Taiwan Assets Outperform Despite Weak Economic Outlook

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Despite having solid fundamentals, Taiwan’s economy continues to underperform. Weak growth is likely to persist in 2016, but probably won’t have much impact in limiting continued outperformance of Taiwanese assets.

POLITICAL OUTLOOK

Democratic Progressive Party candidate Tsai Ing-Wen won the presidential election in January, becoming the first woman to lead Taiwan. The DPP also won control of the Legislative Yuan then. The new government was just inaugurated last week, and Tsai signaled that she will initially focus on the economy.

The DPP won with a stance of cooler relations with mainland China. The outgoing KMT government had pushed stronger ties, which appear to have led to an erosion of popular support. While we do not foresee a flare-up in cross-straits tensions, frostier relations could slow the trend of deepening economic ties with the mainland. Instead, President Tsai is signaling a greater focus on regional economic cooperation and free trade agreements, including the Trans-Pacific Partnership (TPP).

ECONOMIC OUTLOOK

The economy remains weak. GDP growth is forecast by the IMF to pick up modestly to around 1.5% in 2016 from 0.8% in 2015. GDP contracted -0.8% y/y in Q1, weaker than expected and the third straight quarterly contraction. April data remains weak, suggesting Q2 will not see much improvement. Leading indicators are still contracting, and so all told, we see downside risks to the growth forecasts.

Price pressures are picking up, with CPI rising 1.9% y/y in April vs. 2.0% in March. The central bank does not have an explicit inflation target. With the economy so weak, the central bank is likely to continue easing with another 12.5 bp cut to 1.375% at its quarterly policy meeting in June. Money and loan growth are at cycle lows.

Fiscal policy has remained prudent, but is seen deteriorating this year. With monetary policy nearing its limits on stimulating the economy, we suspect fiscal policy will pick up the slack this year. The budget deficit has been less than -1% of GDP for the past several years. As such, we see upside risks to the deficit, which is already expected to widen to around -1.5% of GDP in both 2016 and 2017.

The external accounts are in very good shape. Lower oil prices have reduced imports, and this has outweighed downward pressure on exports. The current account surplus is likely to remain near 15% of GDP in 2016 and 2017. Export orders have contracted y/y for thirteen straight months now, and suggest little relief for exports ahead. Foreign reserves rose to a record high $433 bln in April, which covers an astounding 21 months of imports.

INVESTMENT OUTLOOK

The Taiwan dollar has generally outperformed within EM. In 2015, TWD lost -4% vs. USD. This was behind only HKD, which is pegged. The worst performers last year were ARS (-35%), BRL (-33%), ZAR (-25%), COP (-25%), and RUB (-20%). So far this year, TWD is up 1% YTD and is one of the better performers in Asia. This outperformance should continue, as our EM FX model shows the Taiwan dollar as having STRONG fundamentals. Retracement objectives from this year’s drop in USD/TWD come in near 32.78, 32.97, and 33.16.

Taiwanese equities have outperformed within EM. Last year, MSCI Taiwan was down -11% vs. -17% for MSCI EM. So far in 2016, MSCI Taiwan is basically flat YTD, and compares to -1.4% YTD for MSCI EM. This outperformance could ebb a bit, as our EM Equity model has Taiwan at a NEUTRAL position, down from OVERWEIGHT the previous quarter. We note that Taiwanese technology stocks got a boost this week on reports that Apple asked its suppliers to prepare for a new version of its smartphones.

Taiwanese bonds have done all right this year. The yield on 10-year local currency government bonds is down about 17 bp YTD. This is in the middle of the pack. Compare this to the worst performers Poland (+16 bp), China (+11 bp), and Bulgaria (+7 bp), as well as the best performers Brazil (-385 bp), Peru (-104 bp), and Indonesia (-78 bp). With inflation likely to stabilize and the central bank likely to continue easing, we think Taiwanese bonds could start outperforming more.