Box 6: Can Indian equities find their groove?

Growth or Value?

Value has beaten Growth in 2018, but their relative index remains at the 12th percentile of its historical distribution since 1997 (Figure 102). This ratio is even more stretched for DM. It is largely EM Value sectors, such as materials, energy, financials and utilities that are cheap relative to DM, while Growth-overweight sectors – consumer discretionary, consumer staples and health care – still screen as expensive.

EM Value has room to beat EM Growth in 2019

Figure 102: MSCI EM and DM: Value/Growth relative indices

Source: MSCI, Datastream, UBS

Figure 103: Percentile of current 12m fwd P/E relative to MSCI World (since 2002) vs 6m revisions in 12m fwd EPS

15Cheap and being upgraded

12m fPE relative to DM (percentile since 2002)

Source: IBES, MSCI, Datastream, UBS

These expensive Growth-oriented sectors are precisely the ones facing larger earnings downgrades (Figure 103). The few markets in which we have seen EPS upgrades – Russia, Brazil, Chile, Mexico and Taiwan – have been driven by their deep value sectors: energy and mining. A China infrastructure stimulus should be less relevant for the rest of the EM in this cycle, but should provide some support for commodities, and therefore for Value stocks, over a threeto six-month horizon. Meanwhile, Growth is still adjusting.

EM Growth sectors are facing bigger earnings downgrades than EM Value sectors

Leading indicators suggest Growth heavyweights, consumer and tech, will remain under pressure for now

Consumer sentiment indices across the major constituent countries of the MSCI EM consumer discretionary (Figure 104) show a reasonably strong correlation with trends in EM consumer stocks (Figure 105). Into early 2019 we expect EM consumer spending and consumer sentiment to weaken further as housing markets weaken modestly, financial conditions tighten and trade incomes slow down. This will keep EM Growth under some pressure.

An EM-wide consumer sentiment index explains the performance of MSCI EM consumer discretionary stocks

Figure 104: MSCI EM consumer discretionary: Country composition

Figure 105: Wt avg. percentile of consumer sentiment indices vs composite cons disc price index

Our new UBS Tech Index, that we also used in our MSCI EM first principal component of three series: i) y/y growth in global semiconductor sales; ii) Japan memory chips sales to inventory (3mma); and iii) Japan semiconductor devices sales to inventory (3mma) – is strongly correlated with the level of the MSCI EM index and underlying earnings (Figure 106). The index peaked in September 2017, and has been a harbinger of the ongoing down market for IT globally. In the absence of any signs of a turning point, and being roughly only halfway back to its 2015 trough levels, our Tech Index gives little optimism on the EM IT sector in the coming months.

Our new UBS Tech Index – a harbinger of the EM tech cycle – shows little optimism for the sector

Another metric, which should become even more relevant for EM Tech after the upcoming GICS re-classification, is DRAM prices. Spot prices have shown a correlation of over 90% with the MSCI EM IT index since the start of the EM 'bull market' in 2016 (Figure 107). That said, EM IT 12-month trailing earnings have not yet been affected as contract prices remained at their peak levels until last month, while share prices have been pricing in the deteriorating outlook. Our analysts expect the DRAM downcycle to continue for the next six to seven quarters, with a c45% peak-to-trough decline. This is a more pessimistic forecast than consensus projections and recent guidance from Samsung Electronics. Please see the box on the semiconductor cycle from the UBS head of APAC Tech Research, Nicolas Gaudois, on the following pages.

DRAM prices should fall further; UBS has more pessimistic forecasts than consensus and Samsung's guidance

Figure 106: UBS Tech Index vs MSCI EM IT price index and 12m trailing EPS

11 12 13 14 15 16 17 18 MSCI EM IT: Price index

MSCI EM IT: 12m trailing EPS

First principal component of tech indicators (RHS)

Source: Haver, Bloomberg, MSCI, Datastream, UBS

Figure 107: DRAM prices vs MSCI EM IT price index and 12m trailing EPS

Corr b/w DRAM spot

$4

105 and MSCI EM IT $3

Price index: +0.92

MSCI EM IT: 12m trailing EPS

MSCI EM IT: Price index

DRAM (8Gb DDR4) spot price (RHS)

DRAM (8Gb DDR4) contract price (RHS)

Source: DRAMeXchange, MSCI, Datastream, UBS

In the context of an unappealing outlook for the two major EM Growth sectors – IT and consumer discretionary – we recommend being long EM Value relative to EM Growth as a near-term trade. Once valuations have adjusted, we expect Growth stocks to offer better exposure to EM's more dynamic segments and to constitute a better medium-term investment. So far, investors remain overweight in Growth-oriented stocks despite the fact that market sentiment has retreated nearly two-thirds from the market peak earlier this year towards the 2016 market trough – please see our box on 'capitulation' in EM equities for further detail.

Long EM Value relative to EM Growth in the near term