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Conclusion: Don’t be fooled by the “Thailand is the fourth-cheapest market in Asia” talk. Cheap can get a lot cheaper and, in Thailand’s case, we think it will.

 

Position: Short Thailand Equities via the etf THD.

This morning, we added Thailand to our growing list of short ideas in Asia, and quickly opened a position in the Hedgeye Virtual Portfolio. While we wait to short the next dead-cat bounce in Indian equities, we’ll use today as an opportunity to get ahead of what we think is an asymmetric risk/reward setup.

Though Thai equities are down (-2%) on the week, we’ll use today’s +0.88% up-move as an entry point on the short side. Keeping in context 2010’s +40.6% appreciation of the benchmark Stock Exchange of Thai Index, we think there is substantial mean reversion to be had to the downside based on the following catalysts: 

  1. Growth is slowing;
  2. Inflation is accelerating; and
  3. Interconnected risk is compounding. 

From a global perspective, I know we sound like a broken record here, but until the 1H11 data suggests otherwise, we’ll stick to our guns…

Moving back to Thailand specifically, we think growth is setup to slow based on the confluence of two factors: a deceleration in trade and manufacturing b/c of waning external demand (trade surplus roughly 10% of GDP) and weaker consumer spending as a result of higher inflation and interest rates (~55% of GDP).

To put it simply, Thailand’s December trade data was nasty: YoY Export growth slowed sequentially by (-970bps) and YoY Import growth slowed sequentially as well, falling (-2,380bps).  Akin to our Japan’s Jugular thesis, a measured slowdown in Thailand’s export growth will reverberate negatively throughout the Thai economy, as Thailand is a very trade-heavy nation (its share of global exports is nearly 2.6x its share of global GDP).

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Concurrent with the release, Thailand’s Commerce Minister Porntiva Nakasai affirmed our call for China to lead a regional deceleration of growth:

“It is hard to replicate last year’s exceptional growth. China’s economy, which is the main growth driver in the region, is slowing, while Europe is still having financial problems.”

From a mean reversion perspective, Thailand’s GDP is bumping up against some rather difficult comparisons in the coming quarters. The 3Q10 growth rate slowed to +6.7% YoY – nearly 1/2 the rate of 1Q10 (+12% YoY). Growth in 4Q10 looks to slow even further, bumping up against the first positive comparison in five quarters: +5.9% YoY in 4Q09 vs. (-2.8%) YoY in 3Q09. The comps in 1H11 look even more overwhelming and is likely another reason Nakasai cut his forecast for 2011 GDP by nearly half to +4.5% YoY from an estimated +7.8% YoY in 2010.

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Accelerating inflation lends further conviction to our belief that growth will slow over the intermediate-term TREND. CPI accelerated for the first time in five months in December, climbing +20bps to +3% YoY. While not a high nominal level, the negative real interest rates (-0.75%) are cause for alarm and we think rates are going higher as the central bank attempts to ward off speculation. The Bank of Thailand shares our hawkish view, with Governor Prasarn Trairatvorakul saying today that the bank needs to increase borrowing costs to “dampen quickening inflation”.

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We share his sense of urgency, as the US dollar remains comfortably broken, trading below its intermediate-term TREND line of $78.66 for nearly three weeks on feeble promises of “austerity” and an upward surprise to the US federal budget deficit.  While the inverse correlations between the DXY and many commodities have come down in recent months, we do anticipate them to pick up should the dollar exhibit further weakness from here. Currently rice, a dietary staple in the country, has among the highest inverse correlations to the dollar (r² = 0.80) on a trailing three-week basis.

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A back up in food inflation could prove disastrous to Thai equities. This morning, Egypt EGX 30 Index showed the world what can happen when food inflation ails a country’s citizenry, closing down (-10.3%). There are already 2,500 protestors lining the streets of Bangkok, in an attempt to pressure the government to drop out of the United Nations’ World Heritage Committee, cancel a border-negotiation agreement and urge Cambodians to withdraw from disputed border areas. Should the rate of food inflation creep up from its current +5.6% YoY clip, we could see Thailand’s political risk discount widen, as more demonstrators lock arms in protest.

Currently, there are some in the market that believe Prime Minister Abhisit Vejjajiva can and will bring an end to this round of protests, citing generally firm support from the general public and, more importantly, the Thai military. We feel, however, that his suggestion to call an election “as early as April” might be too long a timeline for the tense political situation to die down over the immediate term. We’ll take the other side of the “trust the Thai government trade” for now:

“The political risks provide a discount, while the country’s economic fundamentals are solid… It’s not a market we want to sell.” - Masahiko Ejiri, a Tokyo-based senior fund manager at Mizuho Asset Management Co., which oversees the equivalent of $41 billion.

We think Masahiko here may be overlooking two very important facts: 

  1. Political risks provide a discount for a reason and the discount can get much deeper than (-2%) on the week; and
  2. When economic fundamentals go from “solid” to “less solid” stock market multiples typically compress. 

Don’t be fooled by the “Thailand is the fourth-cheapest market in Asia” talk. Cheap can get a lot cheaper and, in Thailand’s case, we think it will.

Darius Dale

Analyst

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