Welcome to Thoughts on the Market. I'm Jonathan Garner, Chief Asia and Emerging Markets Equity Strategist for Morgan Stanley Research. Along with my colleagues bringing you their perspectives, today I'll be talking about the path ahead for Taiwan equities. It's Thursday, September 9th, at 7:30am in Hong Kong.
Taiwan equities have been a standout in a generally poor environment for Asia equities this year. In fact, year-to date, only India and Taiwan have come close to keeping up with the performance of the S&P 500. But although we're staying Overweight India, we recently cut our recommendation on Taiwan from Equalweight to Underweight. So let's dive into the confluence of factors behind this.
First, equity valuations are high. The MSCI Taiwan index, which comprises large and mid-cap segments of the Taiwan equity market, is trading at the highest valuation premium to overall emerging markets since the TMT / Dot-com bubble. Market cap to GDP is at an all-time high of 240%. For some perspective, the 20-year average is 137%.
This surge in valuations has been driven by a combination of a boom in retail investor trading activity - which recently has been running at 7x the rate of early 2016 - and also a very strong cycle of Tech spending.
However, we see early signs that both these forces are starting to roll over. Retail trading volume in August was down 34% on July and in 2022 we expect a marked softening in demand for PCs, TV and Mobile handsets. Indeed, we expect PC demand to shrink after two back-to-back years of double-digit growth.
Second issue is that risks over the Delta variant are rising. Although Taiwan outperformed last year in COVID management, vaccination performance has lagged this year with only around 7% of the population fully vaccinated currently on our estimates.
Thirdly, Taiwan geopolitical risks are rising. Tensions over sales of US military equipment to Taiwan and heightened activity by Chinese military aircraft in Taiwan’s declared Air Defense Identification Zone are both key developments worth monitoring.
And finally, Taiwan equities are the most correlated major EM market to Nasdaq. US equity valuations and Nasdaq valuations are also very high to history and global peers, driving the cautious stance of our US equity strategy team.
The bottom line for investors? My team and I recently introduced a new June 2022 target of 16,000 for the key benchmark Taiwan index TAIEX. And that's down from our December 2021 prior target of 16,500 - or around 5-7% downside in local currency terms versus current spot levels. And this compares with mid-single-digit upside for the overall MSCI Emerging Market Index.
We've also lowered our base-case target valuation multiple (down to 19x from a prior 20x) to reflect lower earnings growth into 2022 given a high-base this year and slowing global and Taiwan GDP growth; the potential further retreat of retail trading activity, the likelihood that the U.S. Fed will taper and our expectation of a Taiwan policy rate hike in the second quarter of 2022.
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