprise reforms, market access and tax cuts – are likely to be announced at the upcoming Central Economic Work Confer-ence in mid-Dec 2018 and political gatherings celebrating the 40th anniversary of China’s reforms and opening-up program.

Yifan Hu, Regional Chief Investment Officer & Chief China Economist Daiju Aoki, Regional Chief Investment Officer & Chief Japan Economist Teck Leng Tan, Analyst Hyde Chen, Analyst Kathy Li, Analyst

Idea 1

China-US relations: Managing a new era of strategic rivalry



Monetary policy The reserve require-ment ratio has been cut 250bps in 2018 and another 100–200bps of cuts is likely in the next 6–12 months.

Fiscal policy Deficit to widen from –2.9% in 2018e, to –3.3% in 2019e on:• Infrastructure spending, likely to

grow >10% in 2019, from 2% in 2018.

• Tax cuts worth c. CNY 1trn (1% of GDP) have been announced, with further cuts to property, inheritance and gift taxes reportedly in the pipeline. But the multiplier effect will likely be limited given the weak economic outlook.

Housing policy Select cities have eased mortgage rates for first-time buyers, but broad-based easing is unlikely.

Strategic partnerships with key allies, especially Japan. Japanese PM Abe’s latest visit to China in late October – the first in his 7-year tenure – marked a mile-stone in resetting the tumultuous rela-tionship between the two. They signed a broad range of deals, ranging from infrastructure, energy and car projects to a USD 30bn currency swap pact.

%Credit policy Modest rebound in broad credit growth (2018/19: 10.5%/11%) expected due to:• AMP rules relaxation to cushion

drop in shadow lending;• Direct policy support for SMEs:

National fund set up to guarantee SME loans, extended MLF collateral coverage for banks, and lower MPA parameters for banks.

CNY policy Capital controls to remain highly restrictive. China to combat speculative selling and avoid “weaponizing” the CNY, but will likely allow gradual fall as fundamentals weaken.• USDCNY forecasts: 7.1 in 3M, 7.2

in 6M and 7.3 in 12M (as of 27 November 2018).

Wider market access for foreign investors in manufacturing sectors, including autos, and allowing majority foreign ownership of Chinese financial firms.

Further lowering import tariffs on autos and certain consumer goods.

Policies unlikely to be pursued unless China is pressed into a corner:• Massive 15% depreciation of the CNY in a 12-month period• Selling of US Treasuries• Overtly punishing US corporations operating in China

Trade conflict a potential long-term positive. China’s sizable market is too big for investors to ignore. A positive outcome of US pressures is that Beijing may accelerate the opening up of its domestic market to foreign investment. So far, commitments include:

The road ahead for ChinaBeijing to reach into policy toolbox to ensure stability. Faced with limited options, we expect the Chinese government to hunker down and stabilize the domestic economy, keeping GDP growth above 6% in 2019, via the following policy mix:



Lessons learned from the Japan-US trade warThe Japan-US trade war of the 1980s–1990s bears key lessons for Beijing. Then, as now, a rising Japan-US trade surplus led to a cre-scendo of complaints from the US about unfair industrial policy practices and the loss of manufacturing jobs. As tariffs mounted, Japan yielded by imposing voluntary restraints on exports and shifting its auto production base to the US. It also sought to aggressively boost imports through an ultra-loose monetary pol-icy and fiscal pump priming. And as Japan’s trade surplus continued to grow despite the measures, the US initiated a coordinated inter-vention in dollar sales via the Plaza Accord of 1985, which resulted in USDJPY falling from 240 to 120 in a two-year period. Looking back, many Japanese economists now believe that the concessions made by Japan spurred the hollowing out of its domestic industrial base and the bubble economy of the late 80s

– which ultimately led to the infamous lost decades. From Beijing’s perspective, sharp currency appreciation, aggressive easing of monetary and fiscal policies, and the excessive tolerance of bad debts are policy choices to avoid.

Contest to persist on all frontsChina-US relations have entered a new era of strategic rivalry, one that extends well beyond trade and investment to differences over the rules of the game, values and governance models. It’s also a contest over geopolitical influence and technological supremacy. As the two countries move away from nearly three decades of greater economic engagement, relations will likely get more fractious – although the possibility of a global trade war remains low, in our view. We think a cycle of fight and talk will persist, which ultimately could reshape the current global geopolitical order.

Source: CEIC, UBS, as of 3Q18

China’s GDP growth is on track for moderation

6.0

7.0

6.5

8.0

7.5

0

–20

40

20

120

100

80

60

8.5

1Q17

1Q16

1Q15

1Q14

1Q13

1Q12

1Q18

Quarterly real GDP (% y/y, LHS)

China’s quarterly GDP growth and share of its decomposition, in %

Consumption (% share to GDP growth, RHS)

Gross capital formation (% share to GDP growth, RHS)

Net exports (% share to GDP growth, RHS)Source: Japan Automobile Importers Association, Bloomberg, UBS, as of November 2018

Japan’s auto sectors sharply shied production base to US under yen appreciation in 1980s

0.0

1.0

0.5

3.5

3.0

2.5

2.0

1.5

40

0

120

80

360

320

280

240

200

160

4.0

4.5

20102005200019951990198519801975 2015

Vehicles imported from Japan to US (millions, LHS)

Japanese vehicles assembled in US (millions, LHS)

USDJPY (RHS)

Japanese auto imports from Japan to US and assembled in US, and USDJPY



Firms caught in the middle of the China-US trade dispute face two options: stay and pay the tariffs or move to avoid them. Companies with existing operations in third countries, such as Vietnam, Thailand or Malaysia, may opt to accelerate their pivot to these loca-tions. But those without alternate production sites outside China could choose to wait for more clarity before deciding, especially if they face elevated fixed costs and other considera-tions like synergies with Chinese suppliers or the need for specific skill requirements that cannot be easily replicated elsewhere.

Corporations that shift production may also use this window of opportunity to upgrade their facilities, which would prove to be a windfall for capex and equipment spending globally. So, depending on the location, the reconfiguration of trade could have long-last-ing positive and negative knock-on effects. On a sector level, overall, we think automa-tion will be a universal winner of this supply-chain reorganization.

Thomas Deng, Regional Chief Investment Officer & Chief China Strategist Philip Wyatt, Economist Sundeep Gantori, Analyst Carl Berrisford, Analyst Hyde Chen, Analyst

Idea 2

Trade tensions: The implications for businesses

Asian neighbors likely to be the recipients of production shis

Source: UBS, as of November 2018

Tensions between China and US are diverting business to the neighboring countries

China USA

Japan, Korea, Taiwan

Southeast Asia



Direct impacts (on firms with products placed on US or Chinese tariff lists) When determining the impact on firms from tariffs, a number of factors must be considered such as: the goods in question, the tariff rate to be imposed, the availability and competitiveness of substitutes, the sen-sitivity of demand to a change in price, and for intermediate products, their position in the value chain and their geographic loca-tion. Hence, determining the overall effect is a difficult endeavor.

In the near term, we think companies with greater pricing power are likely to be most defensive and expect them to delay their relocation decisions. In contrast, for cost-sensitive firms with limited pricing power, we believe they will accelerate their reloca-tion to low-cost countries in Southeast Asia (ASEAN) such as Vietnam, Thailand or Bangladesh. Here are some examples of corporate rationale on the subject:

• A China-based robotics company with sizeable US exposure we spoke with has been accelerating shipments to the US in recent months - its products are subject to a 10% US tariff and would face even higher tariffs if new talks between China and the US were to fail. At this stage, it’s planning to keep its operations in China because of the high costs and challenges in relocating. The company is closely watching the pricing of its major compet-itor, a Boston-headquartered firm with

research and design done in the US but products made in China – together they control 80% of the US market.

• Conversely, a China-based automotive parts manufacturer we interviewed said it was scoping out opportunities to expand manufacturing to Mexico as a way of reducing future trade-related risks.

Increased pressure on Chinese exporters’ margins due to higher costs will be a key short-term direct impact of the tariffs. We estimate the tariffs could cut 25–30bps from Asian corporate margins in 2019. The longer-term effect will likely be increased capex from the need to shift manufacturing.

Indirect impacts (from changing global trading patterns) In general, indirect impacts will be seen in macro factors like weaker economic growth, business confidence or capex. For example, Bloomberg Intelligence predicts a 3–4% slowdown in global container demand growth during the next few quarters due to rising trade uncertainty. A broad-based slowdown in capex is possible in the short term, and this would have knock-on effects to activity and consumption in certain parts of Asia – but it would lift firms’ cash flow in the short term. All is not bad, however, as we see a number of opportunities for select companies and sectors in the short to medium term:

Evaluating the direct and indirect impacts



Source: OECD, UBS, as of November 2018

China’s R&D spending has reached 2.1% of GDP in 2015, from 0.9% in 2000

0.0

1.0

0.5

2.0

1.5

3.0

2.5

3.5

20122009200620032000 2015

China

European Union

Japan

United States

R&D spending as a % of GDP

China likely to double-down on investment plansAutomation is the clear winner as new facto-ries regionally move up the value-added lad-der, which should be a boon for low-tech Chinese automation players. Select Chinese companies could also benefit from Beijing’s ramp up of high-tech, basic and applied research in order to move up the global value chain and to improve its technological inde-pendence. Despite these recent challenges, we believe China will eventually achieve greater self-sufficiency in key industries with best-in-class technology. Also, we believe Chinese firms will likely continue to diversify and invest in growth industries regionally in ASEAN and India.

• Two logistics firms told us that these tariffs could boost their intra-Asia trade further, particularly ASEAN-China trade.

• Other examples include Chinese car retailers increasing their imports of Japanese-made luxury models because of Chinese tariffs on US imports, and

Australian beef and South American soybean producers benefitting from increased Chinese demand due to tariffs on US agricultural products.

• The defense sector should be a clear ben-eficiary from any rise in regional geopo-litical tensions.



China’s ascension from abject poverty just 35 years ago to become the world’s second big-gest economy has inspired both admiration and fear, not least because its sociopolitical model is so antithetical to that of the prevail-ing liberal order.

With a population of 1.4 billion and mostly entrepreneurial people, a stable China will anchor much prosperity and progress in both the developing and developed worlds for many years to come. Yet China’s ascent as a global superpower is also bringing with it new challenges and tensions, both as it flexes its growing influence to reshape international rules and institutions to better serve its inter-est, and as powers in relative decline, notably the United States, start to see China as a potential security threat.

Fears of China’s military ambition may be overblownThe tensions between the US and China will dominate regional politics in the years ahead, but a conflict is not inevitable as there remains little appetite among even US allies to overtly take sides against China. At any rate, we think fears of China’s military ambition and expansion plans are likely overblown. In 2017, China’s military spending increased by 5.6%, the lowest annual rise since 2010 and

Kelvin Tay, Regional Chief Investment Officer Delwin Kurnia Limas, Analyst Carl Berrisford, Analyst Valerie Chan, Analyst

remains in line with nominal GDP growth. As illustrated by the table below, China’s military spending does not appear excessive. In fact, considering that China just started to mod-ernize its military in recent years, its spending both in terms of the size of its population and geographical spread is certainly not alarming.

China and the world’s interests lie in creating an environment in which it will not be feared as a revisionist power. Indeed, as the main beneficiary of the current multilateral global trading system, it will serve China well to reas-sure the rest of the world that it would actively refrain from leveraging its economic power in manners that concern its trading partners.

Busy political season ahead in AsiaAlongside geopolitics, Asia has a crowded domestic political calendar in 2019, with cru-cial elections due in India, Indonesia, Thailand, with Singapore also a possibility. So a key pressing question is whether political develop-ments affect capital markets in Asia.

The relationship between politics and financial markets is complex, especially in emerging Asia where a large share of the population still resides in rural areas. This inter-relation is also complicated by the fact that in some of these countries, diverse factors such as reli-

Idea 3

Regional politics: The case for diversification



gion, the military and even the aristocracy may shape the political landscape. In contrast, in the more developed Asian markets, socio-economic issues such as the Gini coefficient, the quality of employment and immigration are often more dominant.

The overriding factor is uncertainty. Regardless of how adverse the politics might seem, if uncer-tainty is reduced, asset prices tend to respond favorably all things being equal. Market volatility increases with uncertainty. The more confused the voting public is about who will win the elec-tion, the more the stock market and the cur-rency will be affected by the ensuing volatility.

But when the political outcome is clear, markets tend to respond positively to the lower uncer-tainty. Take Thailand’s stock market for exam-ple. When the Thai military launched a coup d’etat in May 2014, the Thai stock market, as measured by MSCI Thailand, outperformed the MSCI Asia ex-Japan Index by 12.5% over the next six months, as the military government put an end to months of political gridlock, eco-nomic paralysis and sporadic violence. This con-trasted sharply with the underperformance of 9.5% in the six months and 22% in the 12 months before the military takeover.

In countries where the independence of government institutions has been undermined,

a sudden change in the political landscape could trigger a sharp reaction in asset prices that could have a longer-lasting impact.

Foreign ownership and its domestic implicationThe level of foreign ownership of a country’s assets also matters. Foreign investors may not be as familiar with the nuances of local poli-tics and therefore usually have a smaller appe-tite for political risk, often reducing their equity exposure at the first signs of unfavora-ble political developments. As the majority of these foreign funds are usually USD-denomi-nated, the potential equity losses may even be magnified by local currency weakness. Local investors, on the other hand, are sheltered from foreign exchange exposure and have a deeper understanding of local politics, so they are less likely to be trigger-happy.

In short, knee-jerk asset price reactions to sud-den changes in the political environment are not uncommon but are usually short-term in nature and not uniformly spread out. Fundamentals are far more important over the medium to longer term, although political uncertainty combined with weaker economic conditions tends to com-mand a larger risk premium. Nonetheless, we do not expect any major changes to the funda-mentals of India, Indonesia and Thailand due to general elections in 2019.

China’s military spending is not excessiveBreakdown of military spending in different countries

US China France United Kingdom

Total spending (USD bn) USD 610 USD 228 USD 57.8 USD 47.2

Percentage of GDP 3.2% 1.8% 2.2% 1.8%

Per capita USD 1,872 USD 164 USD 861 USD 715

Per sq km USD 62 USD 24 USD 90,000 USD 194,000

Source: SIPRI Military Expenditure Database, UBS, as of November 2018



2019 will be an eventful year for politics. National elections are set to take place in India, Indonesia, Thailand and possibly Singapore. While we expect no fundamental shifts in any of these markets, the key things we’ll be watching for are listed below. For a list of other political events, please refer to the political calendar on page 11.

IndiaThe next general election will most likely be held in April or May 2019. While opinion polls

suggest that the ruling Bharatiya Janata Party is likely to win again, we believe it could lose its current majority, forcing the party to rely on an unwieldy coalition that may dilute the current government’s reform agenda. The higher policy uncertainty and weaker reformist credentials might be a catalyst for the historically high equity valuation multiple to correct further.

IndonesiaWe expect manageable political risk for the 17 April election. Joko Widodo, the incumbent,

leads the survey polls, controls a coalition that collectively holds about 60% of the legislative seats and enjoys better Muslim credentials thanks to his appointment of Ma’ruf Amin, a prominent Islamic scholar, as his running mate. That said, religious tensions and the rupiah remain the key fac-tors we’re monitoring. Social spending is likely to speed up ahead of the election, benefiting mid-to-low income earners,

Key things to watch in 2019

while infrastructure spending may lose some momentum.

SingaporeThe next general election will likely be held in 2020, before the current parliament’s term ends

in January 2021. As the newly appointed first assistant secretary-general, current Finance Minister Heng Swee Keat will likely run as the next leader of the ruling PAP. His long experience in the civil service and as the former head of the Monetary Authority of Singapore puts him in good stead to ensure policy continuity.

ThailandFree elections, officially set to take place between 24 February and 9 May 2019, will likely gen-

erate positive sentiment both at home and abroad for a return to democratic politics in Thailand, assuming no major hiccups or con-troversies. Some pre-election stimulus has already occurred in 4Q18, which could help lift private consumption and investment in the seasonally strong first quarter in 2019. The key risks relating to the elections include a tactical delay toward the latter end of the electoral window, a potential delay in announcing the election results and, based on past history, delays in forming a new cabinet after the results are announced. These risks would create government policy uncertainty and could impact public spend-ing, corporate capex, foreign direct invest-ment and consumer sentiment.



The regulatory backlash in 2018 is unlikely to derail the long-term growth prospects of Asia’s innovative industries, and we continue to expect them to disrupt traditional industries in the years ahead. While uncertainty may persist in the near term, we see opportunities in public markets following the 2018 sell-off and in private equity for longer-term investors.

Asian innovation boom continuesThe 2018 Bloomberg Innovation Index has experienced two significant milestones in 2018. First, the US dropped out of top 10 for the first time in six years with a new ranking of 11. Second, China jumped two places to 19, entering the top 20 for the first time. While other Asian countries like South Korea (firmly in first) and Singapore (moved up three spots to third) continue to top the index, our key takeaway from this ranking shift is that the innovation gap between China and the US is narrowing. China continues to impress on patent activity with a global ranking of 6. Its ascent is perhaps best epitomized by the jump in the number of unicorns, or unlisted start-ups valued at more than USD 1bn, to 83 currently from 55 at this time in 2017.

Notably, the list of Chinese unicorns is domi-nated by what we call the “secular seven” industries: advertising, biotech, e-commerce,

fintech, gaming, online education and online travel. These sub-sectors account for almost 38 unicorns, with a combined valuation of around USD 84bn, and create significant dis-ruption in China, driving annual sales close to USD 1.4trn and registering 25% revenues growth over the past few years. (The long-term growth potential for these industries is addressed in our past Shifting Asia

Sundeep Gantori, Analyst Carl Berrisford, Analyst Hyde Chen, Analyst

Innovation score

Source: Bloomberg Intelligence, UBS, as of November 2018

China’s innovation gap with US is narrowing

55

65

60

70

80

75

90

85

95

20172016201520142013 2018

China

US

Idea 4

Technology: The tug of war – innovation vs. regulation



publications “The road to cashless societies,” “China’s biotech revolution,” and “Ahead of the game.”)

Impact of regulations: shaken but not stirredHowever, public markets have told us a differ-ent story in 2018 – the share prices of compa-nies in the “secular seven” industries have been hit hard by new regulations in China. Tech stocks corrected by 30–40% as consen-sus revised down earnings estimates, flagging short-term growth concerns. The question remains whether the cloud of uncertainty will eventually lift as regulators clarify the rules of the game, or if regulations will permanently derail the long-term growth potential of Chi-na’s innovative industries.

The brief history of such innovative industries in China makes it hard to predict when regula-tory pressures might cool down. However, les-sons from the regulations of innovative com-panies in other countries lead us to believe that growth rates may reset only slightly as

these companies adjust to the “new normal” of greater scrutiny – but they should still deliver growth rates well in excess of nominal GDP growth thanks to strong secular opportu-nities. For most innovative industries in China, we now expect 15–20% revenues growth rates over the next few years (versus 20–25% previously). Such growth rates – still impressive considering Asian market revenues are grow-ing by 5–10% annually – should be achievable as these industries gain market share from and disrupt traditional industries.

Key to our view is our belief that the intention of the Chinese government is not to deter, let alone to damage, innovative or online business models. Instead, regulations are intended to prevent excesses, improve user protection, and drive healthier and more sustainable growth. For instance, the new nationwide drug tender-ing system in China’s biotech space is a posi-tive long-term development, in our view, given the government’s ambition to shift drug cost reimbursements away from cheaper generics and toward higher-priced innovative and bio-

Summary of key regulations affecting innovative industries in ChinaBy industry and regulation in China

Industry Regulation

Biotech Nationwide drug tender system triggered concerns over generic drug prices.

E-commerce New e-commerce law effective 1 Jan 2019. Increased tax burden and user protection.

Fintech New online lending rules and reserve requirements for payment companies.

Gaming Suspension of new game approvals and comments on near-sightedness effect of games.

Online advertising Network security regulations to protect data privacy.

Online education New education-related regulations including tax obligations.

Online travel No default cross-selling and increased user protection.

Source: Company reports, UBS, as of November 2018



Regulation score (scale: 1–5, y-axis) and Industry’s growth opportunities (%, x-axis)

Note:Bubble size indicates industry size in USD bn.Regulation score based on a scale of 1–5, with 5 being the most regulatedIndustry’s growth opportunities over the next few years based on %Source: Company reports, UBS, as of November 2018

Regulation and growth matrix for innovative industries in China

5

4

3

1

2

0

24120 36

Medium growth, low regulations

70

120

30

38

45 6.5

Fast growth,low regulations

Medium growth, high regulations

Fast growth,high regulations

Fintech

Gaming

E-commerce

Advertising

Online education Online travel

Biotech

1,100

logic drugs, for which demand is high but affordability is low. Similarly, regulations in gaming, online travel and e-commerce are meant to maintain high-quality content, reduce addiction and offer user protection.

Where are the pockets of opportunities?For longer-term investors, we believe most of these innovative industries now offer appealing entry points given attractive valuations. Tactical investors could reference our matrix below comparing the seven industries’ growth rates to their regulatory environment (on a scale of 1–5 with 5 being the most regulated). We believe

companies in the fast growth, low regulation part of the matrix provides relatively less near-term risks – i.e. online advertising. We also believe the worst risks to online travel are behind us, although growth rates for the indus-try are lower than peers’. The other industries like biotech and gaming have more near-term regulatory risks but, as highlighted earlier, have robust structural growth prospects. In addition to public markets, investors could seek oppor-tunities in the private equity space to gain expo-sure to Asian innovations – in areas like artificial intelligence and healthtech, where regulatory risks are limited at this stage.



The real estate markets of key Asian cities are facing headwinds from a mix of restrictive housing policies, slower economic growth and tighter liquidity conditions. That said, supply-demand dynamics are largely balanced region-ally and a major price correction remains unlikely in the key locations. We expect home prices to stay largely stable in Singapore and to decline 10–15% in Hong Kong over the next 12 months. As for China, prices in higher-tier cities should stay relatively resilient but could decline 5–10% in lower-tier cities. Keep

in mind though that any potential price decline in Hong Kong and China follows a sig-nificant rally; since 2010, home prices have risen 130% in Hong Kong, 40–50% in China’s lower-tier cities and 7.5% in Singapore.

Eva Lee, Head Hong Kong Equity Wen Ching Lee, Analyst

The market share of top 10 Chinese developers, in %

Source: Company data, Citi research, UBS, as of November 2018

Substantial consolidation in China housing market

0

15

10

5

20

30

25

35

40

45

2018

E

1H18

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2020

E

>35

%

33%

27.5

%

20.1

%

18.7

%

17.7

%

14.6

%

14.2

%

12.7

%

11.3

%

9.1%

8.6%

6.7%

5.4%

>40

%

bubble risk (>1.5)

overvalued (0.5 to 1.5)

fair-valued (–0.5 to 0.5)

undervalued (–1.5 to –0.5)

2.03

1.99

1.95

1.92

1.65

1.61

1.45

1.44

1.44

1.43

1.29

1.15

1.10

1.09

0.68

0.68

0.45

0.44

0.03

–0.62

–0.5 0.5 1.5

Hong Kong

Munich

Toronto

Vancouver

Amsterdam

London

Stockholm

Paris

San Francisco

Frankfurt

Sydney

Los Angeles

Zurich

Tokyo

Geneva

New York*

Boston

Singapore

Milan

Chicago

UBS Global Real Estate Bubble IndexLatest index scores for the housing markets of select cities

Source: UBS * Index altered due to data source revision.

Idea 5

Asia real estate: Headwinds but no recessions



China: Large cities supported by policy and market dynamics Housing sales volumes in China are likely to decline 7–10% in 2019, in our view, after increasing 1% in 2018, as the economy slows and the government scales back compensations under its shantytown housing scheme. Property values in top-tier cities should soften somewhat, though tight capital controls and gradually expanding money supply should help offset any activity-related weakness. Also, industry consoli-dation and healthier inventory levels have reduced the risk of a selling spree in the dis-tressed market. The industry has consolidated markedly in recent years – the market share of the top 10 Chinese developers increased from 20% in 2016 to 34% by end-1H18. Meanwhile, housing inventories have improved to around 11 months now from an average of 18 months dur-ing the 2015/16 downturn. But for the low-tier cities, where prices have risen strongly in recent years, we see a greater risk of a correction.

Singapore: Affordability improved, restrictive policy a damperRising interest rates – 3M SIBOR now at a 10-year high of 1.76%, or +90bps since the low in 3Q16 – have put the spotlight on the Singapore property cycle. Still, tight government policy, not rates, has been the real damper on Singapore’s home prices, which rose just 0.5% in 3Q18, the slowest pace since prices bot-tomed in 2Q17. That said, we see fundamental support from a robust employment outlook and better affordability. The unemployment rate, at 2.1% in 3Q, will likely remain low at around 2.5% in the next two years. Meanwhile, the price-to-income ratio has since improved from 7.3x in 2010 to 4.8x in 2017.

Hong Kong: Rising rates hurt, but economy matters more House prices in Hong Kong are strongly corre-lated to the city’s economic outlook. A steadily

growing economy, tight supply and low inter-est rates have fueled the 130% rise in home prices for the past eight years. But as rates rise – 3M HIBOR is up 130bps over the past two years to 1.97% – and as the Chinese and Hong Kong economies slow, we believe prop-erty prices are likely to soften by 10–15% in the next 6–12 months. A record-high price-to-income ratio, at 17.2x in 2017 from 9.4x in 2010, remains a key concern. Already, we have seen a 5ppt decline in home prices since the peak in August 2018, the first reversal since mid-2015. That said, we think interest rates need to rise another 75–100bps for negative carry to start biting. Barring a severe economic downturn in China, we believe the tight supply of planned completion should limit the decline of HK home prices.

In the next 12 months, we expect both the 3M SIBOR and the 3M HIBOR to reach 2.5% on the back of further rate hikes by the Federal Reserve.

Source: NBS, CEIC, Citi Research, UBS, as of November 2018

Monetary liquidity is a key driver for China property sales

–20

20

National sales y/y growth vs. M2 y/y growth, in %

0

5

10

25

20

30

15

40

100

80

60

120

–40

1Q18

1Q17

1Q16

1Q15

1Q14

1Q13

1Q12

1Q11

1Q10

1Q09

1Q08

National primary sales - commodity building (in % y/y, LHS)

M2 supply (in % y/y, RHS)



2018 was a difficult year for investors pursu-ing yield strategies; bonds and dividend-yield-ing stocks recorded negative returns due to rising interest rates, widening credit spreads and a stock market correction. With overall bond and dividend yields higher (JACI Com-posite now yields 5.8% versus 4.6% at the start of 2018), we see some opportunities for investors, especially in low-beta instruments that offer safe carry, which should help insu-late against near-term volatility. We expect the Fed to raise interest rates up to three times before 2019 ends, and for the 10-year US bond yield to be at 3.20% in 12 months.

Equities – Income growth and safety in some unexpected placesIncome-oriented investors tend to focus first on bonds, while Asian stocks’ overall 3% divi-dend yield also looks less appealing in compar-ison. However, we see pockets of high-yielding equity investments that are worth exploring. Chinese banks now yield over 5% and offer one of the highest dividend growth rates among key Asian sectors. They also pay out just one-third of their earnings, which helps anchor dividend sustainability even during market turbulence. From a country perspec-tive, Thailand and Taiwan stand out for their relatively rich offering of high-yielding stocks. Taiwanese banks, for example, boast a high

yield spread over the local government 10-year bond – which is likely to be sustainable. Inves-tors looking to enhance yields through a diver-sified portfolio of high and sustainable divi-dend-yielding stocks should also consider REITs in Singapore and Hong Kong.

Bonds – Attractive valuations, but mind the near-term market volatilityWe remain selective in our fixed income strat-egy despite attractive valuations, as market volatility is likely to stay elevated. Higher rates

Timothy Tay, Head APAC Credit Hartmut Issel, Head APAC Equity Teck Leng Tan, Analyst

Source: JP Morgan, Bloomberg, UBS, as of November 2018

Asia credit yields have risen substantially

3.0

4.0

3.5

4.5

5.0

5

7

6

8

9

105.5

Oct-17Oct-16Oct-15Oct-14Oct-13 Oct-18

In %

JACI HY YTM (in %, RHS)

JACI IG YTM (in %, LHS)

Idea 6

Search for yield: Stay safe



and a flattened US Treasury yield curve have dampened the search for yield, reversing the trend of credit spread compression. We expect credit spreads to remain range bound from here as investors re-focus on corporate fundamentals in their valuation of bonds. A positive outcome is that credit spread differ-entials between rating categories have wid-ened over 2018, signaling better credit quality differentiation. Within investment grade (IG), we prefer select BBB government-related issu-ers in China and Tier 2 financials in Asia, yielding about 5% for a 3–5-year duration. For high yield (HY), our preference is for short-dated (1–3 years) fundamentally stronger BB issuers, yielding about 7.5% for a 3-year duration.

Rising funding costs and currency mismatches are potential risks The funding costs of bond and stock carry trades have increased substantially since the beginning of 2018 (3-month LIBOR is now at 2.7% versus 1.7% back then, and is projected to rise to 3.3% by end-2019), which render the past strategy of borrowing to fund low-yielding bonds ineffective. We remain cautious about using leverage to magnify returns, especially for lower-yielding assets including single A bonds. An alternative carry strategy is to borrow in currencies such as the CHF or the JPY, as the funding costs remain low. However, we are mindful of the foreign exchange risk from currency mismatches. A key risk characteristic of safe-haven currencies is their inverse correlation to general risk sentiment. Both the CHF and the JPY tend to rally during periods of risk aversion, exposing investors to higher volatility.

Yield-seeking investors can look for opportunities in stocksComparison of income opportunities by country and sector

Current dividend yield

Yield spread (%) vs local 10Y govt bond

Payout ratio

Dividend growth (FY 2019)

By countryTaiwan 4.4% 3.5% 53% 6.5%

Thailand 3.0% 0.2% 43% 7.0%

By sector

China banks 5.3% 1.8% 34% 8.0%

Hong Kong REITs 4.2% 1.8% 97% 3.5%

Singapore REITs 5.2% 2.7% 97% 2.3%

Taiwan banks 4.7% 3.8% 54% 6.0%

Source: Bloomberg, UBS, as of November 2018



It’s been a difficult year for Japanese equity investors in 2018 – the TOPIX fell by more than 10% and volatility was elevated. We have been neutral all year in our global tacti-cal asset allocation and, at this stage, we look to stay that way in 2019 over concerns about Abenomics’s future and Bank of Japan (BoJ) normalization. This said, within Japan, we see

opportunities in select blue chips whose valu-ations have fallen to unduly low levels and companies involved in digital payments, and focus on longer-term themes like ESG leaders.

Beginning of the end of AbenomicsAbenomics is based upon the “three arrows” of monetary easing, fiscal stimulus and struc-tural reforms, all of which we see as having a lesser focus in 2019. With Prime Minister Shinzo Abe in his final term, we think his attention will shift to his longstanding ambi-tions of reforming the constitution and hiking the VAT (from 8% to 10%). Furthermore, the BoJ is planning to normalize policy in many ways that run counter to Abenomics – less purchases of Japanese government bonds (JGBs) and ETFs, which would lead the 10-year JGB yield higher (0.2–0.3%).

Macro-related headwinds and weak net profit growth – we forecast –2% for the 2018 fiscal year and 0% for 2019 – means we see little upside for Japan’s stock market relative to its global peers in 2019. Within Japan, however, we see tactical buying opportunities in blue chips as they seem oversold, with some P/E ratios dropping by more than 15% after no or only marginal adjustment to earnings expectations.

Daiju Aoki, Regional Chief Investment Officer & Chief Japan Economist Toru Ibayashi, Head Japan Equity Chisa Kobayashi, Analyst Teck Leng Tan, Analyst

Excluding financials, actual/CIO forecast (y/y, in %)


TOPIX 500 net profit growth

30

20

10

0

40

60

50

70

Mar

-19E

Mar

-18

Mar

-17

Mar

-16

Mar

-15

Mar

-14

Mar

-13

Mar

-20E

63%59%

4% 2%

22%

–2%

14%

0%

–10

Idea 7

Japan: Be selective



Economic growth above trendDecelerating global growth, especially in China, and ongoing uncertainty over US auto tariffs, which we expect to be mitigated by concessions, should continue to weigh on sen-timent and the equity market in 2019. Still, we expect growth to remain above trend in 2019, supported by a moderate acceleration in wages and capex due to the tightening labor market, which should lift domestic demand. With Japan’s unemployment rate already below 2.5%, companies need to hire more foreigners to fill vacancies and invest to improve labor efficiency. Capex plans, which are already at their highest level in over 20 years, are there-fore set to climb even higher in 2019.

Meanwhile, we expect USDJPY to fall to 110 in three, 107 in six and 105 in 12 months. In the short term, USDJPY could sustain in a 110–115 range with the Fed hawkish and the BoJ dovish. But we expect the pairing to embark on a downtrend by mid-2019, when the Fed likely turns more neutral given the advanced stage of the cycle and the BoJ starts to guide policy rates higher on the back rising inflation expectations.

Japan embraces sustainable investing Despite its early stage in Japan, we think sus-tainable investing has great potential and could attract sizeable sums of investment in the coming years. Japan’s ESG penetration in investment assets is still low (3.4% out of total manages assets) compared to Europe

(53%) and the global average (26%), while Japan’s overall ESG rating is slightly higher than the global average. Japan’s GPIF, the world’s largest pension fund, and the BoJ are pushing for ESG-related initiatives, which could be a catalyst for change in corporate labor practices and governance overall.

Source: Ministry of Health, Labour and Welfare, UBS, as of November 2018

Japanese companies are likely to hire more foreigners in coming years

0

2

1

7

6

5

4

3

40

0

120

80

320

280

240

200

127.9

190.9

315.9

160

8

2024

2023

2022

2021

2020

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

UBS view (total number of foreign workers, in ten thousands, LHS)

Ratio of foreign labor force to total labor force (%, RHS)

Number of foreign workers (ten thousands, LHS) and ratio of foreign labor forece to total labor force (%, RHS)

2025

2%

3%

5%

Specialized and technical sectors (LHS)

Designated activities (LHS)

Skill training (LHS)

Overseas activities such as studying abroad (LHS)

Resident, permanent resident and his/her spouse (LHS)

ESG/Sustainable Investing Considerations: Sustainable investing strategies aim to consider and in some instances integrate the analysis of environmental, social and governance (ESG) factors into the investment process and portfolio. Strategies across geographies and styles approach ESG analysis and incorporate the findings in a variety of ways. Incorporating ESG factors or Sustainable Investing considerations may inhibit the portfolio manager’s ability to participate in certain investment opportunities that otherwise would be consistent with its investment objective and other principal investment strategies. The returns on a portfolio consisting primarily of ESG or sustainable investments may be lower or higher than a portfolio where such factors are not considered by the portfolio manager. Because sustainability criteria can exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. Companies may not necessarily meet high performance standards on all aspects of ESG or sustainable investing issues; there is also no guarantee that any company will meet expectations in connection with corporate responsibility, sustainability, and/or impact performance.



Tactical viewsMacroAsset allocationEquitiesBondsCurrencies



Philip Wyatt, Economist Valerie Chan, Analyst

Source: CEIC, UBS, as of November 2018

Higher policy rates counter higher CPI and lower FX reserves - as in 2005

–10

10

0

60

50

40

30

20

0

–1

2

1

7

6

5

4

3

70

2014201020062002 2018

Asia Policy rates (ex-Japan) (in %, LHS)

CPI Asia (ex-Japan) (in %, LHS)

Policy rate, CPI (in %) FX reserves (y/y, in %)

FX reserves (Asia ex-Japan) (y/y, in %, RHS)

2018 was a story of firm economic growth in Asia, and though investment broadened out, trade balances deteriorated in most of the region’s economies. In 2019, we expect slowing exports to cut Asian GDP growth by 0.4ppt to 5.8% and global GDP growth to slow as higher policy rates pinch demand. China will likely ease policy further in 1H19 as policymakers seek to support demand, while central banks in the rest of Asia should stop tightening.

Exports slowdown to intensify…Asian exports delivered robust double-digit growth in 1H18, but then decelerated on a sequential basis through 2H18 as demand softened from the EU and China and IT-related exports weakened. We expect Asia’s recent downtrend in export growth to inten-sify to low single digits in 2019, largely driven by a slowdown in US demand (CIO forecasts US real GDP growth to slow from 2.8% in 2018 to 2.4% in 2019).

…partly due to payback from front-loadingUS tariffs on Chinese goods were a catalyst for the export slowdown – tariffs of 10% came into effect on USD 200bn of Chinese products in September with the risk of a step-up to 25% if new talks between the two countries were to fail. US importers have brought for-ward purchases ahead of the tariff increase, causing Chinese export growth to accelerate in 2H18. So we expect a drop-off in exports in 1Q19, and forecast Chinese export growth to slow to low single digits and remain below 5% for most of 2019. For Asia as a whole, we expect export growth to weaken (as global growth also slows) to around 5% in 2019 from about 9% in 2018.

Corporate investment should hit a soft patchWe believe tariffs will also harm investment and erode profits in Asia. Incomes in Asia are

Asset classes

Tactical view - Macro



Note: Economic activity index is a diffusion index of real exports, industrial production and retail sales volumesSource: CEIC, UBS, as of November 2018

Asian export slowdown will weigh on economic activity

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2014201020062002 2018

Economic activity index (Asia ex-Japan) (LHS)

Asia exports ex-Japan (SA) (in %, RHS)

Economic activity index Exports, in %

highly sensitive to export growth and have traditionally funded purchases of machinery and equipment, so corporate investment should hit a soft patch in 2019. That said, the key question is how long will it take for tariff-hit trade to be substituted away from China to other parts of Asia. In the years ahead, Vietnam, Thailand and Malaysia should ben-efit from an accelerated industrial relocation from China as global companies diversify their supply chains.

Regional central banks likely stop policy tightening….As we enter 2019, we expect Asia to have mostly completed its policy tightening, with just Taiwan and Korea left to hike a couple more times. The lagged impact of this tightening should feed through to slower production, credit and imports growth, all of which should be more visible by 2H19. But there is also risk that the external deficit economies of Indone-sia, India and the Philippines – current account deficits in 2019 expected to be 2.6%, 2.5% and 3.2% of GDP respectively – will need to “top up” with additional rate hikes in 1Q19 as their exports slow amid weaker global demand. The key factor to watch for these economies is whether they can stabilize their current account deficits and official FX reserves as US monetary tightening advances further – we expect three hikes in the fed funds rate in 2019.

…and China’s policy stimulus brings stabilityChina is much further ahead in its business cycle than Asia is overall, with its economy slowing and credit regulations tightened. But Beijing has been loosening policy since July, and could ease further if data worsens as if fights to keep real GDP growth above 6% (as targeted by the Chinese government). In our base case, we forecast a moderate rebound in infrastructure investment helped by multiple rounds of reserve requirement ratio cuts – we

expect 100–200bps in 2019 – and faster credit growth. This should offer a stable envi-ronment for the rest of Asia. China’s climb up the technology value-added ladder should also help support capital and IT goods trade with Korea and Japan.

Oil prices the risk to a benign inflation outlook Inflation remains benign (currently 2.3% in Asia) and we expect it to moderately rise to 2.7% by end-2019. Oil remains the key risk to regional inflation and to lesser degree food. However, after crude oil’s spectacular slump, the likelihood of a spike back to USD 100/bbl seems a distant prospect. Still, it cannot be ruled out as our base case is for prices to recover back to USD 80/bbl in six months. The national elections in Indonesia and India also pose modest inflation risks if state-controlled fuel subsidies were to be reset post-election.



Adrian Zuercher, Head APAC Asset Allocation Crystal Zhao, Strategist

Volatility staged a revival in 2018 as markets faced the peak in global liquidity conditions and tensions between the two global super-powers, China and the US, heated up. The coming year is supposed to bring more of the same as the economic cycle draws closer to its tail end. After 3.8% in 2018, we expect global economic growth to slow to 3.6% in 2019 – but we don’t see the conditions com-monly associated with an impending reces-sion. The silver lining is that China is expected to ease policy to support growth, trade ten-sions could be dialed back somewhat and earnings for Asian equities should grow by mid-to-high single digits next year.

Given this outlook, we expect market volatility to stay elevated in the year ahead. So our investment strategy is to mitigate risk without compromising on potential returns. We rec-ommend a strategically well-diversified global portfolio across different asset classes as the first line of defense. Our second tactic is to operate within the full spectrum of our tacti-cal universe, and being more flexible in shift-ing between risky assets to bonds as expected returns dictate. Our third method is to gener-ate returns through relative long/short posi-tions in select markets and asset classes where we see valuation mismatches.

Asia’s beaten-down equity valuations we think offers an opportunity to be tactically overweight, as fundamentals appear more solid than market sentiment suggests. This is contingent on China-US relations not deterio-rating further. To manage the risk attached to our overweight Asia ex-Japan equities, we combine it with a short position on the KRW against the USD as a partial hedge given the won’s sensitivity to global trade.

Within Asia, we’re selecting markets that offer better value than those with similar risk characteristics. We see these opportunities currently by going long China, South Korea, Singapore, and Indonesia and short Hong Kong, Taiwan, Malaysia, and the Philippines. Also, for carry, we’re overweight JACI high yield versus JACI investment grade bonds and in currency, we are long SGDTWD.

Asset classes

Tactical view - Asset allocation


Asian equities are pricing in a combined sub-50 PMI new orders for the US and Asia

44

41

38

35

62

59

56

53

50

47

0

–20

40

20

80

60

–40

–60

–80

–100

65100

201620142012201020082006 2018

MXASJ return (in % y/y, LHS)

APAC PMI new orders + US ISM new orders (RHS)



Hartmut Issel, Head APAC Equity Sundeep Gantori, Analyst Delwin Kurnia Limas, Analyst

Historical returns of Asia ex-Japan equities based on their starting valuationsPrice-to-book (P/B) valuations

Frequency 6M returns 12M returns

<1.2 P/B 3% 43% 70%

1.2–1.35 P/B 9% 13% 28%

1.35–1.5 P/B 30% 6% 10%

1.5–1.9 P/B 40% 2% 8%

>1.9 P/B 18% –9% –9%

Grand Total 100% 4% 10%

Source: Bloomberg, Factset, UBS, as of November 2018

Asset classes

Tactical view - Equities


Select financials and IT names for their strong diversification benefits between growth and value, and equities with high domestic exposure amid the China-US trade tensions.

Beneficiaries of Chinese stimulus, like materials and infrastructure names, given accelerating infrastructure spending.

Vietnam for its structural consumption growth story and potential to receive manufacturing re-routing from China.

High-yielding dividend stocks with sustainable payouts, like Singapore and Hong Kong REITs, for their defensive traits and attractive yields.

Key numbers

6.6% – our earnings growth estimate for Asian equities in 2019 (vs. an estimated 10.6% in 2018). Earnings growth should slow on trade-related uncertainty, but should broaden out with ASEAN and India outpacing North Asia.

Low single-digit re-rating potential in 2019. China/US tariffs should moderate regional earnings growth, but valuations near their support levels (based on ROE estimate of 11% for 2019) do not reflect fundamentals.

10% historical returns for Asian markets in the 12 months after P/B valuations fall to 1.35–1.5x.

Key trends

Expect a moderate slowdown in 2019 earnings growth due to tariff impact. Con-sensus earnings downgrades are likely to con-tinue over the next few months, as we see 4ppt downside to their 10.8% EPS growth estimate.

Near 10-year high operating margins are likely to decline by 25–30bps in 2019 given the tougher macro environment, bringing the region’s ROE down to 11% in 2019 from an estimated 11.5% in 2018.

Capex tailwinds unlikely to last, but pay-outs likely to rise. We think room for further spending cuts is limited. But with the payout ratio at only 34.5%, below the 10-year average of 36%, we expect increased payouts in 2019 to provide a buffer against market turbulence.



Timothy Tay, Head APAC Credit Devinda Paranathanthri, Analyst

Source: JP Morgan, Bloomberg, UBS, as of November 2018

Asia USD bond yields at highest levels seen in the past five years

3.0

4.0

3.5

4.5

5.0

5

7

6

8

95.5

Jul-17Jul-16Jul-15Jul-14Jul-13 Jul-18

Asia IG YTM (in %) and Asia HY YTM (in %)

Asia HY YTM (in %, RHS)

Asia IG YTM (in %, LHS)

Asset classes

Tactical view - Bonds


BBB

Select BBB rated bonds, as spreads between BBB and single A bonds have widened to 100bps from a trough of 30bps.

Bank Tier 2 debt, which offers a 50–100bps spread pick-up on average to senior peers.

Perpetuals with high step-ups, to take advantage of perp underperformance due to higher rates and the lower extension risk of those with high step-up coupons.

Shorter-dated HY China property, as they now offer high-single to double-digit yields after recent issuance pushed valuations wider.

Select SOE names in Asia in IG and HY on the back of strong government support.

Key numbers

3–4% – our 2019 total return forecast for the JP Morgan Asia Credit Index (vs. –2.3% YTD).

9.0% YTM of HY, the widest in the past five years. We believe this provides a good cush-ion against spread volatility.

USD 220bn of new issuance in 2019, similar to 2018 (USD 210–220bn estimated) and lower than 2017 (USD 290bn) due to market volatility.

Key trends

Attractive valuations – Asia credit valuations are attractive, with yields (5.0% for IG and 9.0% for HY) at their highest levels in the past five years. Spreads therefore have to widen sub-stantially to incur negative returns.

Fundamentals – Macro headwinds relating to trade tensions and slowing growth may limit any improvement in credit fundamentals in 2019. Liquidity conditions and issuers’ ability to refinance need to be watched.

Balanced technicals – Total bond maturities in 2019 are around USD 140bn, up from USD 88bn in 2018, which will result in lower net issuance. This should provide some cushion in an environment where demand is weak.



Dominic Schnider, Head Commodities and APAC FX Teck Leng Tan, Analyst


Long SGD, short TWD – The MAS is more hawkish than Taiwan’s central bank, and the SGD benefits from MAS’s policy of SGD NEER appreciation.

Long USD, short KRW – We expect short-term USD strength on the back of rising US interest rates, while the KRW is sensitive to slowing exports.

$ Long USD, short North Asian basket (50% CNY, 25% TWD, 25% KRW) – Slowing Chinese economic growth and a disappearing current account surplus should weaken the CNY over 12 months, dragging down other North Asian currencies.

Yield enhancement for local currency deposits using USD as an alternate currency, given our view for USD strength versus APAC currencies in 3–6 months.

Key numbers

2.4% – CIO’s forecast for US economic growth in 2019, from 2.8% in 2018. Relief for APAC currencies should come toward mid-2019 as US growth slows and as the Fed approaches the end of its rate hike cycle.

7.3 – USDCNY by end-2019. Unlike other APAC currencies, we don’t expect the CNY to recover versus the USD due to slowing Chinese economic activity and a disappearing current account surplus.

Key trends

More pain and then relief for APAC currencies. We see more downside for APAC currencies versus the USD in 3–6 months driven by a rising US yield advantage. APAC currencies should find relief toward mid-2019 as the Fed adopts a more neutral bias.

Asia’s slowing exports cycle to cap APAC currencies’ rebound potential. Although we expect APAC currencies to find a trough versus the USD in 1H19, a slowing export cycle in Asia should cap APAC currencies’ rebound potential. We see little to no spot appreciation on average for APAC currencies versus the USD in 2019.


USD found a peak in late 2005 when Fed turned neutral, even though the rate hike cycle had not ended

0

2

1

5

4

3

70

65

80

75

105

100

95

90

85

6

2016201420122010200820062004 2018

US dollar index (LHS) Fed funds rate (in %, RHS)

Fed funds rate (in %, RHS) versus US dollar index (LHS)

Asset classes

Tactical view - Currencies



UBS APAC economic forecasts% change y/y

Forecasts for APAC currencies versus the USDWe expect APAC currencies to find a trough in 3–6 months, versus the USD

Real GDP CPI

2017 2018F 2019F 2020F 2017 2018F 2019F 2020F

Australia 2.2 3.3 2.8 2.6 1.9 2.0 2.1 2.1

New Zealand 2.8 2.8 2.8 2.5 1.9 1.6 2.1 2.0

China 6.9 6.5 6.0 6.0 1.6 2.2 2.0 1.8

Vietnam 6.8 6.9 6.6 6.6 3.5 3.7 3.8 3.5

Indonesia 5.1 5.3 5.0 5.1 3.8 3.2 4.2 5.2

Malaysia 5.9 4.7 4.0 4.6 3.8 1.1 2.3 2.4

Philippines 6.7 6.3 6.1 6.1 2.9 5.4 4.3 3.1

Thailand 3.9 4.4 3.1 3.3 0.7 1.2 1.3 1.2

South Korea 3.1 2.8 2.6 2.9 1.9 1.6 2.1 1.5

Taiwan 2.9 3.0 2.6 2.8 0.6 1.6 1.4 1.5

India 6.7 7.3 7.3 7.4 3.6 4.2 4.6 4.4

Singapore 3.6 3.3 2.0 2.2 0.6 0.5 1.5 1.8

Hong Kong 3.8 3.8 3.0 3.3 1.5 2.8 3.8 3.4

Japan 1.7 1.0 1.7 1.0 0.5 1.0 1.7 3.0

Asia ex-Japan 6.2 6.2 5.8 5.9 2.2 2.7 2.8 2.7

APAC 5.6 5.6 5.3 5.3 2.0 2.5 2.7 2.7

Source: UBS, as of 26 November 2018

29-Nov-18 3M 6M 12M

USDCNY 6.94 7.10 7.20 7.30

USDHKD 7.82 7.80 7.80 7.80

USDIDR 14395 15750 15500 15250

USDINR 70.6 77.0 75.0 73.0

USDKRW 1122 1170 1170 1150

USDMYR 4.19 4.18 4.15 4.10

USDPHP 52.4 56.0 56.0 55.0

USDSGD 1.37 1.40 1.38 1.37

USDTHB 32.9 34.0 34.0 33.3

USDTWD 30.9 31.5 31.5 31.2

AUDUSD 0.73 0.71 0.73 0.75

NZDUSD 0.68 0.65 0.68 0.71

USDJPY 113 110 107 105

Source: Bloomberg, UBS, as of 29 November 2018



APAC-focused tactical asset allocation deviations from benchmark*

Liquidity

Equities total**

Glo

bal

eq

uit

ies

Asi

an e

qu

itie

s

Global

US

Eurozone

UK

Switzerland

Canada***

Japan

EM

Australia***

Asia ex Japan

China

Hong Kong

India

Indonesia

South Korea

Malaysia

Philippines

Taiwan

Thailand

Singapore

underweight neutral overweight

* Please note that the bar charts show total portfolio preferences, which can be interpreted as the recommended deviation from the relevant portfolio benchmark for any given asset class and sub-asset class. ** We are holding a put option on the S&P 500 to partly protect the tactical asset allocation. *** Note: equity risk profile only.Source: UBS, as of 26 November 2018

Bo

nd

sD

urat

ion

Cu

rren

cies

underweight neutral overweight

Bonds total

USD high grade bonds

USD corporate bonds (IG)

USD high yield bonds

EUR high yield bonds

Asian investment grade bonds (USD)

Asian high yield bonds (USD)

EM sovereign bonds (USD)

EM corporate bonds (USD)

EM bonds (local currencies)

Italian 2-year govt bond overlay

USD duration

JPY duration

USD

EUR

GBP

JPY

CHF

CAD

NZD

AUD

SGD

BRL

TWD

KRW

Current Old

Tactical asset allocation

These preferences are designed for a global investor who can hedge foreign currency fluctuations. For models that are tailored to US investors, please see UBS House View Monthly Letter.



Editor-in-chiefWayne Gordon

Product managementDelwin Kurnia Limas Valerie Chan Sita Chavali Michael Cheong

EditorsAaron Kreuscher Murugesan Suppayyan

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Desktop publishingPavan Mekala*

Editorial deadline30 November 2018

Contactubs.com/cio

* An employee of Cognizant Group. Cognizant staff provides support services to UBS.



ESG/Sustainable Investing Considerations: Sustainable investing strategies aim to consider and in some instances integrate the analysis of environmental, social and governance (ESG) factors into the investment process and portfolio. Strategies across geographies and styles approach ESG analy-sis and incorporate the findings in a variety of ways. Incorporating ESG factors or Sustainable Investing considerations may inhibit the portfolio manager’s ability to participate in certain invest-ment opportunities that otherwise would be consistent with its investment objective and other principal investment strategies. The returns on a portfolio consisting primarily of ESG or sustainable investments may be lower or higher than a portfolio where such factors are not considered by the portfolio manager. Because sustainability criteria can exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. Companies may not necessarily meet high performance standards on all aspects of ESG or sustainable investing issues; there is also no guarantee that any company will meet expecta-tions in connection with corporate responsibility, sustainability, and/or impact performance.

Emerging Market InvestmentsInvestors should be aware that Emerging Market assets are subject to, amongst others, poten-tial risks linked to currency volatility, abrupt changes in the cost of capital and the economic growth outlook, as well as regulatory and socio-political risk, interest rate risk and higher credit risk. Assets can sometimes be very illiquid and liquidity conditions can abruptly worsen. CIO GWM generally recommends only those securities it believes have been registered under Federal U.S. registration rules (Section 12 of the Securities Exchange Act of 1934) and individual State registration rules (commonly known as “Blue Sky” laws). Prospective investors should be aware that to the extent permitted under US law, CIO GWM may from time to time recommend bonds that are not registered under US or State securities laws. These bonds may be issued in jurisdictions where the level of required disclosures to be made by issuers is not as frequent or complete as that required by US laws.

For more background on emerging markets generally, see the CIO GWM Education Notes, Emerging Market Bonds: Understanding Emerging Market Bonds, 12 August 2009 and Emerg-ing Markets Bonds: Understanding Sovereign Risk, 17 December 2009.

Investors interested in holding bonds for a longer period are advised to select the bonds of those sovereigns with the highest credit ratings (in the investment grade band). Such an approach should decrease the risk that an investor could end up holding bonds on which the sovereign has defaulted. Sub-investment grade bonds are recommended only for clients with a higher risk tolerance and who seek to hold higher yielding bonds for shorter periods only.

DisclaimerResearch publications from Chief Investment Office Global Wealth Management, formerly known as CIO Americas, Wealth Management, are published by UBS Global Wealth Management, a Busi-ness Division of UBS AG or an affiliate thereof (collectively, UBS). In certain countries UBS AG is referred to as UBS SA. This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein does not constitute a personal recommendation or take into account the par-ticular investment objectives, investment strategies, financial situation and needs of any specific recipient. It is based on numerous assumptions. Different assumptions could result in materially



different results. We recommend that you obtain financial and/or tax advice as to the implications (including tax) of investing in the manner described or in any of the products mentioned herein. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opin-ions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or com-pleteness (other than disclosures relating to UBS). All information and opinions as well as any prices indicated are current only as of the date of this report, and are subject to change without notice. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result of using different assumptions and/or criteria. At any time, investment decisions (including whether to buy, sell or hold securities) made by UBS and its employees may differ from or be contrary to the opinions expressed in UBS research publications. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be diffi-cult to quantify. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, into other areas, units, divisions or affiliates of UBS. Futures and options trading is considered risky. Past performance of an investment is no guarantee for its future performance. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in FX rates may have an adverse effect on the price, value or income of an investment. This report is for distribution only under such circumstances as may be permitted by applicable law.

Distributed to US persons by UBS Financial Services Inc. or UBS Securities LLC, subsidiaries of UBS AG. UBS Switzerland AG, UBS Deutschland AG, UBS Bank, S.A., UBS Brasil Administradora de Valores Mobiliarios Ltda, UBS Asesores Mexico, S.A. de C.V., UBS Securities Japan Co., Ltd, UBS Wealth Management Israel Ltd and UBS Menkul Degerler AS are affiliates of UBS AG. UBS Financial Services Incorporated of PuertoRico is a subsidiary of UBS Financial Services Inc. UBS Financial Services Inc. accepts responsibility for the content of a report prepared by a non-US affiliate when it distributes reports to US persons. All transactions by a US person in the securi-ties mentioned in this report should be effected through a US-registered broker dealer affiliated with UBS, and not through a non-US affiliate. The contents of this report have not been and will not be approved by any securities or investment authority in the United States or elsewhere. UBS Financial Services Inc. is not acting as a municipal advisor to any municipal entity or obli-gated person within the meaning of Section 15B of the Securities Exchange Act (the “Municipal Advisor Rule”) and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of the Municipal Advisor Rule.

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Version as per April 2018.

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