Conclusion: The bulk of recent economic data points continue to support our long-standing thesis that Growth is Slowing as Inflation Accelerates throughout Asia. When combined with our proprietary bottom-up country analysis, this top-down outlook creates both volatility and consternation – a confluence that allows us to identify alpha-generating investment opportunities across asset classes.
Below we list our highest conviction intermediate-term TREND ideas throughout the Asian geography with a particular focus on Macro/Asset Allocation. Next to each idea, we briefly touch upon the rationale behind the thesis and recent supporting/rebutting data points. This report isn’t intended to be a chronicle; rather it is a compendium of recent internal and external research we’ve done on the region. For more details or copies of related research reports, feel free to follow up with us at your convenience ().
Lastly, but certainly not least, time and price will continue dictate how we chose to express any of these ideas at any given moment within our Virtual Portfolio or Dynamic Asset Allocation.
Bullish on Chinese Equities: While we continue to favor Chinese equities from a research perspective, both our index-specific quantitative model and our 27-factor global macro model have rightfully kept us out of the way on the long side. Still, there’s no denying that our call for Chinese growth to decelerate at a slower pace (i.e. avoid the so-called “hard landing”) is playing out in spades with the recent industrial production, fixed asset investment and retail sales data (May #’s).
As we’ve previously outlined in our Year of the Chinese Bull thesis, we expect Chinese CPI to put in its YTD highs over the next month or so, with June being the most-likely scenario. As our Q2 Macro theme of Deflating the Inflation gathers steam across the commodity complex, we’ll see a measured reduction in Chinese tightening expectations – paving the way for investors to bid up the few pockets of global growth that are likely to be left standing over the intermediate term. As such, we’ll continue to trade China in our Virtual Portfolio with a bullish bias until we see a sustained breakout above the intermediate-term TREND line of resistance at 2,791 on the Shanghai Composite Index. To that point, we’ve just added the CAF to the VP on the long side earlier this afternoon.
Bullish on the Chinese Yuan (CNY): A core long-term position in our Virtual Portfolio, we continue to believe the yuan will benefit in the near term from market fears of incremental tightening in China. While we are not of the consensus belief that the PBOC will continue hiking rates in 2011, what we think China will do and what it does can be two very different things. Even still, a near term rate hike might just make for a very attractive entry point on the long side of Chinese equities (see above) given that our models suggest Chinese CPI is likely to peak in June. Regarding the yuan specifically, we continue to welcome lagging media coverage of China’s inflationary headwinds as supportive of our current long CNY position.
Bullish on the Japanese Yen (JPY): As Global Growth Slows, we expect both compressing interest rate differentials and growing Japanese investor risk aversion to weigh on the yen over the intermediate-term. While we remain bearish on Japan’s currency from a long-term perspective, we do believe the next few months’ worth of global economic data will look sour enough to keep the downward pressure on key global interest rates and the supply of Japanese yen on the global FX market.
Additionally, the Bank of Japan continues to show they aren’t necessarily willing to meaningfully step up monetary easing via its new lending program designed to prevent any potential capital shortage stemming from the recent natural disasters (“only” $6.2B vs. an existing $37.4B credit program). The BoJ’s refusal to cave in to political and investor demands for “shock and awe” sized increases to its current asset purchase facility is a measured delta relative to market expectations (and in some cases, begging) for the short-term elixir of debt monetization. This marginally hawkish lean out of the BoJ is bullish for the yen – so long as Governor Shirakawa can maintain his fortitude.
As always, any exposure to Japan comes with the risk of Big Government Intervention. Back in March, the G7 jointly intervened to stem the yen’s advance to a post-WWII record of 76.25 per USD. To the extent there is the political will to do so on such a large scale remains to be seen (the world has bigger issues to deal with now: Greece, US growth/housing, etc.). Japan’s former senior FX official, Eisuke Sakkibara (a.k.a. “Mr. Yen”), doesn’t seem to believe there will be any intervention this time around, as fundamentals, not speculation, drive the yen higher. We cautiously concur.
Bullish on the Singapore Dollar (SGD): On a long-term basis, we continue favor the equities and currencies of countries where sober fiscal and monetary policy contribute to higher rates of economic growth and lower rates of inflation. Singapore continues to demonstrate what we’re looking for in this regard and recent economic and monetary policy decisions continue to support growth (particularly in the consumer sector via accelerating retail sales and a falling unemployment rate) and slowing inflation readings. As we’ve penned in our recent work on Singapore, we think the outcome of the recent election (PAP winning by less than they’ve ever done so) will result in increased attention paid to the populace over the intermediate-to-long-term. For now, that indirectly translates into the Monetary Authority of Singapore stepping up its hawkishness to get inflation firmly under control.
Bearish on Japanese Equities: While the tragic events which took place in Mar/Apr of this year certainly deserve a great deal of credit/blame as it relates to Japan’s current depressed growth rates we cannot stress enough that Japanese growth was slowing even prior to the earthquake when we were appropriately bearish.
As a function of our Japan’s Jugular thesis, we’ve been quite vocal about Japan’s world-beating debt and deficit issues continuing to structurally impair economic growth over the long term. What is perhaps lost on the market now is its effect on near-term growth. The political instability surrounding the future resignation of current prime minister Naoto Kan following this month’s no-confidence vote only amplifies the damaging psychological effects of fiscal and regulatory uncertainty on consumer and business confidence throughout the nation – at a time when confidence is needed most throughout the island nation. Lastly, we continue to stand counter to the intellectually-lazy thesis that “quake rebuilding is bullish for GDP growth”. In our models, all disasters – be they natural, fiscal, or sovereign debt related – are explicitly bearish for economic growth.
Bearish on Indian Equities: The thesis here is as simple now as it was when we first outlined it in back in early November: Growth Slows as Inflation Accelerates as Interconnected Risk Compounds. Regarding growth specifically, 1Q11 Real GDP growth came in in-line with our bearish estimates and we see further downside from a sequential perspective over the intermediate term. Both industrial production growth and car sales growth (a widely-followed proxy for retail demand) have slowed to multi-quarter lows alongside the most recent services PMI reading (May) falling 4.2 percentage points MoM. Inflation continues to make higher-lows and recent energy price hikes and a highly likely crop price hike of +20%-30% in 2H11 are supportive of this trend continuing. The Royal Bank of India agrees with this outlook, hiking rates overnight by another +25bps citing “high domestic inflation risks”. Net-net, earnings in India over the intermediate term are likely to come up short of what typically are overly optimistic expectations for members of the “BRIC” community.
From an interconnected risk perspective, corruption headlines, the growing likelihood India misses its deficit reduction target by a wide margin in the current fiscal year, and the potential for destabilizing capital withdrawals pose a threat to both India’s equity market and currency (the two have traded in near lock-step over the years). Pardon our sobriety, but we think it’s important to reiterate that the flows work both ways.
Bearish on the Indian Rupee (INR): When screening for FX opportunities, we like to be long of currencies of countries that: 1) have accelerating growth prospects; 2) have a little bit of inflation so that 3) monetary and fiscal policy are proactively hawkish and correspondingly sober. India has nearly the opposite occuring in all three categories: 1) slowing growth; 2) a lot of inflation; and 3) arguably the world’s most misguided monetary and fiscal policy. Recall that (much to our bewilderment) the Royal Bank of India paused hiking rates and embarked on a quantitative easing program late last year – at a time when they should’ve been proactively raising rates to ward off the inflation that has consistently forced them to revise up their WPI targets after the fact. Additionally, recall that we called out the current budget as one rife with pollyannaish economic growth and subsidy expense estimates that was ultimately doomed to fail in meeting its deficit reduction target.
Bearish on Indian Rupee denominated Short-term Corporate Debt: We continue to be of the view that the RBI will continue on its tightening path and could potentially step up the pace and magnitude of rate hikes in an effort to preserve its eroding credibility. To that effect, RBI governor Duvvuri Subbarao’s recent commentary has indicated that the central bank is okay with aggressively combating inflation “even at the cost of some growth in the short run”. As such, we expect decelerating profit growth (see above) and higher interest rates be prove bearish for Indian corporate credit over the intermediate term.
Bearish on Hong Kong Equities: From our vantage point, the conditions which have been supportive of the Hang Seng Index off the March ’09 lows (accelerating growth, abundant liquidity, a perhaps overly robust property market) are eroding on the margin and are being replaced by negative catalysts such as: slowing growth, accelerating inflation (at a 32-month high), and the puncturing of a property bubble. Furthermore, Hong Kong officials remain trapped in a box from a monetary policy perspective, unable to raise rates to cool the overheating economy. Instead, the Hong Kong Monetary Authority has taken to directly to targeting the property market with specific curbs that appear to have significantly slowed the pace of transactions in the real estate market.
At Hedgeye, we commend policy efforts designed to prevent the buildup of asset bubbles; in this scenario, however, the HKMA is about +70% too late with regard to the latest two-year advance in Hong Kong’s real estate prices. As such, we expect bank and property developer stocks to lead the broader market lower over the intermediate-term TREND.
Bearish on Korean Equities: Of all the Asian countries where we find ourselves explicitly bearish on their equity markets, Korea poses the most risk to the upside – particularly if Korea’s GDP growth hangs in there. Of the three algorithms we use to model country-level economic growth rates, the spread between the highest and lowest outputs for Korean GDP growth is the widest throughout Asia. Given this setup, we remain cautiously pessimistic on Korean equities and though we may not necessary be inclined to short them at this juncture, we would be sellers of strength were we long of them in the Virtual Portfolio.
Our negative thesis on Korea hinges on incremental tightening out of the Bank of Korea in an environment whereby economic growth is likely slowing. Additionally, we are bullish on Korea’s core CPI readings over the intermediate-term TREND, and, as such, we are correspondingly bullish on Korean rate hikes over that same duration. Still, should the BoK relent in its hawkishness, we do find waning domestic and global demand as a risk to Korean profit growth over intermediate term. Given how resilient the Kospi has been in recent months (+8.5% on a three-month basis prior to today’s sell-off), we find the potential for an upcoming bifurcation in equity performance and corporate earnings trends as a catalyst for mean reversion to the downside.
Bearish on Thai Equities: Simply put, Slowing Global Growth will continue to weigh on Thailand’s manufacturing sector (industrial production growth is negative and accelerating to the downside recently) and Accelerating Inflation will weigh on Thailand’s domestic demand (retail sales growth slowing; the latest business sentiment reading registered a contraction) as the central bank continues hiking rates. Specifically, recent hawkish central bank commentary expressing concern over core inflation, the removal of diesel subsides, and populist measures support our view that Thai interest rates are headed north over the intermediate-term TREND. Mix in the political equivalent of a Molotov Cocktail with the upcoming elections and we have what continues to be a strong three-factor short thesis.
To the latter point specifically, all signs point to social instability as a result of the upcoming parliamentary election scheduled for July 3. This is due to the likelihood that radical supporters of the opposing parties (Democrats/Yellow Shirts, which are the political elite of Thailand vs. the Puea Thai/Red Shirts, a for-the-people party with a populist agenda) take to the streets in what have historically been violent protests. If the Yellow Shirts win a majority, we can be reasonably assured that Red Shirt supporters will once again march on Bangkok – just as they did last spring. If the Red Shirts win a majority, we are likely to see a second consecutive military coup, which would be implicitly endorsed by the Yellow Shirts. Such an outcome almost guarantees that a major protest takes place in the coming months. As a result of well-crafted political messaging blaming current officials for rising inflation and promises of extraordinary populism, the Puea Thai party has positioned themselves for victory according to the latest poll results (43% vs. 37% for the Democrats) – putting the latter, potentially more violent of the two protest scenarios in play.
Bearish on the Thai Baht (THB): As Slowing Global Growth and Deflating the Inflation continue to get priced into global macro markets over the intermediate term, we expect the demand for Thai bahts to wane (rubber and rice are key exports). We’re already seeing signs of this reflected in Thailand’s trade data with its April trade balance falling -$276M on a YoY basis vs. an increase of +$890M YoY in the prior month. Accelerating global risk aversion driven by the confluence of Thailand’s political uncertainly, the Eurozone’s debt crisis, and a US economic slowdown is something we believe will auger bearishly for baht demand as well over the intermediate term.
Bearish on Thai Short-term Sovereign Debt: By now, it’s pretty clear we really dislike Thailand over the intermediate term – and India and Japan, for that matter. Beyond reiterating our call for more rate hikes and political instability, not much else needs to be said here. Unless you’re at a multi-strategy fund or happen to manage a portfolio of emerging market bonds, it’s probably tough for the typical institutional investor to find a borrow on Thai sovereign debt. Still, on the off-chance you can find some exposure in the OTC market, short away.
Bearish on the Aussie Dollar (AUD): Of all the worthwhile investment opportunities across Asia we have chosen highlight, this position is perhaps the most risky. Not risky in the sense that we haven’t done the work and lack conviction, but rather in the sense that if this trade works in any meaningful way, it’s likely going to be concurrent with some level of investor deleveraging across the global equity and commodity complex (a la Deflating the Inflation). For reference, the trailing-one year positive correlations of AUDUSD to the S&P 500 and CRB Index are r² = 0.86 and r² = 0.84, respectively. While correlation implies neither causality nor future performance, we do believe that all three have been recipients of the now-unwinding Inflation Trade over the last 10 months or so.
Looking at Australia specifically (which is what we must do if we’re going to have any reasonable level of conviction in authoring such a thesis), we continue to stress that market and sell-side expectations of 1-2 rate hikes over the intermediate term are borderline irrational. By talking hawkishly in recent commentary, we feel Australian central bank governor Glenn Stevens is simply doing what any credible central banker would do in such an uncertain economic environment where a rate hike may actually prove to be a dagger to the ailing Australian economy.
To the latter point specifically, the bulk of Australia’s recent economic data has come in light – particularly in key areas such as employment, PMI surveys, and consumer and business confidence. We find the Australian economy to be at/near a point where a rate hike might actually prompt a sell-off in the Aussie dollar as the market looks forward to: a) that being the end of the RBA’s tightening cycle over the intermediate term; and b) the increasingly likelihood of slowing growth prompting the RBA to speak and/or act in a dovish manner.
All told, we hope you find something that fits your investment mandate in the list of ideas above. As mentioned before, these brief synopses are by no means all-inclusive of the research we have done and continue to do in support of these theses and the geography at large. As always, feel free to follow up with us for additional details and dialogue.
Best of luck out there,