Taiwan Strategy:TAIEX up but foreign buying slowing

NT$ weakening after 3Q16 strength

The TAIEX was up 1.3% in October and the NT$ depreciated 0.7%. Taiwanoutperformed the region (MSCI Asia-ex was down 1.5%), and within Taiwanboth tech and non-tech outperformed (financials and small cap underperformed).

Tech was lead by TSMC, up 3.3% in Oct, after giving better thanexpected 4Q16 guidance. Non-tech saw strength in petrochem names (onhigher oil prices) more than offsetting weaker textile names.

After three months of strong foreign buying in Taiwan (NT$300bn duringJune-Aug), both September and October were only slightly positive (localfunds bought a small amount in October after selling in August/September).

Our 2016 year-end TAIEX target of 9000 and our preference for tech overnon-tech remains unchanged.

Our top picks for November (stocks we like fundamentally, but also believeshould have good short-term momentum during the month) are tech: TSMC;non-tech: Basso; and financials: E.Sun. On the short side (don’t like) are: tech:HTC; non-tech: St. Shine; and financials: Mega FHC. See Figure 1, page 2 forour complete Taiwan top picks.

November top picks

Tech: Key tech drivers in October/November is the 3Q16 earnings season.

Thus far, Apple and TSMC’s guidance was better than expected, while Intel’sguidance disappointed. Samsung’s Galaxy Note7’s production/salessuspension may also continue to boost China smartphone brand sales as wellas give more legs to the iPhone7/7+ launch. Our top Taiwan tech buy pick forNovember remains TSMC, on a combination of: expected upcomingsemiconductor growth, better than normal seasonal momentum in 4Q16 andits relative defensiveness. Our top tech short pick is HTC, as the company isup 50%+ off its 2016 lows and 20%+ off its mid-September dip despite its sixconsecutive quarters of operating losses (smartphone market remainschallenging), and a mixed bag of continuous investments in the VR business.

Non-tech: We continue to suggest staying defensive in Taiwan non-tech,preferring companies with quality growth stories, lower valuations and gooddividend yields. We continue to see more negative data points on the (US)textile and footwear chain and continuing interest in Formosa Groupcompanies on higher oil prices. Our top November non-tech buy pick is Basso.

The stock is down 26% off its August highs, and we believe post 3Q16 results(November 10 release) will offer a good entry point (weak 3Q16 earnings dueto FX). Our top non-tech short pick is St. Shine, given slower growth entering4Q16, rich valuations, and a heightening competitive environment.

Financials/economics: We prefer private banks over state-owned banks into2H16. In particular, post the anti-money laundering investigation by the USgovernment and resignation of Taiwan’s FSC chairman (on 3 October), webelieve state-owned banks’ new management (appointed by the DPP) willtake more stringent approach to examining asset quality and complianceissues...and, in addition to potentially higher credit costs, operating costscould rise, too, due to lack of past investments. Our top pick Novemberfinancials picks remain E.Sun on the long side and Mega FHC on the shortside.