Rolling out their top picks in Asia this year, they said global investors should also  overweight Chinese shares, though less so than in 2007, as well as Hong Kong issues, while going underweight South Korean and Taiwan markets.

They predicted India will fare better than more trade-dependent economies as US growth slows, noting exports of goods and services account for about a fifth of its gross domestic product, compared with 40 per cent for China.

“Its valuations look steep, and it’s a crowded trade, but it’s the nature of lifeboats to get crowded. And there is some merit to the idea of India being seen as one now,” Mark Matthews, Merrill Lynch’s Chief Asia Equity Strategist, told a media briefing in Hong Kong. “It’s our sense that it can remain in a protracted expensive valuation zone because there’s not enough reason to sell it.”

India’s benchmark BSE index, Sensex, which hit a record high on Thursday, trades at more than 20 times 12-month forward earnings, as compared with about 18 times for Hong Kong-listed shares of Chinese companies.

The US investment bank said China is still its second favourite Asian market after Hong Kong, but it had reduced its overweight rating partly because of concern about China’s high inflation rate. It warned the market could face a tough first half. “The jury is still out on Chinese inflation, and because exports are not a small part of Chinese GDP, that market is likely to remain in a directional no man’s land until there’s firmer evidence on both inflation and exports,” Matthews said. 

Other suggested stock market overweights included Malaysia, Pakistan, Singapore and the Philippines. Merrill said these were preferable to South Korea and Taiwan, where economic growth prospects are "Unexciting at best.”

Currency issues

On the currency front, the investment bank said the US dollar was likely to come under further pressure in the first half, which would benefit Asia currencies. It said the yen was likely to rise against the dollar, and that investors should be long the Singapore dollar against the US currency.

“The world will increasingly come to realise that the larger Western economies are in a structural decline relative to Asia, and the transfer of wealth from the West to the East is not ending. In fact it’s just started,” Matthews said.