Global EM Equity Strategy: 2017 outlook: Staying the course

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 1 December 2016 Global/Asia Pacific/EEMEA/Latin America Equity Research Investment Strategy Global EM Equity Strategy Research Analysts Alexander Redman 44 20 7883 6896 alex.redman@credit-suisse.com Arun Sai 44 20 7883 0002 arun.sai@credit-suisse.com STRATEGY 2017 outlook: Staying the course Source: iStock.com ■ The blend of a significantly looser fiscal policy espoused by President-elect Donald Trump in combination with our forecast for a tighter Federal Reserve monetary policy provides a textbook scenario for US currency strength—typically detrimental to emerging equity investing. In combination with our anticipated cooling of the Chinese residential real estate market, this will likely serve to restrict absolute and relative performance dynamics for emerging markets in 2017. ■ Nevertheless, we maintain a recommended overweight stance on emerging markets in a global equities portfolio (albeit advocating a smaller above-benchmark stance than a year ago) with an MSCI EM index price target of 920 indicating 8% potential US dollar return by year-end 2017. We identify eight positive attributes for the 2017 emerging market investment case while warning of five credible risks to the narrative. ■ We continue to believe in a sustained outperformance of value as a style within emerging markets, as growth loses its scarcity premium in a more broad-based recovery, incentivizing investors to seek cheaper assets offering similar growth rates. ■ We recommend overweight positions on China, Korea, Brazil and Indonesia, funded by underweights on Taiwan, India, South Africa, Malaysia, Thailand, Chile and Poland. We have a benchmark stance on Russia, Mexico, Philippines and Turkey. 1 December 2016 Global EM Equity Strategy 2 Table of contents Focus charts 3 Recommended EM country weights 4 Emerging markets top ideas list 5 Executive summary 6 Staying the course 10 China (5% overweight) 38 Korea (10% overweight) 49 Taiwan (5% underweight) 58 India (15% underweight) 68 Brazil (10% overweight) 77 South Africa (15% underweight) 91 Russia (benchmark) 105 Mexico (benchmark) 113 Malaysia (15% underweight) 128 Indonesia (20% overweight) 136 Thailand (20% underweight) 142 Philippines (benchmark) 147 Chile (20% underweight) 151 Poland (5% underweight) 154 Turkey (benchmark) 160 Appendix I: Emerging markets FX scorecard 169 Appendix II: Emerging market valuation metrics 170 1 December 2016 Global EM Equity Strategy 3 Focus charts Figure 1: EM net income margins are recovering, boosted by faster growth in productivity than in wages Figure 2: EM currencies remain particularly cheap (on deviation from PPP) versus long-run history Source: Thomson Reuters, Credit Suisse research Source: Oxford Economics, Thomson Reuters, Credit Suisse research Figure 3: EM earnings revisions are on the cusp of breaking positive for the first time in six years Figure 4: Owing to improved capex discipline, we forecast free cash flow yields to hit multi-year highs Source: MSCI, I/B/E/S, Credit Suisse research Source: Credit Suisse HOLT, Credit Suisse research Figure 5: But the risk of further structural US dollar strength in 2017 may limit EM/DM relative returns Figure 6: Moreover, we expect 2017 to be characterised by a cooling in Chinese real estate Source: MSCI, Bank of England, Credit Suisse research Source: China National Bureau of Statistics, Credit Suisse research -12-9-6-303694%5%6%7%8%9%10%11%Jan 97Jan 00Jan 03Jan 06Jan 09Jan 12Jan 15Emerging market non-financial net profit margin (%, LHS)EM7 productivity versus wage differential (detrended, RHS)-65%-60%-55%-50%-45%-40%-35%Jan 95Jan 99Jan 03Jan 07Jan 11Jan 15EMEM exChina-50%-30%-10%10%30%50%70%-20%-15%-10%-5%0%5%10%Jan 00Jan 03Jan 06Jan 09Jan 12Jan 15EM breadth in earnings revisionsEM yoy performance (RHS)-2%0%2%4%6%8%10%12%Emerging marketsEM materials & energyEmerging markets ex resources80130180230280330380708090100110120130Jan 88Jan 92Jan 96Jan 00Jan 04Jan 08Jan 12Jan 16Trade weighted dollar (LHS, inverted)MSCI EM / MSCI World (RHS)-12%-8%-4%0%4%8%12%-20%0%20%40%60%80%100%Jan 98Jan 01Jan 04Jan 07Jan 10Jan 13Jan 16China res. real estate sales(CNY, yoy % chg, LHS)China (70 cities) real houseprices (yoy % chg, RHS) 1 December 2016 Global EM Equity Strategy 4 Recommended EM country weights Figure 7: Credit Suisse recommended country weights ver