Views from the Bund

- Key investment theme: "We expect China’s equity market to experience more volatility in coming months due to downward earnings revision pressure as the economic slowdown ripples through the whole economy, but recommend buying on dips because: (1) China’s real GDP growth, on a sequential basis, may have bottomed out at 7.2% Q/Q in 2Q10. Yet, we believe China’s final demand growth will not bottom out until late FY10, because the modest sequential rebound in GDP in 3Q will be driven by a slowdown in de-stocking and the widening of the trade surplus on sharply falling imports, rather than by a decent recovery in final demand; (2) improving liquidity conditions—(a) China’s M2 growth (which tends to lead H-share performance), on sequential terms, is expected to bottom out, with the trend growth reaching a trough of 11.8% 3m/3m, saar in September before rising to 16.8% in December; (b) we estimate new loans made by Chinese banks in 2H10 will reach around Rmb3 trillion, up 37% Y/Y; (3) we believe the worst of the policy tightening environment may be behind us. Key investment risks include: (1) the market may be concerned about a return of government tightening measures, if CPI continues to surprise on the upside; (2) assetinflation risks, mainly on the property front; and (3) China’s A-share market to face potential supply side pressure in 4Q10."
- What is changing: "In light of our positive views on mid-cap sticky growth names in China’s consumer staple and low-end consumer discretionary sectors, and factoring in the four key consumer stock picking criteria, we have chosen 20 names to form the J.P. Morgan China Mid-Cap Consumer (sticky growth) Basket. The Bloomberg ticker for this basket is JPHCHMCS Index ."
- China model portfolio adjustment: "In our model portfolio, we are overweight on: (1) mid-cap consumer names in staple, low-end discretionary, and service areas; (2) menswear; (3) beneficiaries of western China development strategy and China’s visible railway capex; (4) insurance; and (5) mid-cap banks. We stay neutral on telcos, and underweight on commodities, energy, and property. We reduce our weighting in IPPs from overweight to underweight."

JPMorgan Views From the Bund 20100827

Academic Research Digest

- Citi Global Quantitative Research Conference — 16th/17th September, Barcelona. For more information, please see page 3 of this document, or contact the Citi Global Quant Team.
- What's New in Academic Research — In this issue of the Academic Research Digest, we discuss three articles on stock selection and one article with style rotation implications. We also highlight two articles that have recently been published, and cite five additional working papers that we believe are of interest.
- Measuring Expected Return in a Novel Non-Stats-Reliant Way — Return forecasting using a dynamic equity valuation model.
- Stronger Idiosyncratic Volatility Returns — The informational role of options in the context of the idiosyncratic volatility anomaly. The relation between informed option trading and stock/option mispricing is due to two combined effects: a selection effect; and a causality effect
- The More (often) the Merrier — Analysts who issue stock recommendations more frequently may bring more valuable and timely information to the market. Analysts who most frequently change their recommendations are the ones with the highest excess returns.
- Style-Returns in Different Sentiment and Macro Environment Regimes — What determines the strength of a market anomaly? Psychology vs. economic environment.


ECB may keep monetary policy loose for a long-time

- "Most US macro-economic data continued to disappoint last week. This week’s data (especially the ISM manufacturing index and the US labour market report) will be very important for the direction of sentiment and maybe also for the Fed’s willingness to adopt further QE (p.2, p.3 & p.4)."
- "This week’s focus is on the US ISM manufacturing index on Wednesday and the labour market report on Friday, on the euro zone CPI estimate tomorrow and the ECB meeting on Thursday, and on the UK PMIs (p.2, p.3 & p.4)."
- "The Chart of the Week shows lending by the ECB to credit institutions in the 11 largest euro zone countries and to credit institutions in Portugal, Ireland, Greece and Spain. On Thursday, all eyes in the euro zone will be on the ECB meeting. Although Q2 GDP growth was quite strong, uncertainty about the sustainability of the economic recovery has increased since the last ECB meeting on 5 August. Given low inflationary pressures, official policy rates will probably have to remain at extraordinary low levels for a very longperiod, in particular for countries that face severe fiscal tightening. The ECB is therefore likely to remain very cautious regarding economic prospects. Moreover, the Chart of the Week suggests that credit institutions in the so-called PIGS countries have become increasingly reliant on the ECB’s refinancing operation: they accounted for more than 40% of total ECB lending to credit institutions in June. As such, the ECB is expected to keep the fixed rate, full allotment procedure for regular refinancing operations until the first quarter at least, as was already signalled by President Weber 2 weeks ago. All in, then, the ECB will likely keep monetary policy loose for a very long-time, in our view."

NIBC Markets Roundup 20100830

Changing Our H2 US Growth Outlook

- From above- to below-trend growth: "We are downgrading our outlook for second-half growth to 2-2.5% from 3-3.5% previously. This downgrade from above-trend to below-trend growth has important implications for forecasts of the unemployment rate, inflation and monetary policy."
- More slack, lower inflation: "Slack in the economy likely will widen slightly in this new outlook, implying a slower rise in inflation. The unemployment and housing vacancy rates may rise. So while core inflation has bottomed, it may linger below the Fed’s comfort zone for longer."
- The Fed shifts to an easing bias: "At Jackson Hole, Fed Chairman Bernanke clearly indicated that the Fed is prepared to ease monetary policy if needed. The odds of such action are considerably less than certain, however; they will hinge on additional weakness in incoming data."
- Sources of weakness: "Difficult diagnosis: We think the main culprit for weakness relative to our forecast is less than expected support from global growth. But other factors — temporary loss of stimulus measures and hesitation resulting from policy uncertainty — likely also played a role."
- Implications for 2011: "We don’t think this slowdown will last beyond H2, much less morph into a downturn. Policymakers may take action, household balance sheets continue to improve, and we still think net exports will add to growth. We see no reason to downgrade 2011 and even possible reasons to upgrade, especially if policy turns more stimulative."

Morgan Stanley US Economics 20100827

Policy Patience

- "At the last two monthly press conferences, ECB President Trichet acknowledged the then normalisation trend visible in markets. Nevertheless, there was no complacency about the challenges that lay ahead. Had normalisation continued, the ECB may have been prepared to re-engage the ‘gradual exit’. However, market events over the last month suggest the potential cost of an early exit from full allotment liquidity probably exceeds the risks from being more patient. As such, it seems likely that the ECB will announce on September 2 to push-back the exit from the full allotment regime from Q4 2010 until at least Q1 2011."
- "Beyond the push-back on the exit from full allotment, the ECB is likely to remain prudent and cautious. We expect the neutral bias on the monetary policy stance to be retained. The staff macroeconomic forecasts probably won’t change much, other than an upward revision to 2010 GDP growth care of the stronger-than-expected outturn to Q2. Nuance will be important. The Council’s rhetoric on global activity could weaken and exports as an upside risk to growth could be dropped. That could presage expectations of a longer spell of full allotment liquidity and unchanged rates."
- "Also in this week’s Focus Europe we delve into S&P’s raised estimate of the Irish banking crisis which caused the agency to cut Ireland’s sovereign credit rating to AA-. It has been called “extreme” and “flawed”, but if S&P’s estimate credibly draws the upper boundary on the cost, it could be an important source of surety for the market. We also review the latest euro area inflation expectations data, including forward-starting breakevens which have fallen to new lows; the state of the Swedish recovery, the outlook for Riksbank policy and the upcoming election; and the impact of declining worker remittances on Romania’s current account position."

DeutscheBank Focus Europe 20100827

China's medium-term inflation outlook

- "Average inflation, as measured by the CPI, has been largely on a downtrend in the past decade till early 2007 (Chart 1). Such a downtrend not only permits the central bank to cut interest rates in times of economic difficulty, but also encourages authorities to keep rates low even when the economy recovers. Real GDP growth is likely to accelerate to 10% YoY this year from 9.1% in 2009. The CPI is likely to rise from -0.7% to a projected rate of 4% (CPI averaged 2.7% in the first seven months of 2010) during the same period. Acceleration of the general price level has been faster than that of the real economy. Yet, the PBoC has chosen to keep lending rates on hold despite the fact that most Asian central banks have hiked interest rates."
- "We reckon that the PBoC's decision to hike rates will depend on the timing of the Fed hikes. The Fed seems unlikely to raise rates until mid-2011 and perhaps not until later. Weak economic data in the US have renewed fears of a double dip recession and mounting speculation over whether Beijing will start loosening (at least pertaining to those measures placed to cool the property market) towards the end of the year. Inflationary pressure, however, has been rising on most fronts, including wages (See China: Rising wage concern and China: Implications of rising wages (Part II)). China will soon have to choose between sustaining high growth at the cost of higher inflation or dampening growth in return for lower inflation."
- "Policymakers might be tempted to let interest rates remain at the current levels. After all, an annual inflation rate of 3% is perfectly acceptable when the real economy is growing at 10%. From a monetarist's perspective, the current inflation level may seem too good to be true. Broad money supply (M2) was advancing at 3.27x of nominal GDP in 2009, compared with an average of 0.91x between 04 and 08. The general price level started responding only one year later."

DBS Economics 20100827

It is logical that the news from the United States should be bad

- "The latest figures published on the US economy (job market situation, consumer confidence, production prospects, housing starts, retail sales, defaults on mortgage loans, decline in credit) show that the United States is not yet out of the woods and that growth there is slowing."
- "This situation was predictable: the adjustment of households' balance sheets is far from over, their solvency is still in a poor state, companies are looking to distort income sharing in their favour, leading to sluggish employment and wage growth, while deindustrialisation continues."
- "Investors will therefore have to be more patient regarding a real recovery in the United States; from the viewpoint of financial markets, because the growth gap between the United States and the euro zone will be smaller than expected and because US monetary policy will remain very expansionary, one can expect a flattening of the dollar yield curve, renewed appreciation of the euro, and a correction of the performance differential between European and US equities."

Natixis Flash Economics 409 20100824

China: PMIs improve and it looks like a soft landing

- "Both of China’s manufacturing PMIs improved in August, suggesting a soft landing in the Chinese economy rather than a sharp slowdown. Nonetheless, GDP growth will be weak in the current quarter, but should start to improve in Q4."
- "Further monetary tightening is still off the table for the rest of the year. However, it looks increasingly likely that existing tightening measures will remain in place and the government will not be forced into new fiscal easing."

DenDanske Flash Comment 20100901

Company results and GDP growth: A divergence that investors will have to get used to

- "The results of listed companies improved sharply in the first half of 2010, while growth remains sluggish in the euro zone and the economic situation is deteriorating again in the United States. Equity investors are therefore faced with this divergence between results and growth which makes it hard to decide whether now is the right time to invest in equities."
- "We believe that this situation will be long-lasting. Like in Germany and Japan since the end of the 1990s, the United States and the euro zone as a whole are likely to be characterised by distortion of income sharing in favour of companies and to the detriment of wage-earners, which explains the divergence between results and growth. The divergence is also due to the global diversification of the large listed groups."
- "An analysis of the pattern of events in Germany and Japan should provide information on the resulting effects of these diverging profit and growth trends on the stock market."
- "In Japan, the stock market index was clearly adversely affected by such configurations, but not in Germany, which makes the effects of this situation hard to predict."

Natixis Flash Economics 405 20100824