China: Implications of rising wages (Part II)

- Capital – labor substitution to accelerate "Rising wages should lead firms to to substitute labor for capital over time."
- Migration of investment to inland will intensify "Some manufacturers will choose to diversify their production across Asia as labor costs in China increase."

DBS Economics 20100804

China Property: Precautious Measures Good for Sustainable Recovery

- Speculation on new wave of tightening measures led to recent mini sell-off —
"Given improving sales performance and expected lower policy risk, the China property sector had recorded a strong share price rally since mid-June. However, this week caution has returned due to recent speculation the government may introduce a new wave of tightening targeting: 1) development schedules, 2) crack down on land hoarding, and 3) further tightening of mortgage loans for third-unit purchase. Moreover, it has been reported by the local press that China banks have been asked to stress-test for a 60% home-price fall. The above news got a lot of market attention, resulting in a mini sell-off in the China property sector, though most of the news has not yet been made official."
- Policy side neutral, precaution is good for sustainable recovery — "As for recent
speculation of new tightening, we don’t think it is likely, instead believing that in 2H the Central Government will mainly focus on the implementation of existing tightening measures. Moreover, it should shift more focus onto the construction of social welfare housing and monitoring developers’ construction schedule, to prevent a potential construction slippage. The Central Government must balance property market tightening with overall economic growth. However, relative to the recent strong volume rebound and significant improvement in market sentiment, we view the Central Government is wise to introduce precaution measures before property/land prices revert to an upward trend. For us, these kinds of precautions are positive for a sustainable recovery of the China property market outlook."
- Leading developers’ life is not so tough, likely become market consolidators —
"The leading developers have seen sales improving significantly in 3Q given better brand names, product quality, and flexible pricing strategies. We estimate profitability would still be decent (GP>30%) even if they cut prices by c.20% from the peak. In June/July, the land market overshot the property market significantly, with achieved land price down 30% from the peak vs. property price only mildly correcting by 10% in key cities. As for leading developers, if they can use the opportunity to replenish prime land reserves at a reasonable price, this should be positive for sustainable growth. This has led to leading developers hungry for capital raisings, which are unrelated to concerns on their own financial positions. We prefer low cost capital raisings, such as share placement, syndicated loan etc."
- Selectively focus on beta – Shimao and Agile — "If we expect the physical market
turning point to emerge in 1Q2011, a further opportunity to buy into the China property sector should emerge in early 3Q 2010, which is also the reason why investors should selectively focus on higher-beta names in 3Q to hunt for returns. Moreover, second tier market developers – such as our top picks Shimao and Agile – offer defensive valuations. We believe these names not only have higher beta but also have specific catalysts that could result in outperformance."

Citigroup China Property 20100806

UK: British upswing running out of steam

- "British GDP has advanced for three consecutive quarters after plummeting in 2008-09. However, OECD's leading indicator for UK has fallen in the past two months, indicating that the economic upswing is losing steam."
- "Perception of the overall economic situation is also worsening. The output gap has not been closed and spare capacity remains."
- "Retail sales are getting weaker, trend in disposable income is declining. Consumer sentiment is
deteriorating, business confidence is fading."
- "We expect only a slow recovery, the robust Q2 numbers were a one-off affair. Exports, private consumption and investments remain well below trend. In our view, economic growth will undershoot government projections."

DenDanske UK Outlook 20100806

China banks: We expect solid interim results and stable operating trend in 2H10

- Expect solid 2Q10/1H10 profits. "We expect the 10 banks under our coverage to post 5% q/q (and 28% y/y) profit growth during 2Q10. We expect their aggregate net income in 1H10 to grow 30% y/y and 38% h/h, thanks to strong balance sheet growth, NIM recovery, robust fees as well as improving asset quality. Our forecasts are about 5% above consensus."
- Solid operating performance continues so far into 3Q10. "1) NIM further expanded in 2Q10 despite rising competition for deposits and pressure to lower L/D ratios at some medium-sized banks. We expect stable NIM in 2H10. 2) Fees were robust on the back of strong corporate bills/paper issuance and bank wealth management sales. We however
expect fee growth to soften to 30% for FY10. 3) Solid asset quality improvement. Likely NPL formation may only pick up in 4Q10."
- Our model assumes NPL formation pick-up in 2H10. "The market may focus predominantly on policies and trend in LGFV asset quality, as well as the property market. In our current model, we factor in about Rmb78bn gross new NPLs in 2H10, enough to include 1-1.5% of outstanding LGFV and property development loans to be downgraded to NPL during 2H10. We believe LGFV NPL ratios should stay at 1% or below. Meanwhile, our
models also reflect some dynamic provisioning in 2010."
- Modest earnings revisions: "We now factor in fewer rate hikes, leading to a modest cut in NIM assumptions, particularly in 2011-2012E. Except for a 6-7% downward earnings revision for Citic in 2010-2012E, our earnings cuts are in general insignificant for 2010 and modest at 3-4% in 2011-2012E. Our estimates however remain above consensus mean estimates."
- Undemanding valuations. "We believe the sector may continue to enjoy some re-rating. We still expect 30% earnings growth for FY10E, and 20% plus CAGR growth in 2011-2012E. At 1.75x forward PB and 9x forward PE, valuations appear undemanding. Top pick in H-share remains Citic-H, BOC-H and to less extent BoComm-H. In A-share, we upgrade Minsheng-
A to OW. In A-shares, although big state-owned banks are better value, we prefer Minsheng-A and CMB-A."

JPMorgan China Banks 20100808

A very important point: Is it possible that the crisis has changed potential growth in some countries?

- "Actual growth in certain countries may have been changed by the crisis, while potential growth has not: the halt in indebtedness, in the real estate boom and in immigration, as well as the rise in unemployment, have led to a halt in actual growth, which has been very impressive for instance in Spain."
- "But the question is whether potential growth may have been changed by the crisis. We start off from potential growth to assess the quality of the countries’ growth, their capacity to stabilise their public and private debt ratios, to cope with ageing, to have sufficient return on capital to attract savings, etc."
- "Now, one may think that potential growth is affected by the crisis; if there is for instance a change in the investment rate, in the sectoral structure of the economy, or in taxes or government expenditure that have an effect on the supply of goods and services."
- "When looking at the large OECD countries, we believe that these developments can be seen everywhere, and seemingly to a great extent in certain Southern European countries (Spain, Portugal)."

Natixis Flash Economics 380 20100727

Does stock market valuation take into account the international diversification of listed companies?

- "Large companies have diversified their turnover internationally. We seek to ascertain whether investors associate these companies too closely with the countries where they are quoted. This would create an abnormally close link between the trend in these companies’ share prices and changes in the macroeconomic situation of the countries where they are quoted, while stock
market prices ought to react far more to the international macroeconomic situation."
- "We show:
• that the financial markets do not take into account the geographical structure of the turnover of listed companies;
• but that they give significant weight to the trend in the country’s exchange rate compared with these markets of listed companies."

Natixis Flash Economics 379 20100727

Europe’s problem today: Economic policies should reduce neither demand nor supply

- "European countries (euro zone, United Kingdom) have decided to rapidly trim their fiscal deficits. This is being done in a situation where the balance sheet adjustment is not completed, and where private demand accordingly is sluggish."
- "It therefore seems logical to avoid reducing private demand by reducing fiscal deficits, which would lead to even more pronounced underemployment."
- "But the key problem for most European countries is weak long-term (potential) growth, due to population ageing and low productivity gains. So the countries must also avoid a negative impact on supply (of goods and labour) when reducing their fiscal deficits."
• "They must therefore be able to reduce their fiscal deficits without reducing demand and without reducing supply; which leaves them with only two options:
• cutting useless government expenditure;
• taxing saved incomes, as these savings are not used to finance useful investments (but rather speculative investments)."

Natixis Flash Economics 378 20100727

QE2?

- "We have had a lot of questions recently on the possibility of renewed quantitative easing – and, in particular, on:
■ When the Fed will restart QE 2;
■ Whether it would work;
■ How the market would react – and what should investors buy if QE is restarted."

CreditSuisse Global Equity Strategy 20100809

FX Strategy Weekly

- "Dollar weakness continues to characterise G10 fx markets as doubts over the US economy multiply and all-time lows for US yields boost the attractiveness of carry. With the Fed running out of policy options and evidence of macro economic decoupling in the G10 prevailing, we look for the AUD to remain a desirable G10 destination. A test of 85.0 in USD/JPY now looks probable. Though next week will be dominated by the FOMC, all eyes in the UK will be on the latest BoE Inflation Report (QIR) on Wednesday. The QIR has proved a hurdle for GBP in the past and could again prove the proverbial ‘bridge too far’ that forces GBP/USD bulls to rein in their exuberance. Special notes on GBP/USD and AUD/ZAR are included in this week’s publication."
- "GBP/USD closed up 1.7% at 1.5962 and just fell short of 1.60. GBP lost 0.04% vs the EUR as EUR/USD (+1.7%) kept track of GBP/USD. GBP/CAD burst through the 1.64 level (1.65 target) after a shock 139,000 drop in Canadian employment in July. The MPC left Bank Rate on hold at 0.50% and the APF at £200bln, but suspense is set to stay elevated over the next two weeks and leaves GBP vulnerable to possible profit taking after a stellar run. Elsewhere, we note the gains for the JPY and the fall in USD/JPY blow 0.8550. A test of the Nov-09 low now looms, prompting possible intervention to weaken the yen."
- "US payrolls dropped 131,000 in July, double the consensus estimate. Data for June was revised down to -221,000 from -125,000. The unemployment rate held unchanged at 9.5%. UK data highlights were the 4.3pt drop in the construction PMI in July, and smaller falls in the manufacturing (-0.2pts) and services (-1.3pts) PMIs. The three PMIs have now declined simultaneously for two consecutive months, pointing to a slower rate of expansion in Q3. The NIESR reported a rise in GDP of 0.9% in the three months to July vs 1.1% in June. The ECB left its interest rate on hold at 1.0% but reined in optimism over the economy and declared no recovery victory. Strong Q2 GDP data are expected from Germany next week."
- "Backed by bullish seasonals and weaker macro data, gilts logged an impressive week with yields dropping markedly across the curve, but with the long end outperforming. 10y yields descended below 3.25% to a 3.23% close. Support for a further decline towards 3% could be on the cards. 5y swaps dropped 7bp to 2.35% and the 10y closed 11bp down at 3.27%, causing the 2y/10y spread to flatten below 190bp. The 2y/10y gilts spread tightened below 250bp and closed the week at 245bp. The 3mth Libor/Ois spread held steady at 25bp. The 10y swap spread was also unchanged at 5bp. The 5y gilt auction drew solid demand and was covered 1.99 times (0.7bp tail)."

LLoydsTSB FX Strategy Weekly 20100806

Non-commercial investors add to short USD positions

- "The latest IMM data cover the week from 27 July to 3 August."
- "Non-commercial investors added further to short USD positions, which have now reached USD17bn. The dollar has lost close to 10% since its early July peak and with Friday’s disappointing US labour market report (released after the collection of IMM data) positioning is likely to have turned even more against the dollar. As short USD positioning becomes more stretched so does the upside risk to USD from a potential position squeeze."
- "Coinciding with the strong rebound in EUR/USD over the past month speculative investors have unwound their short EUR positions. EUR positions are now back at neutral levels (net shorts at 3% of open interest) for the first time since December last year."
- "Net long positions in the commodity currencies (AUD, CAD and NZD) have become even more stretched with NZD looking most vulnerable with net longs at 62% of open interest. A position squeeze, potentially driven by oil prices correcting fast back below USD80 per barrel (watch Wednesday’s IEA oil market report), could see AUD, CAD and NZD correct lower."
- "Net long JPY positions have now reached 36% of open interest despite the current strong JPY level fuelling speculation in the market about the potential for interventions by the Bank of Japan."

DenDanske IMM Positioning 20100809

‘Risk-On’ Returns To Commodity Markets

- DBLCI Commodity Returns: "Commodity index returns continue to be strongly positively correlated with the S&P500. This has led some investors to questions the diversification benefits of commodities. We find this is encouraging a new generation of commodity indices to emerge, namely the Risk Parity Commodity Index."
- Crude Oil: "Oil prices in 2007-08 seemed linked to shifts in the value of the dollar. Since 2009, the S&P500 appears to be the main driver. We are not convinced that recent dollar weakness and S&P strength can be relied upon to consistently drive oil prices upward over the next six months particularly in an environment where crude oil and product inventories have been slow to fall."
- Refined Products: "From a demand perspective, the US summer driving season has been stronger than expected. June-July gasoline demand is up 1.9% yoy. However, demand continues to be insufficient to eat through the high level of inventories."
- Natural Gas: "The continuing surge in shale gas production in the US raises the possibility that the US might export LNG rather than import it. A minimum spread of USD3.62/mmBtu on top of HH prices would likely be required to generate a positive netback on a sustained basis.
- Precious Metals: The positive correlation of gold prices to EUIRUSD is reestablishing
itself. Given our bearish outlook for the US dollar we believe this will trigger further gains in the gold price. We expect the liberalisation in China’s gold market will sustain the country’s rising market share of gold consumption relative to the rest of the world."
- Industrial Metals: "The industrial metals sector has dismissed fears of a slowdown in China and instead focused on the possibility that monetary authorities will do all that is needed to underpin economic recoveries. Copper rose to a three month high supported by China’s rural electrification program and production challenges in Chile."
- Agriculture: "Russia’s decision to ban wheat exports threatens hoarding and further price advances. However, we believe the relatively high level of US and global inventories in wheat and possibly upgrades to the Australian wheat harvest during the fourth quarter will limit price advances beyond October."

DeutscheBank Commodities Weekly 20100806