Positions in Asia: Long Chinese equities (CAF); Long Indian equities (INP); Short Japanese equities (EWJ).
It was a rough week for the bellwether markets in Asia (China’s Shanghai Composite down -2.5%: Japan’s Nikkei 225 down -3%; India’s SENSEX down -2.8%). On the positive side, Thailand’s SET Index continues outperform the broader region, up +1.1% wk/wk and up +9.7% mo/mo. On both a median and average basis, Asian equity markets are down for the YTD – not confirming the “global growth will come roaring back in 2H” sentiment embedded in consensus estimates. The Japanese yen stole the show on the currency front (+1.8% wk/wk) and we think BoJ intervention is just around the corner from current levels. In the fixed income market, Indian sovereign debt yields ripped across the curve after the RBI hiked rates more than anticipated (+50bps vs. consensus estimate of +25bps). U.S. dollar correlations to Asian asset classes picked up noticeably over shorter durations – mostly inverse, though Chinese equities stand out as having a positive correlation of r² = .50 on a trailing 3wk basis. Dollar UP = Deflating the Inflation.
China: A tragic bullet train accident dominated the headlines earlier in the week followed by accelerating industrial earnings growth (+28.7% YTD). Though nothing more than consensus hearsay at this point, rumors which suggest that China is looking to accelerate diversification of its $3.2T of FX reserves (at least $1.2T are denominated in US dollars) continue to pickup as the debt ceiling drama accelerates. The “China diversification story” is not new news, FYI.
Japan: The key callouts out of Japan this week are directly related to monetary and fiscal policy. BoJ governor Masaaki Shirakawa signaled to the market that the BoJ stands ready to intervene (again) in the global FX market to stem the yen’s rapid appreciation. We’ve been bullish on Japan’s currency for the last few months, but are now bearish as BoJ intervention and a likely government shutdown in early fall looms large. Japan’s manufacturing data continues to improve on the margin, but it remains decidedly negative and our models point to a continuation of that phenomenon throughout the remainder of the year. Household spending growth slowed to -4.2% YoY in June and we do not see a meaningful acceleration on the horizon in 2012 if the consumption tax is doubled in upcoming Diet legislation.
India: The RBI hiked rates by double that of consensus estimates and we used the resulting equity market weakness to buy Indian equities. We’ve been the bears on India since early November and we see the vast majority of our negative catalysts in the rear-view mirror. Food inflation slowed to the weakest pace of growth since February ’09 and our models point to India’s monthly WPI figure to peak in August. We look for the implementation of Prime Minister Singh’s rice subsidy and health insurance to be bullish near-term for Indian growth (our models point to the first sequential acceleration since 1Q10 in 4Q). Further out, the program is likely to incrementally stoke inflation (wider fiscal deficit) and slow growth (higher interest rates), so, needless to say, we’ve got this position on a tight leash in the absence of further color.
South Korea: GDP growth slowed sequentially in 2Q (+3.4% YoY), while June industrial production growth slowed to the lowest rate in nine months (+6.4% YoY). Our models put us 100-200bps below the Bank of Korea’s GDP estimates for 2H11 and we expect their hawkish talk to subside on the margin as Korean economic growth comes in below their forecast. Korean growth is healthy; it’s just not as healthy as they’d like.
Australia: Both CPI and PPI came in faster on a YoY basis and slowed on a QoQ basis in 2Q – in line with our expectations – and created incremental RBA rate hike speculation in the FX and swaps markets. We think Stevens would be foolish to hike rates on Monday and risk sending the Australian economy into a potential recession. Simply put, there is not end demand on the ground: corporate credit growth contracted in June on a MoM basis for the first tin since October ’09 and mortgage origination grew at the lowest rate ever (+6% YoY). Forget the Chinese demand story; Australia’s housing market remains anemic and looks to hang over the economy for the foreseeable future (RPData’s House Price Index posted a sixth-consecutive monthly decline in June: -0.2% MoM).
New Zealand: Rates are going up in New Zealand soon (bullish for NZD). Reserve Bank of New Zealand governor Alan Bollard said it and recent economic data supports it: widening trade balance in June (+9.3M NZD YoY); rising business confidence in July (47.6 – a 14-month high); faster Money Supply growth in June (M3 = +7.3% YoY). The bifurcation between the Australian and New Zealand economies continues to widen.
Thailand: The Bank of Thailand reiterated our call that populist Pheu Thai policies will stoke inflation by stating, “The risk to inflation outweighs the risk to growth – especially in light of continued fiscal stimulus”. We remain bullish on Thai interest rates over the long-term TAIL, as we see little way around the government’s stated objectives other than higher rates of growth and inflation. Nearer term, accelerating industrial production growth (+3.3% YoY), quickening trade balance growth (-$656M YoY vs. -$2B YoY prior), and improving business sentiment (53.1 vs. 50.9 prior) all proved bullish for Thai stocks.
Singapore: CPI accelerated in June to +5.2% YoY alongside a sharp acceleration in industrial production growth to +10.5% YoY. The pickup was driven largely by pharmaceutical output (+41.5% YoY) while electronics production fell (-15.3% YoY). The jobless rate ticked up +20bps to 2.1% in 2Q and we should see that edge down in 3Q as growth reaccelerates. The inflation reading continues to support our bullish bias on the Singapore dollar (SGD).
Taiwan: GDP growth slowed in 2Q to +4.9% YoY alongside a deceleration in industrial production growth to +3.6% YoY – a 21-month low. As we called out in November of last year, Asia’s weakening manufacturing statistics continue to stand counter to overly-bullish expectations for U.S. GDP growth in 2H11 (Asian factories produce the stuff we consume typically 6-9 months before we buy it).