Alive and Well: The Equity Cult in Emerging Markets

- Equities v. Bonds — "A recent CIRA Global Strategy report described the collapse of the ‘cult of the equity’ in global markets and the rise of the ‘cult of the bond’ in recent years. The process of de-equitization is a key symbol of these trends. Deequitization means the shrinkage of equity markets, via cash-financed M&A and share buybacks, alongside limited IPO activity. Market cap falls."
- Alive and Well — "The exception to the de-equitization trend is the emerging markets. The weight of GEMs in MSCI ACWorld has risen from 3.8% in June 2002 to 13.1% at end-August. Price performance alone would have lifted this weight to 9%; the rest is explained by the relative pace of equitization/de-equitization in emerging versus developed markets over this period."
- The Evidence — "The ongoing equitization process in emerging markets is shown by: i) strong flows into GEM equity funds ($40bn in 2010, a year of virtually flat markets); ii) rising equity weights in GEM pension fund assets; iii) a structure of bond v. equity yields that does not encourage the retirement of equity; and iv) heavy IPO activity and secondary issuance."
- Q4 Rally — "The ongoing appetite for equities in emerging markets should help to fuel a strong fourth quarter in EM equities. The trading range in MSCI GEMs, in place for several months now, looks set to break at any moment. Ample liquidity, reduced fears of a US ‘double-dip’, favorable seasonals, a rally in the US market and attractive valuations should trigger a Q4 rally in emerging markets."

SMEs, keys to recovery

- "Hard hit by plummeting demand, threatened by globalization, facing unexpected financial difficulties and tackling a regulatory environment that has often been yet another obstacle, the more than three million small and medium-sized firms in Spain have suffered the worst of the crisis. A difficult time in addition to the customary competitive challenges facing SMEs, forcing entrepreneurs to redouble their efforts in order to navigate such rough waters. Because entrepreneurs make SMEs, their commitment and dedication, their view of the market, their management experience, their knowledge of the sector, their ability to take on risk. SMEs represent the entrepreneurial spirit in its purest state."
- "But the evidence shows that good entrepreneurs are not enough. The environment is also vital. A stable economy, with access to sources of both finances and skilled workers, good infrastructures and a suitable framework of labour, financial and accounting regulations are all essential to creating the right mix for SMEs to be born and grow. Society at large needs to realize and appreciate the crucial role played by SMEs in economic life and the development of shared wealth. Studies have confirmed that, proportionally, small firms create more jobs than large ones. Moreover, the new firms started up generate more competition and also make it easier for large firms to outsource, leading to synergies that enhance the progress and development of the economy in general and society."
- "Business people, public authorities and economic and social agents must sort out their capacities in order to optimize results. Entrepreneurs, committed to growing the business and striving to take on new challenges, and the rest, provide resources that help to overcome the intrinsic deficiencies of SMEs. In particular, their lower work factor productivity compared with large firms, in general resulting from the sector orientation, capital intensity or economies of scale, among other factors. Moreover, in a world where innovation and internationalization are decisive in economic progress, it’s important to recognize that SMEs play a fundamental role. In the case of innovation resulting from big investment in research and development, it’s evident that such heights are off limits to SMEs, but when we look at non-technological innovation, their role is key. This is a wide range of innovations that do not come out of the laboratory but result from contact with clients, suppliers and the market; particularly in a world where consumers develop a preference for variety, leading to many different demand niches that can be exploited with the agility and adaptive capacity of small firms."
- "On the other hand, SMEs must also be capable of taking on the challenge of globalization, although this may seem contradictory to their size, taking advantage of advances in information and communication technologies, establishing strategic alliances and cooperation networks that reduce the effects of economies of scale. Here economic policies (international promotion, providing efficient technological structures) also have a vital role to play."
- "SMEs were the first to notice the crisis but they will also be the first to bear out the recovery, once again contributing decisively to growth, to creating jobs and to supporting local and regional economies. Their success will be the success of all."

Tin sparkles

- "Tin’s impressive performance among the base metals is long overdue. By the end of August it was the star performer amongst base metals in 2010, with the price up 21% since the start of the year, to $21,475t, and 53% higher on year ago levels, with only nickel threatening its ascendency, at 16% and 21%, respectively. Although tin volumes traded on the LME are dwarfed by those of the other base metals (apart from molybdenum and cobalt), tin nevertheless remains a crucial industrial metal, particularly since the demise of lead in electronics’ soldering. The global tin market remains in a chronic supply shortfall that can ultimately be traced back to the tin price collapse some 25 years ago. Since that time, tin mineral exploration has been constrained, and compounded in the past five years by the lagged rebound in the tin price compared with the other base metals. Now tin faces what might be a prolonged period of price  strength due to a worsening supply shortfall that might persist for some years to come."

Battle of the QE2s

- Japan’s intervention: a sterile debate
"The MOF’s FX intervention gives the BOJ another shot at QE, which it should take."
- United States: Time to act
"Growing downside risks warrant the next phase of QE."
- Europe: Shell-shocked but not shell-bound
"Euro-area consumers seem to have resumed spending but a boom is not imminent."
- Japan: Policymaking for a new cabinet
"The new Kan cabinet faces challenges on a range of economic issues."
- China: A soft landing underway
"We lower our growth forecast to 10.2% for 2010 but hold to our 9.8% forecast for 2011."
- EEMEA: Minimal impact from Basel III
"Most EEMEA banking sectors already meet Basel III standards but challenges remain."
- ASEAN: Fiscal exit by stealth
"Fiscal 2010 results will likely exceed budget and in some cases may be contractionary."
- Turkey: No ‘new normal’ yet for Turkish GDP 
"The recovery increasingly looks like previous ones. We revise our 2010 forecast."
- South Africa: Pravin Gordhan and Susan Shabangu event
"We hosted a meeting with South Africa's Ministers of Finance and Mineral Resources."
- Mexico: Policy rate cuts unlikely
"Expectations of an interest rate cut have risen but we expect no change until Q1 2012."

Asian Banks: The Mid-Autumn Review

- India, China to Continue Robust GDP Growth into 2011 – "Our real GDP growth estimates for 2010 show stellar GDP growth for Singapore, mainly attributed to a rebound from a low base. However, on a sustained basis, China and India are expected to continue robust GDP growth well into 2011. Indonesia is also expected to maintain strong growth in the 6.1%-6.2% range."
- 2Q10 Loan and Deposit Growth Trends — "Loan growth at 2Q10 was moderate for Taiwan, Thailand, Singapore and Malaysia and strong for India, China, Indonesia and HK. Korea was the only market with low (~3%) loan growth YoY. Deposits growth was also strong (with the exceptions of HK, Thailand and Taiwan). However, loan growth surpassed deposit growth for all markets except Korea. Also, the loan / deposit ratio was <100% for all markets except Korea (116%)."
- Consumer Loans/GDP Lower Than Non-Consumer Loans / GDP — "Consumer loans as a % of nominal GDP lag the business loans / nominal GDP ratio for most markets (except Malaysia). Consumer loans as a % of GDP are lowest for Indonesia (8.4%), India (9.5%) and China (16.5%). However, a recent steep rise in household debt across Asia also hints at asset/property bubble formations."
- Policy Rate Trends Suggest Uptick — "With central banks pressing the brakes, monetary tightening across the region is expected to push up interest rates. So far, India (+100bps), Korea (+25bps), Taiwan (+12.5bps), Thailand (+25bps) and Malaysia (+75bps) have increased rates since Dec 2009. For the remainder of 2010, Citi’s macro team expects no hikes in China, Indonesia and Malaysia; 1 hike in TW (+12.5bps) and Korea (+25bps), 2 hikes in India (+50bps) and 3 hikes in Thailand (+75bps)."
- Credit Multiplier and Market Cap / GDP Studies – "India, Korea, Thailand and Singapore banks are close to the low end of their respective credit multiplier range (credit multiplier = loan growth / nominal GDP growth). HK and Malaysia are at the top ends of their similar range. However, low recent credit multipliers for some markets may also be attributed to a stellar 1H10 GDP rebound from a low base and hence may understate the actual credit multiplier. Banking sector size in equity value terms relative to local economy (i.e. banking sector market cap / GDP %) is low for India, Indonesia and Korea compared to others, highlighting possible scope for improvement in banking sector market caps over time."

Asian Banks: Re-Leveraging Asia, Big Deposit Franchises Shine

- Loan Growth Recovery – "Loan growth for most Asian countries has recovered strongly, with four markets on ~20% growth (IN, ID, CN, HK) and three markets on ~10% growth (MY, SG, TH). Loan growth has mostly outpaced deposit growth; negative real deposit rates have encouraged outflows from bank deposits."
- Tightening Liquidity – "LDRs have risen but are generally still low. But this masks potential liquidity pressures building up, as liquidity/reserve requirements are high in some countries (eg. IN, CN, ID). Excluding these reserves, the loans/lendable deposits ratio rises to 106% for IN, 92% in TH and 87% in ID. Continuation of rapid loan growth could see funding pressures first in IN, followed by TH and ID."
- Rising Household Debt – "Consumer loans have mostly outpaced the growth in overall lending across Asia. Low nominal rates and negative real rates are likely to drive asset prices further, leading to higher levels of household debt. MY and KR have the highest levels of household debt in the region; if adjusted for GDP/capita, MY’s level of household debt would be the highest in the region."
- Rate Normalization Continues – "We see the most rate hikes in the next 12-18mths in IN, ID, TH and KR; least hikes in HK, SG, CN, MY and TW. Banks/sectors with high levels of CASA deposits and low fixed rate lending benefit most. HK, CN, TW, TH and selective ID banks are structurally best positioned; MY and KR banks seem least sensitive to rate hikes."
- Big Deposit Franchises With Liquid Balance Sheets – "Key beneficiaries of strong credit growth and a rising rate environment are mostly low-LDR banks with big deposit franchises. We highlight: BCA, Mandiri in Indonesia; KTB, BBL, KBANK in Thailand; SBI, PNB, HDFCB, AXIS, ICICI in India. Big HK banks BOCHK, HSB are the most liquid regionally but HK has the least potential for rate hikes."
- Valuations Not Cheap Post Re-Rating – "Most Asian banks re-rated sharply in past 3 mths as prices in most markets (except CN, KR, SG) have climbed ~20% vs positive consensus EPS revisions only in MY and ID. Most Asian banking sectors are now over 13x forward PE; cheapest are KR and CN on less than 10x."
- Overweight CN, TH – "CN banks’ valuation gap vs the region has widened further; most concerns seem priced-in. TH banks still at a discount to ASEAN peers but with better growth, although there is potential policy risk to curb liquidity inflows. Overweight CN, TH. Neutral IN, KR, MY, HK. Underweight ID, TW, SG. Top buys: CCB, ABC, SCB, KTB, Stan. Top sells: BDMN, UOB, OCBC, Cathay, Fubon."
- Multi-strategy — "We recommend 1) Long investors to buy a customised basket of selected regional top picks, 2) Derivatives investors to buy single-stock calls."

Latvia and Hungary: Start October headache

- "We see a troublesome threesome in emerging Europe, hidden below the current decent risk conditions and bond inflows to emerging market funds. Hungary, Latvia and Romania each have risks connecting fiscal, politics and elections. We wrote about Romania last week in “Metastable Equilibria” and the rising risks of early elections and disintegration of the cabinet. Now we look at the other two countries in a little more depth. However, these three countries and their respective domestic fiscal nd political stories can feed back on one another, and we believe this could develop into a more generalised regional sovereign risk story. This could well become important at the start of October with the Latvian parliamentary elections on the 2nd and then the Hungarian local elections on the 3rd."
- "This theme is particularly relevant as we move though H2 and towards next year as these countries are reaching the end of their IMF credit lines (October 2010 for Hungary, April 2011 for Latvia and May 2011 for Romania). More than that these countries face potential difficulties funding in the market under adverse risk conditions, and IMF repayments could add further difficulties down the line (although all have a significant proportion of IMF/EU aid still in reserve, drawing down reserves is not a good sign) although that will not start for another year or two. On top of this, we expect the market re-focus on the issue of peripheral Europe and how it will fare through 2011, and so any risk in CEE is likely to be associated with a corresponding country in western Europe. In particular Hungary is obviously linked via its banking system to Germany. Romania is linked to Greece and the rest of the periphery in both banking and export terms, while Latvia has its classic linkage to Sweden."
- "The Hungarian government has turned its back on the IMF/EU lending package and appears to have “got away with it” so far. Risk sentiment towards EM countries in general is positive and bond inflows have remained moderately supportive. In addition, some in the market believe that the government is on the right path. However, the risk that other governments (or opposition parties) try to force a similar anti-Brussels/Washington consensus line is being closely watched by the EU and we believe any such behaviour will be stamped out quickly in a flurry of rhetoric and if necessary warnings of likely consequences."
- "As ever with such events, markets are likely to be slow to react, in part because results will not be known for some time and also in the case of Latvia because coalition talks may well take a month or more. The speed of market reaction may well be influenced strongly by the degree of risk tolerance of markets in three and a half weeks’ time."

Tax Policy Could Break U.S. Economic Stalemate

- "Changes in income tax rates in isolation have virtually never set the U.S. economy in an entirely different direction. Nonetheless, as the sharp turning points of 2008/2009 fade behind us, tax scenarios that could mean fiscal tightening of 2% of GDP or zero represent quite meaningful differences to the 2011 outlook."
- "Our base case U.S. economic view embeds tax increases close to 0.8 percent of GDP, similar to the Obama administration’s proposals and a bit less than we assumed earlier this year. Compared to our earlier views, a scenario of forestalling all tax increases now seems possible, if not probable, in our view."
- "While income tax increases for the highest earners would affect a small minority of tax payers, it would be a drag on a relatively large share of income and spending. According to the Congressional Budget Office, across all sources of income, the top 5% of income tax filers accounted for 44% of all
federal tax liabilities in 2007. It would also affect the employers of millions, if not the millions of small business (S-Corp and proprietors) employees directly."
- "The case for a stronger recovery in the U.S. is clearly centered on reviving business expectations amid a massive precautionary liquidity buildup in both the business and household sectors that could be put to more active use. Some certainty and consistency on tax rates could eliminate a barrier to action."

India: Lay of the land

- Demand and growth – tightening, capacity constraints, rural versus urban
- Government finances – telecom collections upside surprise, growth leverage, rolling back of sops
- Inflation – about to roll over
- Rates – short versus long term, liquidity lessons, inflation and policy
- Currency – flows, current account, intervention policy, monetary policy
- Market valuations and sector preferences

India: Land Lock? The Key is Economics and Equality

- Land: Could rising Tension accelerate Reform? — "In the recent past, developments on Vedanta and the Yamuna Expressway have highlighted development vis-à-vis EEE, Economics/Environment/Equality trade-off. This makes reform imperative on (i) land acquisition related issues and (ii) viable resettlement and re-habilitation policies. To this end, the recent political focus and proposed amendments in land acquisition/mining bills (annuity and royalty/profit sharing) – if implemented could unlock development value that’s currently trapped in land."
- Development Yes, but Likely at a Higher Price — "As India moves to a higher growth trajectory, industrialization and urbanization will necessitate the continuing need for land acquisition. There will constantly be issues that will warrant an effective balancing act between development and the EEE. There could be delays and at times politics may prevail over economics. However, if land reforms do come through, it should speed up economic development but will most surely come at a higher financial cost for business and be supported by higher socio-economic pay-off."
- Macro: Maintain 8.4% Growth Estimates but Revise Current Account Deficit — "India’s monthly trade deficit which was in the US$8-9 bn range in the 1H10 has now widened to US$13bn largely due to the rise in non-oil imports. Consequently, we have revised our trade deficit estimates from US$128bn in FY11 to US$144bn. With estimates on invisibles (software + remittances) unchanged, we now expect the current account deficit (CAD) to widen to US$49bn or 3.1% of GDP from US$35.1bn or 2.2% expected earlier."
- Financial Markets — "On the rupee, taking into account global factors – yen intervention and the run up in CNY, we are maintaining our March 11 and March 12 estimates of Rs45.5/US$ and Rs43.5/US$ due to the rise in the trade deficit. On rates, given that inflation remains significantly above trends, we expect one or possibly two more hikes in the next 6 months. This should take repo and reverse/repo rates to 6.50% and 5.50% respectively vs. our earlier expectations of repo/reverse repo rate at 7% and 6% by Dec 11"

What are the prospects for stock market indices?

- "In the short term, since 2008, stock market indices (we look at the S&P, the Eurostoxx and the CAC) have moved in line with risk aversion, which itself depends on economic news and concerns about some financial markets and some classes of borrowers."
- "In this Flash we look at a longer-term horizon, and we seek to ascertain what the economic environment implies for stock market indices."
- "It seems to us that:
• their stagnation in 2010 is consistent with the downward revision in growth prospects, and hence in PER levels, and investors are adopting a virtually deflationary equilibrium scenario, which is the most likely for the United States and the euro zone;
• subsequently (2011-2012), the indices can be expected to rise in line with earnings per share, which are rising rapidly because of the distortion of income sharing at the expense of wage earners."

Equity Issuance: Alka Seltzer, Anyone?

- The equity pipeline for this year is estimated to be US$116bn — "Add on what has already been done year to date and, at US$ 291bn, it will set a new record. Issuance will be heaviest in China, India and Singapore, and lightest in Taiwan, Thailand and the Philippines. By sector, financials, materials and energy lead."
- Relative to market cap, issuance will be 2.9%, slightly above average — "There is little relationship between markets and issuance: they are coincident at best. It the market’s down, issuance will be down and vice versa. Issuance does not cause the market to fall, it mere slows the ascent. Issuance is in excess of dividends paid and inflows, so we need to see a shift out of bank deposits or more interest from overseas investors."
- Best way to avoid the Alka Seltzer is stay away from the crowd — "With cash levels just at averages, investors may have to sell something in order to buy something. Consensus overweights are thus vulnerable to being sold down, since you can’t sell what you don’t own after all. Div financials, materials and consumers are vulnerable were this to happen."

Spain: near-term risky, medium-term more promising?

- "We see several near-term risks for the Spanish economy. GDP is likely to contract in the third quarter following the VAT hike, while the political environment remains difficult ahead of the 2011 budget vote."
- "We believe that the risks of a double-dip recession have receded, however, and that the economy is more likely to edge towards a protracted period of modest expansion in activity."
- "The main challenges are in the medium term as Spain has to switch to a more competitive growth model at the same time as the private sector succumbs to a drastic deleveraging process."

Public debt cannot be substituted for private debt

- "The argument used to defend the implementation of highly expansionary fiscal policies since the start of the crisis is that private debt must be replaced by public debt since private economic agents are deleveraging. But we saw that this substitution of public debt for private debt came to a halt very fast: as governments reduced their fiscal deficits while the private sector continued to deleverage, some countries found it impossible to finance their fiscal deficits under normal conditions."
- "Admittedly, the increase in the public debt has often gone far beyond the level that corresponded to a replacement of the private debt, but especially for investors, public debt cannot be substituted for private debt, and they therefore refuse to permanently accumulate public debt in their portfolios instead of private debt:
• investors (lenders) need a default risk-free asset; they accept the default risk on household and corporate debt, but not on public debt, which must play this role of default risk-free asset;
• investors (lenders) assess a debt’s solidity by looking at the counterpart of the debt in the borrower’s assets; for households, we are talking about a real estate asset (collateral), even if its valuation has often turned out to be abnormally high; for governments, the debts mainly finance current expenditure or tax cuts, not the accumulation of an asset, and this worsens their quality."

To what level can the savings rate of the Americans go?

- "If Americans’ (net) savings rate remains close to 6% - as it has for several months - the United States will not slide back into recession, but post slower growth for a long time to come."
- "But if we believe that there will be a new recession - i.e. a double dip - in the United States, we also have to believe that the savings rate among Americans will rise again and their consumption drop, which is possible given the changes in Americans’ wealth and the labour market situation, and despite
the low interest rates and the erratic stock market return."
- "In view of the trends in asset prices (real estate, equities), unemployment, problems encountered in the labour market, interest rates, etc., we seek to ascertain at what level Americans’ savings rate should normally be today, and whether there is a risk that it will continue to rise sharply. Our econometric analysis, which seems to be of good quality, shows that Americans’ current savings rate (6% for net savings) seems to correspond to the savings rate that is consistent with the trend in all determinants of household savings. So we do not believe in a further sharp rise in the savings rate or, accordingly, in a double dip scenario."

The role of the Chinese cycle in the global cycle

- "We seek to ascertain the role played by the Chinese cycle in the global cycle."
- "This poses two types of questions:
• to measure the weight of the Chinese cycle, we can use an accounting approach (China’s weight in global GDP, in global trade); but it overlooks the multiplier effects of the Chinese cycle: growth motor of other Asian economies, effects of the sharing of the production between China and other Asian countries. Effectively, we find an elasticity of output (GDP and manufacturing output) to output in China of 0.4 and not from 0.1 to 0.2 according to the accounting approach;
• we also have to look at the direction of causality between the Chinese cycle and the cycle of the rest of the world; in certain periods (after Lehmans’ bankruptcy), the freezing of the global economy has weakened the Chinese economy; in other periods (late 2009, early 2010 for instance), Chinese growth has driven upwards the global economy. However, overall, statistical tests show that causality definitely heads from China to OECD countries."