China’s 12th Five-Year Plan: Investable shift from growth quantity to growth quality

- More evolutionary than revolutionary "With the aftershocks of the Global Financial Crisis and “global imbalances” still reverberating through international markets, and with China having recently attained the status of the world’s second-largest economy, investors are looking toward October’s release of China’s 12th Five-Year Plan for key guideposts. Yet investors may need to temper expectations. With China well along in its market development, the days are gone when Beijing could exactly determine China’s economic path; and much of the new plan’s thrust should be a continuation of the economic rebalancing initiatives laid out in the 11th Five-Year Plan (2006–10) – a policy bias already well known to markets, and thus in many cases largely priced into listed equities."
- Investable themes – from growth quantity to growth quality "Still, we believe China is marking a path where the quality of growth – in terms of composition, efficiency, and environmental impact – now commands more attention at the margin than sheer quantity. This includes efforts to rebalance aggregate demand toward domestic consumption and service-sector activity from export manufacturing and investment. This implies reduced material- and energy-intensivity, to be effected in large part through higher factor costs – such as wages, energy/utility tariffs, land, and (potentially) capital costs. While these initiatives will generate relative winners, they may also imply downward pressure on margins generally, and a decline in China’s overall profits-to-GDP (which rose precipitously over the past decade). As in recent years, we expect to see continued emphasis on rural reform and Western-regional development – a policy bias that will continue affecting patterns of consumption, credit growth, and construction / investment activity, among others."
- The search for net-yet-fully priced plays "We distil these themes into a select list of ‘Top 25’ Five-Year Plan stocks (Figure 3, page 4). Key among these are names involved in 1) new energy vehicles, 2) clean power (including gas, wind, coal-to-liquid), 3) western-regional development and/or urbanization into lower-tier cities, 4) urban rail build-out, 5) medical system expansion, 6) private consumption and retail mall development, and 7) financial innovation. Yet, as noted, many of these themes are already well known to the market. In the effort to identify outstanding value, we filter our ‘Top 25’ for 1) historical PER discounts larger than the current MSCI China discount of 8%; 2) historical P/BV discounts of 30% or more; and/or 3) a PEG ratio (based on three-year 2010–12E CAGR) below MSCI China’s 0.6x PEG. By these standards, relative value among Five-Year Plan beneficiaries is found in Dongfeng Motor, ABC, Minsheng Bank, Sinoma, Guangshen Railway, Mindray, PetroChina, Longyuan Power, Dongfang Electric, Shenhua Energy, and China Coal Energy."

Italy: Public finances on track

- "After the solid performance in 1H 2010, we have revised slightly up our GDP growth call from 0.9% to 1.0% in 2010, and from 1.0% to 1.1% in 2011. However, our outlook envisaging a moderation of growth in the second half of this year remains safely in place."
- "Data on the labor market remain mixed and do not suggest that a genuine turning point has been reached yet. The unemployment rate seems close to peak, but recent dynamics of inactive people and labor force are less encouraging."
- "Even taking into account the statistical discontinuities introduced in June by the Bank of Italy, bank lending to households and non-financial corporations recorded a further improvement in recent months, confirming that the credit recovery is proceeding on the expected path."
- "After the remarkable surge in July, Italy’s CPI inflation edged down mildly in August to 1.6% yoy. The core inflation differential vs. the eurozone has widened over the past year. Producer prices accelerated further but surveys suggest that some moderation might lie ahead."
- "In the Focus section we analyze the details of the budgetary correction that had been unveiled in May and that was approved by the Parliament during the summer. The commitment on expenditure-cutting measures is encouraging, but implementation risks call for close monitoring ahead."

Fed has more flexibility after last week’s statement

- "Last week, NBER officially declared the end of the US recession in June 2009. Ironically, it was the same week in which the Fed said that it’s prepared to take additional action if needed (p.2, p.3 & p.4)."
- "This week’s focus is on the US ISM manufacturing index on Friday, on the euro zone CPI estimate on Thursday, and on the UK manufacturing PMI on Friday (p.2, p.3 & p.4)."
- "The Chart of the Week shows the Federal Reserve’s and Bank of Japan’s total assets outstanding as a percentage of nominal GDP. Last week’s FOMC statement showed that the Fed is ready to act if needed. The possibility that the Fed will purchase additional Treasuries in the coming months has therefore clearly increased. Indeed, it feels as if these ‘unconventional’ monetary policy measures are getting almost conventional given that the Fed already engaged in quantitative easing in 2008. The chart shows that the Fed acted aggressively as financial markets were in a deep shock that year. The chart also shows that while the BoJ has acted far less aggressive over the last few years, the total assets/nominal GDP ratio is still well-above that of the Fed. Over the last few months, the Fed slowly moved towards last week’s message that they are “prepared to provide additional accommodation”. Financial markets likely interpreted this as if additional quantitative easing will be coming (soon). Consequently, the USD depreciated last week to 1.35 against the euro. In addition, the downward trend of the USD on a trade-weighted basis that started in 2002 seems to be still intact. That said, although it remains uncertain whether the Fed (if they act) will be as aggressive as in 2008, additional QE could result in a further drop of the USD."

Non-commercial investors turn marginally long EUR

- "The latest IMM data cover the week from 14 to 21 September."
- "JPY longs remained in place after the BoJ intervention: The intervention from Bank of Japan that sent USD/JPY from 83 to almost 86 was not enough to square long JPY positions. IMM data show that speculative JPY net longs remained in place last week, reaching 20 percent of open interest. The market looks increasingly likely to re-test the central bank as USD/JPY is gaining downside momentum."
- "Non-commercial investors turn marginally long EUR: For the first time since December last year speculative investors are net long the euro. Net long positions have reached 3 percent of open interest, as improved risk sentiment - and increased concerns about the potential effect of QEII on the dollar – has sent EUR/USD higher to trade near 1.35. IMM data indicate that there is plenty of room for a further build-up in EUR longs, although we suspect that investors will be cautious adding too much EUR exposure as long as Euroland debt uncertainties remain high."
- "Commodity currencies still vulnerable to position squaring: September’s risk rally, which has seen the S&P500 index gain almost 10%, has coincided with a further build-up of long positions in the commodity currencies. Net longs are now at 69 percent in NZD, 50 percent in AUD, and 29 percent in CAD – indicating that these high beta currencies are becoming increasingly vulnerable to a potential position unwind. A trigger for this could be a sell-off on the stock market, which our equity analysts see a high risk of over the coming months."