Taiwan becomes the 'less ugly duckling' in Asia this year: UBS

Exports expands for the first time in 3Q since late 2014.

At the beginning of 2016, UBS argued that a better tech product cycle and a more favourable manufacturing inventory cycle should propel some moderate cyclical improvement in Taiwan this year, despite still weak external end demand. This view is coming to pass. Taiwan's cycle, it said, has indeed turned more constructive since 2Q16.

"Taiwan has turned out to be the 'less ugly duckling' in Asia," it said in a report.

In particular, USD exports marginally expanded 0.2%y/y in 3Q16, the first positive quarterly print since late 2014, and industrial production expanded on average 3.6%y/y in July and August.

However, UBS cautioned that growth will likely slip in 2017.

Here's more from UBS:

For 2016, we think real GDP growth is on track to expand 1.5-2.0% (UBS forecast: 1.6%y/y; consensus: 1.0%), reflecting the better-than-expected pickup in manufacturing activities since 2Q.

The question is how sustainable the ongoing improvement will be. Unfortunately, the boosts from product and inventory cycles tend to be short-lived. A sustained rebound still hinges on end demand improving. 

However, end-demand will likely remain subdued next year, given the absence of a decent CAPEX recovery in DM, excess capacity in China, and continued downward adjustment in Chinese construction cycle. Contrary to consensus, which expects growth to accelerate next year, we expect real GDP in Taiwan to slip back to around 1%y/y in 2017.

Positive product cycle could soon run its course. It is because the positive product and inventory cycles could fade by late 2016/ early 2017. A better tech product cycle, reflecting the launch of Apple iPhone 7 in September, is driving the current rebound in exports.

Tech exports, comprise mainly of  semiconductors and constitute a third of the total, expanded on average 7%y/y in USD terms and 11%y/y in real term since 2Q. Better tech shipments have single-handedly pushed real export growth back to positive territory, when non-tech exports marginally improved but largely remained sluggish.

However, real tech exports have already been expanding above trend since June. And product-led above trend growth is empirically unsustainable, unless end-demand is improving significantly or if there will be a succession of positive product stories taking over next year (not that we are aware of).

The last major product cycle (the launch of iPhone 6 in 2014) had kept tech exports above trend by 2-3 quarters. This gives us a reference that the current cycle could well run its course by late 2016/early 2017.

Inventory boost could also fade. Manufacturing inventories are currently falling but shipments (domestic manufacturing sales plus exports) are picking up. This bodes well for production because manufacturers will naturally respond to rising shipment-inventory by ramping up production

 Industrial production will likely accelerate further in 4Q16 to high single digit year-on-year pace, a rate nevertheless generally marks the cyclical peak in Taiwan's post global financial crisis manufacturing cycle.

In other words, the room for further pick up in Taiwan's production should be limited beyond 4Q16. Besides, the inventory cycle on average lasts about 4 quarters. The current cycle bottomed in 4Q15/1Q16, so the peak might not be very far from here.