Taiwan Likely to Continue Outperforming

Taiwan Likely to Continue Outperforming

INTRODUCTION

Despite the instability emanating from mainland China, Taiwan has been a beacon of stability.  With fundamentals expected to remain strong, we think outperformance by Taiwan assets is likely to continue.

POLITICAL OUTLOOK

The situation ahead of the presidential election is getting interesting.  Current President Ma Ying-jeou of the KMT cannot run for a third term in the next elections in January 2016.  Ma stepped down as party leader back in December 2014 after his KMT did poorly in local elections.   Parliamentary elections will be held at the same time as the presidential vote.
Right now, it appears that the race will boil down to two women.  The KMT has confirmed deputy speaker of the parliament Hung Hsiu-chu as its likely presidential candidate.  However, she faces an uphill battle as the public has shown strong opposition to the KMT’s efforts to deepen ties with mainland China.  For instance, the KMT proposal for the Trade and Services Agreement (TISA) led to a five-week occupation of parliament last year.

Running against Hung will be opposition DPP candidate Tsai Ing-wen.  While she has vowed to maintain cordial relations with the mainland, the DPP has maintained independence as a formal goal for Taiwan.  This would be problematic for cross-straits relations, to say the least.  For now, we expect the status quo in China-Taiwan relations to be maintained ahead of the January elections.

ECONOMIC OUTLOOK

GDP growth has slowed three straight quarters to 0.5% y/y in Q2 2015, which was the slowest rate since Q2 2012.  Monthly data so far in Q3 suggest further slowing ahead.  The IMF forecasts 2015 and 2016 GDP growth at 3.8% and 4.1%, respectively.  Both seem too optimistic.

The central bank has kept its policy rate at 1.875% since the last 12.5 bp hike back in Q2 2011.  CPI fell -0.7% y/y in July, the seventh straight month of deflation.  Low base effects should see the y/y rate rise to positive y/y territory as H2 progresses.  Still, the weak economic outlook supports our view that the central bank could embark on an easing cycle at its September quarterly meeting.

Export orders contracted -5% y/y in Q2, the deepest quarterly contraction since Q3 2009.  July saw a -5% contraction too and points to continued export weakness ahead.  However, collapsing import demand has led the external accounts to generally improve.  The current account surplus is expected to remain near 12% of GDP in both 2015 and 2016.  This is TWD-supportive.

The fiscal accounts are in order, giving policymakers to utilize fiscal stimulus as needed.  The IMF sees the budget deficit narrowing to -2.2% and -1.9% of GDP in 2015 and 2016, respectively.  We think there are upside risks given slow growth and likely fiscal stimulus ahead, but the deficits should remain manageable.  Low bond yields currently suggest that the market is comfortable with the situation.

INVESTMENT OUTLOOK

Due to strong fundamentals, TWD has been the best performer in EM this year, -2.3% YTD.  Our EM FX model taps TWD to outperform within EM over the course of Q3.  Still, USD/TWD has edged higher after the break of the January high near 32.00 and is now trading at levels not seen since 2009.  Long-term charts point to a test of the March 2009 all-time high near 35.25.

Taiwan stocks have outperformed within EM this year.  MSCI Taiwan is -12.6% YTD, and compares to -16.5% YTD for MSCI EM.  Our EM equity model taps Taiwan to outperform EM over the course of Q3.  Foreign equity investment currently totals $3 bln YTD.  This is down from the peak of $9 bln YTD back in May, but still compares favorably to $4.5 bln YTD for India and $2 bln YTD for Korea.

Taiwanese local currency government bonds have outperformed in 2015.  The 10-year yield has fallen 45 bp YTD, one of the best EM performers.  This compares to the group of worst performers that include Turkey (+212 bp), Peru (+195 bp), Brazil (+193), and Colombia (+107 bp).  We think that a potential CBC easing cycle coupled with the low inflation environment will continue to be factors behind further bond outperformance.