Conclusion: From a monetary and fiscal policy perspective, we continue to see a widening divergence between developing Asia vs. developed Asia, which is contributing heavily to the divergent paths of the real economies. Net-net, we remain favorably positioned to China and Singapore and bearish on Japan and Hong Kong.
Long Chinese equities (CAF);
Long Chinese yuan (CYB);
Bullish on the Singapore Dollar for the intermediate-term TREND and the long-term TAIL;
Getting constructive on Singaporean equities for the intermediate-term TREND and Bullish for the long-term TAIL;
Bearish on Japanese equities for the intermediate-term TREND and the long-term TAIL;
Bearish on Japanese yen for the intermediate-term TREND and the long-term TAIL;
Bearish on long-term JGBs for the intermediate-term TREND and the long-term TAIL; and
Bearish on Hong Kong dollar-based fixed income for the intermediate-term TREND and long-term TAIL.
Developing Asia: China & Singapore
Judging by our writing over the past three years, it’s no secret that China and Singapore continue to be our favorite investment destinations in Asia on the long side – be it equity, currency, or fixed income. That certainly doesn’t mean we’re married to these ideas, or perpetually bullish, and we have no problem managing risk around these long-term theses within narrower windows of duration. Key examples of this duration agnosticism include our decisions to put Chinese equities in the “penalty box” for the bulk of 2010 via our Chinese Ox in a Box theme and our decision to back off Singaporean equities alongside all other emerging market equities in early November.
As the positioning in our Virtual Portfolio would indicate, China is no longer in the penalty box, and we are getting incrementally warmer on Singaporean equities, as overly bearish consensus growth estimates are likely to be surpassed in the coming quarters.
From an absolute perspective, Singapore growth data lags China’s in our models by one quarter, meaning that we expect Singapore’s YoY GDP growth rate to bottom out in 2Q11 before reaccelerating in 3Q11. Tomorrow, China’s 1Q11 YoY GDP report should come in as both a sequential deceleration from 4Q10 and a cycle bottom, which sets the stage for a reacceleration over the next 3-6 months.
From a relative perspective, these rebounds in growth are likely to come at a time when global growth (particularly US and EU) is slowing sequentially – especially if crude oil prices stay elevated. That’s certainly not to say that China and Singapore are immune to this phenomenon and we expect high energy prices to impose a similar burden on these economies as well. That said, however, we do expect equity market investors to once again pay a premium for absolute, unlevered growth – particularly when it’s accelerating on a relative basis (i.e. we expect the “flows” to head toward China and Singapore in the coming months).
On a P/E basis, both China and Singapore are “cheap” relative to the last time their growth rates were accelerating on a relative basis to global growth.
Recapping recent economic data, we continue to see more signs of the resultant effects of sober and proactive fiscal and monetary policy in both countries. For instance, Singapore’s preliminary 1Q11 YoY GDP report showed a deceleration to +8.5% YoY vs. +12% YoY in 4Q10, largely due to a measured slowdown in manufacturing growth (+13.9% YoY vs. +25.5% YoY in 4Q).
This growth slowdown is a welcome event by Singaporean officials, as the county has been in a tightening cycle since mid-2010. Still, the robust QoQ SAAR growth rate (+23.5% vs. +3.9% in 4Q) was enough to strengthen their resolve to continue tightening, which they did by re-centering the currency’s trading band upwards (the Singapore central bank uses the Singapore dollar, rather than interest rates, to implement monetary policy). We welcome this proactive maneuver, as Singapore looks to continue warding off inflation, currently running at +5% YoY. This latest revaluation is a net positive for the Singapore consumer, given that we anticipate Singaporean CPI to accelerate into the early-to-mid summer months.
Shifting gears to Chinese economic data, we see that the main event is scheduled for later tonight (GDP, CPI, Manufacturing, and Retail Sales). This morning, however, we continued to get positive signs that the Chinese economy is responding well to the recent tightening measures. While both Money Supply (M2) and Credit growth accelerated sequentially in March (+16.6% YoY and +679.4B yuan, respectively), Total National Financing growth came in at 4.19T yuan in 1Q11 – down (-7.1%) YoY.
This new, encompassing metric includes bank lending, trust loans, corporate bond issuance, equity fundraising by non-financial companies, and other sources of capital accumulation, and it shows that recent PBOC efforts to combat inflation are having the desired impact. M2 and Credit growth rhymed with this reading when analyzed with a wider lens: M2 growth remains (-1,310bps) below its Nov ’09 peak growth rate and aggregate Credit growth fell (-13.3%) on a YoY basis in 1Q11. All told, we expect the Chinese equity market to welcome these depressed growth rates because they: a) give the PBOC headroom to slow the pace of tightening; and b) they provide stability for China’s long-term economic growth.
Developed Asia: Japan & Hong Kong
Insomuch as we love China and Singapore for the long term, we have an equal disdain for the Japanese economy due to its inability to grow organically – which is made worse by its massive sovereign debt load (north of one QUADRILLION yen) and the Japanese government’s heavy hand in its economy and financial markets. Hong Kong also remains in our penalty box, but for different reasons (reactive, rather than proactive monetary and fiscal policy) and to a lesser extent.
Take Japan for instance. In the wake of this recent string of unprecedented natural disasters, the BOJ did what it always does every time the Japanese equity market loses any meaningful amount of value – PRINT LOTS OF MONEY. Unfortunately for Paul Krugman, who advised them to do so in the late 90’s, the tactic has yet to create positive effects for Japan’s real economy. The effects of massive stimulus still remain muted in Japanese financial markets as well, with the Nikkei 225 still trading (-11.1%) below its Feb. 21 peak.
To their credit, however, Japanese officials (with the help of their G7 counterparts) did manage to successfully weaken the yen over the near term, as it trades (-5.4%) below its March 17th peak closing price. We continue to echo the sentiment put forth in our recent work, which effectively warns Japan’s bureaucrats to lay off attempts to weaken the yen due to the likelihood it causes a significant uptick in inflation and bond yields in Japan:
“History shows us that G7 intervention to weaken the yen has resulted in a significant uptick in inflation within Japan. In fact, if the G7’s plan to weaken the yen is “successful”, we expect the inflationary impact to be even greater this time around, particularly given Japan’s current staggering sovereign debt load and easy monetary policy.”
-Japanese Yen: Be Careful What You Wish For, Consensus… 3/18/11
In fact, we’re already seeing signs of the weak yen perpetuating inflation, as well as stirring up inflation expectations in Japan. Yesterday, Japan’s Corporate Goods Price Index accelerated for the fourth straight month, coming in at +2% YoY. Import prices accelerated to +9.4% on a YoY basis and we expect this trend to continue in the coming quarters as Japan accelerates purchases of raw materials and energy products in its rebuilding efforts.
A weak yen is definitely not beneficial for Japan’s rebuilding cause. A (-29%) slide in the yen after the G7 intervened in the wake of the Kobe earthquake caused Japanese Import Price growth to peak at +15.1% a year later. This surge in raw materials costs was eventually passed through to end consumers as Japanese CPI accelerated from marginal deflation to +2.5% YoY in the ensuing months. Unlike then, however, we contend that the Japanese consumer is unable to absorb rising prices this time around – particularly after a near-decade long trend of wage deflation.
From an expectations perspective, we see that Japan’s short-to-intermediate-term inflation swaps are on the uptrend. In addition, expectations for a major uptick in future JGB issuance is putting a great deal of political pressure on the BOJ to fund the debt via monetization. If Shirakawa elects to go the route of former Japanese Finance Minister Korekiyo Takahashi, “look out above” is the only advice we’d offer to Japanese inflation and inflation expectations. For more details on how this is likely to end up over the long-term TAIL, please refer to our March 25 post titled “Japan: A Fiat Fool’s Game”.
Shifting gears to Hong Kong, we continue to see signs that inflation is a real problem in the former British colony. Hong Kong Property Prices have recently exceeded their all-time highs last seen in 1997 – shortly after the Asian Financial Crisis began. On a YTD basis (through Feb.), property prices have increased +7.2% YoY; this is on the heels of a +24% increase in 2010 and a +30% increase in 2009.
In waking up to this gravely concerning property bubble, Financial Secretary John Tsang had this to say:
“I am deeply concerned that overall property prices in February have surpassed the peak in 1997. I shall pay close attention to developments in the property market… The current abundant liquidity and low interest rates will not last forever. Neither will rising property prices.”
This rhymes with Bernank-style reactionary central banking strategy, whereby officials finally start to “pay close attention” to inflation when inflationary headwinds are beyond obvious and hint at tightening only after the bubble peaks. With GDP growth well above its historical average on just about any duration, it’s no secret that Hong Kong’s Monetary Authority should have tightened interest rates several quarters ago, as both Hong Kong’s main policy rate and real interest rate remain at all-time lows.
When Hong Kong’s property bubble pops (and it will), Indefinitely Dovish central bank policy should receive the bulk of the blame for any ensuing economic hardship. Princeton-trained economists will blame supply and demand imbalances, all the while ignoring the impact of incredibly dovish monetary policy on aggregate demand. We find this ironic, given that at the heart of Keynesian economics is a belief that monetary and fiscal policy can be used to increase or decrease said aggregate demand.
In Hong Kong currently, accelerating inflation (be it in housing, goods, or services) is depressing aggregate demand and causing citizens to take to the streets in protest with increasing frequency and severity. A growing imbalance in per capita income between Hong Kong’s elite and middle class is forcing the government to react to these violent demands, with the latest budget calling for the government to literally give away money to disgruntled citizens, many of whom will likely want more than the $770 handout that’s currently on the table when it’s all said and done.
All told, both Hong Kong and Japan show us just what happens to an economy when fiscal and monetary policy remains Indefinitely Dovish; structurally depressed growth rates (Japan), runaway inflation (Hong Kong), and civil discontent (both) are just some of the more pronounced ill-effects. Needless to say, our outlook for both Japan and Hong Kong is not positive on a long-term basis. On the flip side, however, we continue to like the proactive and sober monetary policy of China and Singapore and, thus, we remain favorability positioned to their financial markets.