The immaculate recovery

- "Seems like every time you turn around lately someone in the G3 is falling over. Earlier this year it was Europe: the Greek debt crisis spread across the continent, sovereign spreads rose and, in shades of Autumn 2008, libor-OIS spreads headed wider too. Belt tightening became the order of the day. Growth forecasts were lowered. Market sentiment soured."
- "None of this could be good for Asia, which, after all, exports as much to Europe these days as it does to the US. The region’s central banks, which had begun to tighten monetary policy in March, paused in May and June. No surprise; discretion is the better part of valor. But they resumed their hikes in July and August. Why? Because Europe wasn’t holding back Asia’s V-shaped recovery or its rapidly accelerating rate of inflation like they thought it might."
- "A handful of hikes in half a dozen countries later, it’s the US’s turn to take a spill. GDP growth drops to 1.6% (QoQ, saar) in 2Q10 and fears of a double-dip consume the markets. The Fed makes a symbolic shift back to strict neutrality and, rather than assuaging markets, only convinces them the sky is falling. Private sector hiring, still barely positive, drops to 67k in August from 107k in July."
- "None of this looks good for Asia either. The region’s central banks – still far behind the curve in normalizing interest rates – will once again put tightening on hold. They will, once again, wait to see how things pan out. And they will, once again, resume tightening in very short order."
- "By December, most of Asia’s central banks will be hiking rates again and we expect their ranks will, by then, include China and Indonesia, Asia’s two key holdouts so far (though Indonesia did raise reserve requirements by 300bps at one go last week, a move that’s probably equivalent to two 25bps rate hikes)."
- "How can Asia’s central banks push ahead with monetary tightening when the Fed is discussing QE2 (additional long-term bond purchases)? More to the point: why isn’t trouble in the US and Europe killing Asia’s recovery?"
- "The short answer is: the US and Europe did not contribute to it. Or very little anyway. If you only thrown a nickel into the pot, taking it back out again doesn’t change much."
- "Take a look at the consumption plots on the previous page. It’s important because consumption is the final demand that drives all other final demands, like investment or imports. At the end of the day, consumption drives global growth, period. And who is doing the driving? Asia. Almost by itself."
- "In the two years since Lehman Brothers imploded, consumption in the US has gone absolutely nowhere – it still has not returned to precrisis levels. Ditto for Europe. Ditto for Japan. But compared to precrisis (3Q08) levels, consumption in Asia is up by 18%."
- "Eighteen percent? Hold on a minute. This is Asia – the place that everyone said had to consume more. The place that could only save and could only export. The place that could not possibly grow unless the US was growing because the US was doing all the buying."
- "Yet there it is. Zero buying in the US. Zero buying in Japan and in Europe. And a boatload of buying in Asia. It’s the immaculate recovery – the thing that everyone said could never happen. The pregnant Asian shopper standing next to an utterly superfluous US, JP and EU."
- "That’s why Asia’s central banks will be back in tightening mode soon – because Asia’s recovery is not about the US. It’s about Asia. And there’s nothing fishy and certainly nothing religious going on here. The hard fact and simple arithmetic (that we’ve shown regularly over the past 4-5 years) is that Asia has been growing rapidly for years and, after a few decades, it adds up: Asia is no longer too small to matter. Among other things, this means Asia can and will consume whether the G3 does or not. And it means Asia’s monetary policies will depend more on what happens here in Asia and less on what happens elsewhere in the world."
- "Still, something doesn’t add up. Much of this report (below) argues that Asia is finally starting to slow down. If so, why will central banks start hiking again?"
- "Because Asia’s slowdown is being driven – or, rather, constrained – by the supply side, not by a slowdown in demand. Asia’s V-shaped recovery and double-digit GDP growth over the past 4-5 quarters have exhausted the excess capacity that used to exist. When that happens, output growth starts to fall and inflation starts to rise."
- "Asia may be slowing on the margin but central banks will have a tougher time dealing with inflation, not an easier time. And if the Fed (counter to expectations) goes ahead with QE2, Asia’s tightening will become all the more difficult. And all the more ‘ironic’."

Regulations will change, banks will change

- Capital adequacy level to be announced soon — "We think an announcement regarding the Basel III capital adequacy standard and transition period will come early next week. We expect a detailed outline early in October, at which time we intend to issue an amended report."
- Significant revisions — "International agreements on banking regulations, hammered out in Basel, undergo major revisions in roughly 10-year cycles. This round (Basel III) will likely change the framework of banking regulations more than ever before."
- Restrictions on leverage — "In addition to capital quality and volume requirements, regulations where risk assets are the denominator will necessitate securing an additional capital buffer when the economy is recovering. Simple leverage (not based on risk weights) will also need to be made sufficient, so it will become harder to increase capital efficiency via leverage."
- Stabilizing financing — "New regulations regarding liquidity will be added, which will look at whether banks 1) are fully prepared for a short-term capital outflow and 2) can maintain stable financing over the long term. We think Japanese banks are in a relatively good position, but European banks may have to shrink capital to meet numerical targets."
- Road to final proposal — "BIS already detailed some supplementary proposals (capital buffer) and palliative measures (items deducted from capital, etc.) based on discussions regarding the consultative document released in December 2009. After the Basel conference in September, the G20 will agree on a framework in November, with the final proposal to be inked in December."
- Impact on banking sector — "We think major banks and major regional banks in Japan have more or less finished preparations for stricter regulations. However, with scope for leverage-based operations limited, bank capital ratios are likely to fall globally."

On a knife’s edge

- "A flow of disappointing news – particularly in the US – has led us to revise down our global growth expectations. Focus will probably continue to be on the US where the economy is expected to balance on a knife’s edge between recovery and another downturn. Double-dip fears are likely to be an ongoing theme for some time."
- "We now have below-consensus forecasts for US growth at 2.6% and 2.3% for 2010 and 2011 respectively – a downward revision of around one percentage point in both years compared with our June forecasts. We look for the economy to grow by 1.5-2.0% in H2 10 before recovering gradually during 2011. The main risk is that the economy gets stuck at a low growth level. We see the risk of a new recession as very low."
- "In Euroland, activity surprised strongly on the upside in Q2 10, leading to an upward revision of our 2010 growth expectations. We have probably seen the peak, though, and we see the economy growing more in line with the long-term trend at around 2% in 2011 as the export engine loses some steam. Our forecasts for Euroland continue to be above consensus."
- "The Asian economy surprised on the downside during the spring, leading to a downward revision of our growth expectations for 2010. However, we expect Asia to recover during the coming quarters."
- "Inflation is expected to remain subdued and policymakers in G3 will continue to focus on supporting growth. We see a 40% probability that the Fed will start another round of quantitative easing (QEII). The ECB is expected to keep rates on hold throughout most of 2011. Chinese policymakers are sidelined but we expect tightening to resume in 2011."

Emerging Shale Plays Alter Landscape

- Natural Gas Price Outlook — "We are revising our 2010 composite spot natural gas price forecast to $4.50/MMBtu from $4.75/MMBtu. Although a cold start to the year and a record-hot summer helped to tighten the supply/demand balance, continued rig efficiency improvements and a strong pace of capital outlays has driven domestic production to higher levels than originally forecast. For 2011, and assuming normal weather, we are revising our forecast to $4.25/MMBtu from $5.75/MMBtu. Even though we are assuming a 15% drop in the domestic gas rig count by the end of next year, with difficult yr/yr weather comps, the supply/demand balance appears looser than this year. We are reducing our “normalized” price to $5.50/MMBtu from $6.25/MMBtu because we believe that significant running room still lies ahead in numerous North American shale plays, providing acceptable returns at $5.50/MMBtu and yielding ample supply to meet demand for at least several years ahead."
- Glimmer of Hope in 2012? — "Given our current projections, 2012 provides perhaps the first glimmer of hope wherein total U.S. natural gas production peaks in the third quarter of next year at the same time that drilling to hold acreage begins to abate. Hence, our $5.50/MMBtu forecast beginning in 2012 and going forward."
- Longer-Term Oil Price Outlook Unchanged — "We are lowering our 2010 WTI spot oil price forecast to $78.20/Bbl from $81.00/Bbl. Our 2011 and normalized price forecasts remain $85.00/Bbl and $80.00/Bbl, respectively."
- Adjusting estimates and price targets — "Based on our revised commodity price outlook, we have adjusted earnings, net asset value and price targets for our coverage group. On average, we have lowered 2010 EPS/CFPS estimates by 11%/4%, for 2011 by 27%/18% and for 2012 by 13%/26%. Proven reserve NAV estimates have dropped, on average, by 10% while price targets, on average, are now 7% lower."
- Continue to Prefer Oil-Leveraged Names — "Overall, we continue to have a greater proclivity for the more oil-leveraged names. Our top picks are APC and APA."

Still swings in mood next week

- FI Strategizer: "A clear trend for USTs is unlikely to emerge given the light calendar and a cautious investor stance ahead of the September 21 FOMC meeting. In the EMU, the Greek T-bill auction and news on Irish banks should be the main drivers putting pressure on periphery spreads."
- EU Portfolio Strategy: "Just as the double-dip discussion lost steam, another round of credibility erosion moved center stage, although a clear Bund yield rally did not emerge. We return to a modest long duration stance to benefit from renewed uncertainty."
- MM: "Excess liquidity has stabilized in the EMU as shown by the recent 1W and 1M auctions. Portuguese and Greek data show that borrowing at the ECB has not eased in August after the stress test results."
- Trade Idea (I): "The Portuguese curve has cheapened vs. swap at the 15Y and offers an interesting switch with Ireland. Our Z-score system also suggests switching from the BTP Apr15 into the SPGB Apr15."
- Trade Idea (II): "The 10/30Y spread in the UK trades close to all-time highs and has recently started to tighten. We expect the recent trend to gain momentum, also thanks to a slowing in inflation."
- Supply Corner: "There is no liquidity next week, while gross supply should be EUR 25/30bn, with almost an auction per day. 68% will come from core countries, the remaining will come from Italy and Spain. Keep an eye on Tuesday's Greek T-Bill auction (EUR 0.9bn of 26W T-bills)."
- FX Strategizer: "Safe-haven currencies (i.e., JPY, CHF & USD) should remain favored as long as global uncertainty persists. Next week's data are unlikely to cause direction-setting impulses, but large swings should prevail in the medium term too, preventing the formation of clear trends."
- EUR: "We do not expect heavy EUR-USD losses over the next couple of weeks, but we don’t rule out a retest of 1.25-1.20 in the coming months, if EMU worries escalate. A recovery up to 1.30-1.35 may occur only in late 2011, when the ECB starts its tightening process."
- JPY: "The JPY should stay strong and BoJ intervention, if any, may at best contain its rise. A weaker JPY may occur only from 2Q11 onwards, if risk appetite resumes, but USD-JPY is unlikely to rally above 90-95."
- CHF: "The SNB meeting on Thursday will be a crucial test, but we won’t be surprised if EUR-CHF slides to 1.27-1.25 before December. This will limit the room for a pullback in 2H11 that won’t exceed 1.30-1.35."
- GBP: "Cable should be dragged down towards 1.52-1.50 if risk aversion persists and we don’t see great upside potential towards 1.60 before the end of 2011. EUR-GBP should stay locked within the 0.80-0.85 band."
- Pacific Rim: "The three dollars shrugged off risk aversion, but we would handle their strength with care. A more sustained rally may resume in 2H11, when interest rate spreads may offer stronger support in the wake of a less uncertain global scenario and a weaker JPY."
- Nordics: "EUR-SEK and EUR-NOK will fall towards 9.15-9.10 and 7.65-7.60, respectively, but attacks and retreats will remain the theme. Book squaring may weigh on the SEK ahead of the September 19 elections."

Alternative Energy

- We see a rebound in clean energy investment in 2010F …• "Of the total US$177bn pledged towards investment in renewable energy and energy-efficiency measures by governments worldwide, only 14% was utilised in 2009. According to New Energy  inance (NEF), nearly 68% of the clean energy stimulus spending will be in 2010 (35%) and 2011 (33%)."• "We expect government support for clean energy to continue in 2010F and 2011F."• "Total new financial investment in clean energy grew 31% y-y to US$27.3bn in 1Q10 from US$20.8bn in 1Q09, according to New Energy Finance."
- … but performance of clean energy stocks has been divergent…• "performance of clean energy stocks, especially solar, has been lacklustre YTD, owing to several factors"
1) "Uncertainties over government subsidy plans"
2) "Looming cuts in feed-in tariffs (FIT)"
3) "Difficulties in raising funds for renewable energy projects"
- … nevertheless, countries across the world remain committed to clean energy technologies.• "G-20 countries account for more than 90% of total clean energy investment"• "Over the past five years, their investments in clean energy have grown more than 5x"
- Latest industry trends and key investment themesMarket:
1) "Global new energy end-market demand growth is shifting from Europe to Asia and the US, with wind power continuing to be the technology of choice, followed by nuclear, biomass and solar."
2) "We believe the changing nature of Europe and Japan as a manufacturing and technology location in the broader global sector context, while outsourcing to lower-cost Chinese manufacturers, should increase, owing to pressure on ASPs and margins along the value chain."
3) "Renewable energy as a challenge and opportunity for other sectors."
1) Short term — "FIT or other financial incentives are critical to trigger demand growth."
2) Long term — "National portfolio standards play a significant role in promoting renewable energy, sustaining its growth and attracting investments."
3) "China, Germany and the US have a higher probability of emerging as market leaders in clean energy technology."
1) "Subsidy cuts in European countries should lead to increased outsourcing to China; this should benefit Chinese solar players such as JA Solar, LDK and Renesola, which have exposure to non-brand OEM businesses."
2) "Strong growth in solar end demand, along with solar companies’ focus on cost leadership and efficiency to maintain profitability amidst falling ASPs, should lead to strong order inflows for European solar equipment manufacturers, such as SMA Solar and Centrotherm."
1) "We find Chinese wind turbines component manufacturer CHST in a sweet spot, as it should benefit from the company’s strong position in China, as we expect China to remain one of the top wind countries, and have great export potential due to its impressive cost competitiveness."
2) "European wind turbine players, such Vestas and Gamesa, should benefit from their diversification of manufacturing base outside of Europe as it would help them to meet customers’ demands more effectively."
3) "Europe will be the main growth driver of the offshore wind market and we expect the global offshore market to grow 113% y-y in 2010F and 111% in 2011F. The offshore wind segment will be the next growth driver for the Chinese WTG market as attractive locations for onshore wind farm development have already been exploited. Potential beneficiaries are Vestas and Repower in Europe and Sinovel, China High Speed and Goldwind in China, in our view."
1) "New build in Asia is set to be dominated by China, India, Japan and Korea, while that in the rest of the world is likely to be more widely spread."
2) "However, ex Asia, three countries stand out as having significant new build aspirations over the next 15 years. They are Russia, where we see 16 GW of capacity additions, the US (12GW) and the UK (10GW)."
Key beneficiaries:
1) Solar: JA Solar, Yingli, Wacker Chemie, SMA Solar, Centrotherm and Ulvac;
2) Wind: China High Speed, Vestas and Gamesa;
3) Nuclear: KEPCO, EDF, GDF Suez, E.ON, Toshiba Plant Systems & Services, Hitachi, Toshiba Corp, Tokyo Electric and Kansai Electric;
4) Geothermal: Energy Development Corp.

Offshore drilling in very deep water

- "Big Oil has had a terrible year so far. The explosion on 20 April that killed 11 men and sent BP’s Deepwater Horizon drilling rig to the bottom of the Gulf of Mexico set off an environmental, commercial and political firestorm that may take years to extinguish. The catastrophe raises uncomfortable questions
about the offshore oil and gas sector’s operational safety standards, about the regulatory frameworks within which it works and, by no means least, about the insatiable demand for energy that increasingly is sending exploration companies into more difficult and potentially hazardous territory."

Japan: Stocks unlikely to move off their bottom until year-end at the earliest

- Severe deterioration in market sentiment points to bottom for share prices: "Sentiment on the Japanese equity market worsened markedly between August and early September, and many signs evident in previous phases where Japanese stocks fell to lows came to the fore again. The September QUICK survey of stocks indicated a severe deterioration in stances on both the portfolio weighting of Japanese equities and the economy/corporate earnings among equity managers at Japanese institutional investors."
- Recession unlikely: "We think the Japanese economy is highly unlikely to fall into recession between now and the end of 2011. The focus of market concerns about the global economy is on trends in the US economy once policy stimulus is withdrawn. However, in both Japan and the US, business managers have recently been reining in capital expenditure and employment as they take a cautious view of the economic outlook. In the past, both countries have tended to fall into recession following capex adjustment. With companies curbing capex, we see little possibility that either economy will enter a recession given the current absence of surplus capacity."
- Earnings estimate revision index likely to bottom in late 2010 or 2011 Q1: "Reflecting the building sense of economic slowdown of late, the earnings estimate revision index for Japanese companies has been falling. We think this index will need to bottom out before Japanese equities can form a major bottom from which to rally. We see late 2010 as the earliest timing for such a move, and think the most likely timing will be 2011 Q1. Critical to this are developments on the monetary and fiscal policy front, especially with the US economy expected to remain anemic through end-2010. Whether or not Bush era tax cuts will be allowed to expire as initially planned at end-2010 merits particular consideration. Another key issue is global inventory adjustments in the electronic parts and devices industry. Trends in this industry are closely watched as a leading economic indicator, as they often reflect marginal changes in the global economy. The industry's inventory/shipment balance has worsened recently, and looking at the past 10-year average cycle we think the balance will continue to deteriorate until around March or April next year."
- Investment strategy: "In view of the above, we project that Japanese equities will form a major bottom from which to rally from late 2010 onward. With share prices at or near lows, however, we do not recommend lowering portfolio beta values. To raise portfolio beta value, we continue to recommend trading companies and construction machinery manufacturers, and from this month we also include automakers. We believe trading companies and construction machinery manufacturers will benefit from an expected alleviation of concerns about Chinese economic slowdown. For automakers, we expect the market to react to excessively steep share price declines owing to negatives such as yen strength and the end to eco-car subsidies."

Lower debt yields should drive confidence

- "Firms have taken advantage of falling corporate bond yields and investor demand to issue new debt; this should support equities and global business confidence"
- "The improvement in financial conditions should help the Fed to proceed with a steady policy on September 21"
- "Political developments are likely to be significant during the next few weeks as EU countries complete their 2011 budgets, and with the focus on US mid-term elections and the forthcoming DPJ President election in Japan"
- "With the contribution of net exports to GDP growth swinging back again in China's favour, FX-related tensions could re-emerge"

Regional Implications of China’s Wage Inflation Part 1: Reshaping the Regional Production Chain

- China’s wage inflation could alter the wage cost rankings within Asia1 — "Wages of unskilled labour in China may accelerate 15-20% in coming years from 10- 15% over the past decade, further eroding China's relative cost advantage. Out  of twelve Asian economies, China has risen from being third lowest in terms of hourly manufacturing wages in 2000, to being the sixth highest currently."
- China’s wage “catch-up” may reshape the regional production chain — "While the relocation of labour intensive activities could benefit lower cost regional economies, strong incentives exist for firms to retain production within China, including the large domestic end-market and China’s diverse array of cost structures which effectively allows it to replicate the pan-Asian production network within its own borders. Moreover, to the extent that it incentivizes higher wage coastal regions to automate and shift towards higher value added production, China’s coastal regions may over time compete more directly with Asian NIEs which compete on technology rather than low cost."
- Relocation in electronics and low tech; catch-up in capital intensive sectors — "Our Revealed Comparative Advantage (RCA) analysis identifies the activities where China has a comparative advantage in production, the activities that are likely to relocate, as well as the likely winners and losers of this reconfiguration. Low tech sectors aside, we think labour intensive activities within E&E production, including telecomms and household appliances, may see greater pressures for relocation out of China or into inland provinces. More capital intensive sectors where China has the greatest scope for catch-up include chemicals, autos, pharmaceuticals and semiconductors."
- MY, TH winners in med/high-tech, JP, KR, SG potential losers — "Within the medium and high tech space, Malaysia (electronics, high-tech consumer goods) and Thailand (electrical, autos) could benefit, especially in labour intensive areas. Korea and Japan (autos, machinery, high-tech consumers), Singapore (electronics, pharmaceuticals, non-road transport, high tech consumer goods) and India (metals, non-road transport, pharmaceuticals) could face greater Chinese competition in capital intensive sectors, as higher Chinese wages spur automation and technological/productivity catch-up."
- IN, ID, VN, Cambodia, Sri Lanka to gain from relocation in low tech space — "Within the low tech space, there are few losers given limits to automation. By becoming relatively cheaper, countries with marginally lower RCA scores than China would potentially benefit. For garment/textiles, India and Indonesia are bigger beneficiaries, while Vietnam could gain in low-tech consumer products. Bangladesh, Cambodia and Sri Lanka with currently higher RCA ranking vs. China would continue to hold comparative advantage in low-tech production."

$175bn+ of balance sheet headroom by 2011… but can they resist another cycle of overpriced M&A?

- A prolonged period of supernormal free cash flow "By the end of 2011, we forecast balance sheet headroom of over $175bn for the UK-listed mining sector. In the last cycle, over exuberant M&A destroyed value for shareholders. The past few weeks have seen three potential acquisitions in the sector (BHP/Potash Corp, Vedanta/Cairn India and ENRC/Camrose), and we do not like any of them. In the current cycle, we think investors should favour those companies most likely to return excess capital. We highlight Rio Tinto and Antofagasta here."
- Pushing out the commodity price peak "We have pushed out our assumed cyclical peak for commodity prices and mining industry earnings to 2012, in line with Nomura's view for a modest recovery in OECD economic growth. In specific cases, we have increased our medium-term commodity price forecasts to reflect worsening supply lags (mainly copper). We continue to forecast the majority of excess cash to be generated from copper, iron ore and coking coal exposure, and our new commodity price forecasts remain the most bullish versus consensus for these commodities."
- Valuation and top picks "Rio Tinto (Buy, TP £59) remains our top pick, driven by iron ore exposure and a renewed discipline to M&A after overpaying for Alcan. We retain our negative view on BHP (Reduce, TP £23), and we downgrade our recommendation for ENRC (Reduce, TP £9.5) from Buy previously. We reiterate our positive view on the miners with valuations still undemanding. However, we also recognise the additional risks (political, fiscal and M&A) that an environment of high free cash flow brings, and we have widened the spread of discount rates applied to our NPV valuations across the sector."

The International competitiveness of the Turkish economy: some stylised facts

- "In the first quarter of 2010, the scale of the recovery in the Turkish economy caused some surprise, with GDP growth of 12% year-on-year, against an average of just 2% for the four countries of Central Europe (Poland, Hungary, Czech Republic and Slovakia) and a further contraction in GDP in Eastern European countries (Bulgaria, Romania). In the second quarter, on the basis of trends in industrial production, the gap between Turkey and Central and Eastern European countries narrowed significantly. However, Turkey, which has emerged swiftly from recession, gives the impression of being an economy that whilst vulnerable to the international environment is more solid than its European neighbours."
- "The budget deficit is likely to be lower than in all Central and Eastern European countries apart from Bulgaria in 2010 and probably again in 2011, with the return to growth and the increase in the exchange rate helping reverse the snowball effect(1). Moreover, although unemployment is still higher than it was before the recession, it has eased since mid-2009 (which is not the case for other Central and Eastern European countries). Lastly, underlying inflation remains under control at below 5%."
- "Thus the Turkish economy displays satisfactory macroeconomic fundamentals. In addition, both the
banking system and businesses withstood the recession well. Lastly, the trade balance remains the economy’s Achilles’ heel, and it could worsen if the 2011 elections led to a relaxation of control over the budget."
- "In fact, in June 2010, the current account deficit was nearly $21bn, cumulatively over the first six months of the year, or nearly three times the Chart in the same period of 2009. As a percentage of GDP and over the full year, it remains modest at around 4% of GDP, compared to 5.6% on average between 2005 and 2008, but not far off the alert threshold, which is generally set at 5% of GDP. Does the Turkish economy suffer from competitiveness problems? The purpose of this article is to identify some of the factors that will help answer this question. In the first section we will examine the usual aggregate indicators: apparent and structural trade balances and price competitiveness indicators. We
complete our analysis by summarising the main trends in the structure of international trade in goods and in the country’s share of export markets (part II) before drawing our conclusions."

China’s Struggle with Capital Flows

- Opening up capital accounts in China may exaggerate excess liquidity near term — "Recent measures by China to encourage outbound investment likely aims to alleviate excess domestic liquidity and to help diversify excess FX reserves. But as policy continues to support exports, the reserves would only become more excessive in coming years."
- USD assets have already been reduced sharply, further cuts difficult — "We update a study by Brad Setser on China’s reserves and US asset holdings. We found that USD’s share of China’s total FX reserve assets had fallen from 73% in end of 2008 to 58% in June 2010. USD’s share of new FX purchases has been cut to about 30%. Given that the US accounts for a majority of China’s trade surplus, it would be difficult to further reduce purchases of USD assets."
- China’s total FX assets already exceed $3 trillion — "After folding in FX assets on the books of the central bank and the rest of the banking system, we found an extra $566bn on top of the $2.454tn published by SAFE."
- FX reserves may continue accumulating at $250-300bn in the next few years — "The trade surplus is likely close to $200bn this year, at par with $197bn in 2009. We see the surplus staying at $150-200bn over the next couple of years. Moreover, net FDI and portfolio inflows could each contribute $50bn a year."
- Offshore RMB settlement may actually boost FX reserve accumulation — "When appreciation expectations are alive, businesses would pay for imports with RMB rather than use FX revenues from exports, which would be used to buy more CNY. The result is more CNY abroad and more FX in China’s reserves."
- Market implications — "China would likely still invest one third of new reserves in USD assets ($80-100bn a year), possibly favoring agency and corporate securities, as long as the recovery doesn’t falter. USD’s share of the total portfolio should still fall. Euro, EM and commodity currencies would likely pick up the bulk of the remaining new reserve accumulation. Investments in Japan could be risky with already expensive yen."
- Investing excess reserves would have international repercussions — "Exporting the massive amounts of liquidity could be destabilizing for smaller economies, potential for political friction. This issue would only grow as China reduces the weight of USD in its expanding portfolio."
- Overseas direct investment (ODI) and portfolio outflows face hurdles — "We do not doubt the potential for China to export capital, but ODI must overcome the state owned stigma to be more accepted abroad. QDII must overcome the poor performance stigma from the first batch of funds. Further privatization and financial market liberalization could help improve these conditions."

France: Can foreign trade be a growth engine?

- "During the last cycle, French growth was mainly - not to say exclusively - based on domestic demand, especially household consumption. While it has markedly - and permanently - weakened, it would seem that foreign trade has now taken over the role of driving force of activity. That is in any case what the latest national account figures suggest, excluding effects of changes in inventories, since France pulled out of recession in the spring of 2009."
- "For our part, we believe that French foreign trade has primarily benefited from a series of favourable and temporary factors, against the backdrop of a sharp pick-up in trade after the post-Lehman collapse in global trade. Insofar as structural problems persist, we remain relatively sceptical about the probability of a rebalancing of French growth to the benefit of the export sector. The weaker domestic demand will only just generate a smaller negative contribution of foreign trade over the next two years."
- "We therefore remain relatively pessimistic about French growth prospects for 2012."

Sovereign doubts still linger for Greece: Earnings/ratings changes as tough times continue

- Economic uncertainties continue to weigh on investment case "Despite the progress being made by the Greek government on deficit reduction, risks and uncertainties still lie ahead. The recession has intensified and bond markets remain sceptical (as shown by the continued high bond spread/yields). In this context, and although on cheaper valuations and having significantly underperformed peers, we remain cautious in our outlook for Geek banks relative to the sector."
- Waiting for consolidation "The IMF stability fund of EUR 10bn, to help strengthen Greek banks, and potential consolidation among the major Greek banks means there could be significant changes in the structure of the Greek banking sector in the coming months. We estimate that some mergers could generate value of up to 40% of the combined market caps."
- Rating changes/earnings downgrades "We remain negative on Greek banks relative to European peers. We downgrade our earnings estimates by c. 48% over the period 2010-12.
Upgrading Alpha to Buy. Based on valuation and exposure to Greek bonds we upgrade Alpha Bank to a Buy rating from Reduce. New price target EUR 7.0 per share.
Downgrade NBG to Neutral. Independently of the rights issue, but based on our outlook for profitability we reduce our rating on NBG from Buy to Neutral, new price target EUR 9.0 per share (price target reflects rights issue)."

Wealth, indebtedness and investment

- "Since the second half of the 1990s, in the United States and Europe, there have been fairly strong correlations between:
the debt burden of companies and their market capitalisation (except in the United Kingdom);
investment by companies and their market capitalisation;
households' debt burden and their property and financial wealth (predominantly property wealth in the United States and the United Kingdom)."
- "We use these correlations to try to ascertain the length of the period of deleveraging by households and companies."
- "We find that, to be consistent with market capitalisation and household wealth:
the debt ratio of companies must decline by a further 5 percentage points of GDP in the United States, and 10 percentage points of GDP in the euro zone;
the debt ratio of households must decline by a further 12 percentage points of their disposable income in the United States, 6 percentage points in the euro zone and 15 percentage points in the United Kingdom."

Dollar/euro exchange rate: The only thing we can predict is high volatility

- "The dollar/euro exchange rate has shown very high volatility since the beginning of the crisis, between 1.18 and 1.60."
- "We believe this will continue, as the exchange rate between the dollar and the euro depends on numerous factors that may play in opposite directions and are perceived one after another by the financial markets:
the growth prospects; they are poor in both cases, but the financial markets, which believed in markedly stronger growth in the United States, now have to revise this belief; the US external deficit and external debt: they will not disappear unless US households save more; the developments in the sovereign debt crisis in the euro zone: for the time being, the news is good (reductions in fiscal deficits, countries are able to issue), but uncertainties persist."
- "From May to July 2010, poor figures were published in the United States, the US trade deficit increased and the public debt crisis in the euro zone became less acute, leading to a rise in the euro. But there are now poor figures in the euro zone as well, and, in the future, bad news about certain budgets, perhaps a rise in the US household savings rate, which would be consistent with the changes in their wealth. Together, these factors account for our forecast of high volatility in the USD/EUR exchange until end-2011."