Outlook brightest for Asian giants

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Chinese large cap stocks are set to out perform small caps, says BNP Paribas. (Getty Images)

Large cap stocks expected to perform best in most Asian markets this year.

As the former engines of world economic growth start to slow this year, it looks like much of the gains will come from emerging Asia. However, returns cannot be taken for granted; different investment styles will perform differently.

BNP Paribas issues research reports monitoring six to nine style factors in the equity markets of Korea, China, Taiwan, Hong Kong, India, Singapore, Malaysia, Indonesia and Thailand - the Asia-9 countries.

These markets are studied using six criteria: technical, volatility, profitability, monetary condition, inflation and foreign fund flows.

"March saw a revival of the large cap effect, with most markets outperforming the small cap indices, except for Taiwan and Thailand," says BNP's report.

"As market volatility increased, all Asia-9 countries saw a deterioration in earnings revision (ERI).

"We believe these changes are generally more negative for small caps. Our style signals are tilted to large cap for all countries bar Korea, Singapore and Thailand."

BNP uses technical indicators such as the Relative Strength Index (RSI), which is traditionally used to indicate when individual stocks or indices are overbought or oversold.

It is applied to the small-to-large cap price ratio to signal trend reversals for small caps' out performance relative to large caps. When the RSI is above 70, small cap stocks are over bought, and when it is below 30 they are over sold.

Increasing interest rates in the six Asian markets tilted to large cap strategy are likely to make it more expensive and difficult for small cap firms to obtain funding. Small caps also tend to under perform when the profitability outlook is deteriorating, and when market volatility increases.

BNP Paribas' strategy for Singapore still slightly favours small cap stocks. It notes: "Falling liquidity conditions and deteriorating earnings have historically favoured large caps; however, such an impact is more than offset by the recent falling borrowing costs."

Interest rates and real interest rates have fallen recently, helped by Fed cuts and a rise in consumer prices. The same factors were also seen in Korea.

BNP's report says: "Interestingly, the style cycle in Singapore has rotated every two years."

It is neutral on Thailand, after earnings deterioration slowed in March, consumer prices rose and liquidity conditions fell.

BNP Paribas has also looked at how these factors relate to the Asian crisis of 1997. "The crisis saw international mutual funds selling Asian stocks and bonds of both crisis and non-crisis countries in an effort to raise cash," says the report."

"During this period, however, the countries with solid economic growth, namely China, Taiwan and India, all showed a significant small cap effect. Small caps out performed during this period, confirming our view that their performance is more related to domestic interest because foreigners have, as always, greater exposure to the large caps."

Thailand was the exception among the Asian countries and was among the first to see the equity downturn.

BNP Paribas says this reaffirms its view that small caps tend to begin out performing when economic growth is bottoming, anticipating economic recovery.

With growth still strong, but increasing rates starting to restrain borrowing by small caps, large cap stocks look like the best bet in most Asian markets for the near future.

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