Taiwan Strategy:Taiwan tech continues to outperform

Foreign investors returned to Taiwan in January (first meaningful month ofinflows since August 2016), pushing the Taiwan dollar up 2.7% and the TAIEXup 2.1% (tech outperformed up 3.1%). After President Trump’s inaugurationon January 20, we are likely entering a phase of a higher risk for US tradeprotectionism (see Figure 23 on page 7 for list of Taiwanese companies withboth high exposure to US exports and China production bases).

In 2016, despite weak iPhone shipments, Taiwan outperformed the region(and tech outperformed non-tech) driven by TSMC (semiconductor),automation and auto electronics (areas we expect to continue to outperform in2017). We also expect a better year for iPhone (return to positive unit growthrates) in 2017 – positively impacting many of the Taiwanese tech companies.

Our TAIEX target for 2017 is 9500 (or 14X P/E / 1.7x P/B). Consensusearnings growth for the TAIEX in 2017 is currently at 9.0%. Key risks globallyare potential demand shock brought on by weakening (and/or volatile) EMcurrencies and higher component costs. Key risk for Taiwan specifically arepolitically focused (relationship with / high production exposure base in China).

Over the past ten years, February returns of the TAIEX have averaged up3.1% (only 2 in 10 years showed declines), followed by up months in March,April, and May.

2017 outlook and February top picks

Tech: We continue to be bullish on the memory cycle into 2017 (Powertechtop Taiwan memory pick), expect 9% semiconductor growth (after 2 flat years)and continued spending and growth in the automation (Chroma/AirTAC toppicks) and auto electronics (CUB top pick) sectors. We expect TSMC tocontinue to outperform in 2017, have a non-consensus buy on MediaTek(expect margins to rebound from 2H17), and also like ASE (SPIL acquisition)and King Yuan in the semi space. Our top pick in the downstream space isHon Hai (expecting another mega cycle and leveraging its robot strength intonew area (EV)). We maintain our negative outlook on the LCD industry andcontinue to expect the PC market to decline (albeit moderating in 2017). Ourtop tech shorts are AUO, Acer, HTC, Advantech and Largan.

Non-tech: In 2017, we continue to suggest to stay defensive in Taiwan nontech,preferring companies with quality growth stories, lower valuations andgood dividend yields. We continue to see more negative data points on the(US) textile and footwear chain. Our top pick is Basso, a potential beneficiaryif US puts higher tariffs on imports from China. We also like Giant, on a better2017 outlook. We continue to be short the textiles names (Eclat top short) andalso downgraded Petrochem to underweight as we believe its earnings cyclepeaked in 2016 (FPCC top short – added to Marquee list). In the consumerspace, our top picks are TCI (a global ageing play) and Gourmet Master.

Financials/economics: We continue to prefer private banks over stateownedbanks (could be hurt by their aggressive lending before the change ofthe government). Life insurers should benefit from rising expectation for ratehikes and strong USD despite new premium growth could decelerate. Our toplongs are Cathay and CTBC. Our top shorts are Mega FHC and Chailease.