Asia-Maxima-(Delirium)---3Q14-20140703

Asia Maxima Quarterly review and asset allocation

G7 credit-to-GDP gap and asset-to-GDP gap

Note: The gaps measure deviations of the credit and asset to GDP ratios from their long-term trends.

Credit includes lending to the non-financial private sector. Assets are total household assets.

Source: CLSA, BIS, Datastream, CEIC Data, IIF

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor proprietary database at clsa.com

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Christopher Wood

[email protected]

+852 2600 8516

Joe Man

[email protected] +852 2600 8570

3Q14

Asia Strategy

Includes:

Asia ex-Japan thematic equity portfolio for long-only absolute-return investors

Japan thematic equity portfolio for long-only

absolute-return investors

Recommended long- only asset allocation for US-dollar-based pension funds

www.clsa.com

Delirium

Extremely low volatility. Financial markets are in a condition of false

euphoria, characterised by extremely low volatility, the result of more

than five years of unconventional monetary policy. The Achilles’ heel in

the system is exposed by the divergent trend between asset prices and

credit growth in the developed world.

Fed tapering continues. The Federal Reserve continues to taper but the

US economy remains far from robust. A successful exit from quantitative

easing remains as unlikely as ever, though there is growing possibility that

wage pressures in a structurally constrained US labour market could trigger a tightening scare.

ECB’s version of QE. The European Central Bank is likely to have adopted

its own version of quantitative easing before the end of the current

quarter. Investors will be particularly excited if the ECB follows through on its talk of buying asset-backed securities.

BoJ’s attempt to end deflation. The coming quarter will be critical for

judging the success of the Bank of Japan’s attempt to end deflation. For now,

the Japanese central bank believes its policy is working, which would be

positive for the stock market. But if that view is proven wrong by the data,

then another bout of unconventional monetary policy becomes likely, which would also support the stock market, albeit at the cost of a weaker yen.

Beijing’s commitment to reform. China remains the main area of systemic

risk in emerging markets, given the massive build-up of debt in recent years,

amid growing evidence of an increasingly porous capital account. But

investors are still advised for now to give Beijing the benefit of the doubt,

given the apparent commitment to reform. The two main areas to monitor remain the residential property market and capital flows.

Gold insurance. With central banks in the developed world remaining

committed to unconventional monetary policies, the case for gold bullion as

essential insurance remains clear. Gold will be the best asset to own when

investors finally question the efficacy of quantitative easing. This will only

occur when the consensus realises that unorthodox monetary policy does not

lead to healthy sustainable growth but only boom-bust asset-inflation cycles.

http://www.clsa.com/

http://www.clsa.com/member/bios/index.asp?alogin=WOODC&pagename=bios

http://www.clsa.com/

Asia Maxima

2 [email protected] 3Q14

Contents Global and regional overview ............................................................ 3

Asia asset allocation ........................................................................24

Country views

Japan: Inflation stress test ................................................................... 38

Australia: Mining and housing paradox ................................................... 42

China: Conflicting signals ..................................................................... 46

Hong Kong: A degree of tension ............................................................ 50

India: Gujarat model on national stage .................................................. 54

Indonesia: Close election race .............................................................. 58

Korea: Growing pressure to ease .......................................................... 62

Malaysia: More macro than micro .......................................................... 66

Philippines: Macro positives .................................................................. 70

Singapore: Affordability issue ............................................................... 74

Taiwan: Technology driven ................................................................... 78

Thailand: After the coup ...................................................................... 82

Appendix: Tables and charts ............................................................86

All prices quoted herein are as of 30 June 2014

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https://www.clsa.com/member/reports/547693005.pdf



Section 1: Global and regional overview Asia Maxima

3Q14 [email protected] 3

Global and regional overview There have been numerous crises and mini crises in financial markets in recent decades. But the markets ended the past quarter in a situation where the dominant sentiment among investors was a growing focus on the lack of volatility. If moves in the world’s major equity markets have been relatively subdued, the major area characterised by such a lack of volatility has been the foreign-exchange market. Here volatility has sunk to record lows. Thus, JPMorgan’s Global FX Volatility Index has fallen from a recent high of 11.8 in mid-2013 to a record low of 5.5 in late June (see following chart). But the same trend of declining volatility is also clear in the world of stocks and bonds.

JPMorgan Global FX Volatility Index

Source: Bloomberg

One way of interpreting this is that central banks in the developed world have succeeded in persuading investors that interest rates will stay very low for a very long time. It is also this confidence in the continuation of low interest rates which has resulted in the chief feature of current markets. That is a growing ‘reach for yield’ as investors buy ever more complex debt securities, often with leverage, to generate a greater return. This process, which has been aptly described as a ‘yield bubble’, is a direct consequence of more than five years of zero interest rates and unconventional monetary policy. It can be chronicled by the continuing revival of risky lending practices, which were discredited in the financial crisis.

This trend is worth going into in some detail to demonstrate the point since it is in one sense truly remarkable that the appetite for aggressive debt structures has rebounded so strongly just six years after such structures were discredited in the global financial crisis. Yet in another sense, of course, it is quite logical since this is the behaviour encouraged by unconventional monetary policy. One obvious example is the surge in high yield issuance, which is now back above pre-financial crisis levels. Thus, US high-yield corporate bond issuance has risen from US$43bn in 2008 to a record US$336bn in 2013 and US$146bn in the first five months of 2014 (see following chart). But as yields on more conventional subordinated debt have come down, debt investors have increased their exposure again to structured products. Consider, for example, collateralised loan obligations (CLOs). CLO issuance totalled US$82bn in 2013, a mere 15% below its peak level in 2006, and is forecast to reach US$100bn this year. A further example is the

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A lack of volatility

The reach for yield

The revival of risky lending



renewed appetite for so-called covenant-lite loans, often coupled with bullet repayments, where interest is rolled up and not paid to the end of the loan. Thus, US “cov-lite” loan volume rose by 41% YoY to US$84bn in the year to mid-June, according to Dealogic. Meanwhile, US leveraged loan issuance rose by 68% YoY to a record US$1.1tn in 2013 (see following chart).

US high-yield corporate bond issuance

Note: YTD14 = January-May 2014. Source: SIFMA, Thomson Reuters

US leveraged loan issuance

Source: Bloomberg

These sorts of imprudent lending and investing practices are normally associated with credit bubbles. But an interesting feature of the Western world post-financial crisis is that there has not been a credit bubble. Rather, credit growth has remained subdued in the developed world post-2008, be it in America, Europe or Japan. US bank loans rose by 4.8% YoY in June, compared with the pre-crisis average growth rate of 10%, while Japanese bank loans rose by 2.4% YoY in May. As for the Eurozone, loans to the private sector declined by 2.0% YoY in May (see following chart). Indeed, this ongoing subdued credit growth, and related deleveraging dynamic as reflected in continuing declining velocity, is the reason why central banks have continued to indulge in unconventional monetary policy as economic growth has remained subpar. Thus, annualised real GDP growth in America has averaged only 2.1% between 2Q09 and 1Q14, while in the Eurozone it has been only 0.7% during the same period (see following chart).

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Still sluggish credit growth



US, Japan and Eurozone bank loan growth

Source: Federal Reserve, Bank of Japan, ECB

US and Eurozone real GDP growth

Source: Datastream

The resulting paradox is perhaps best highlighted by research done of late by the Institute of International Finance (see IIF reports: Capital Markets Monitor, April and May 2014 issues). This research has focused on the divergent trend since the crisis in the developed world between the credit-to-GDP ratio and what the IIF describes as the asset-to-GDP ratio, which is defined as household wealth or assets to nominal GDP. This shows that the asset-to-GDP ratio has shown a large positive deviation of nine percentage points from its long-term trend in the G7 world based on IIF data. By contrast the credit-to-GDP ratio has shown a contrasting trend. The G7 credit-to-GDP ratio, which includes all lending to the non-financial private sector, has collapsed since the crisis to eight percentage points below its long-term trend, down from a positive deviation of over 10 percentage points in mid-2009.

The obvious conclusion from this is that there is a growing risk that asset prices are becoming increasingly disconnected from the realities of the underlying economy. A similar chart to the one shown in the IIF report highlighting the relevant divergent trends is shown below (see following chart). It should be noted that the data is based on the BIS’s long-term series on credit to the private sector and the central banks’ flow of funds data on household assets.

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The asset-price credit-growth divergence



G7 credit-to-GDP gap and asset-to-GDP gap

Note: The gaps measure deviations of the credit and assets to GDP ratios from their long-term trends. Credit includes lending to the non-financial private sector by domestic banks and non-bank, as well as non-residents. Assets are total household assets. Source: CLSA, BIS, Datastream, CEIC Data, IIF

The above is interesting because it provides a conceptual framework to help understand what is going on in a world of quantitative easing where it has become increasingly evident in recent years that the rich or ‘asset owners’ have been the chief beneficiaries of such unorthodox monetary policies. Thus, in the world of equities, multiple expansion not earnings has been the chief driver of equity gains in America and Europe in recent years, whereas wages have remained subdued. On this point, price-earnings ratio expansion contributed to an estimated 75% of the gains in the US stock market last year and 43% so far in 2014, and accounted for all the gains in Europe in both 2013 and 1H14 (see following chart). By contrast, US average hourly earnings rose by only 2.1% YoY in May, while Eurozone hourly wages rose by just 1.5% YoY in 1Q14 (see following chart). Similarly, in the world of fixed-income capital gains and related yield compression have been driven by the leverage employed in carry trades, leverage only available in a post-financial crisis world to the affluent.

MSCI USA and Europe: 2013 and 2014 performance attribution

Note: Price performance in local currency terms. Source: MSCI, Datastream, CLSA evaluator

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Multiple expansion driver



US and Eurozone hourly wage growth

Source: CLSA

If asset prices are increasingly disconnected from economic reality, this situation can only be addressed either by developed economies achieving a more healthy recovery or by asset prices correcting. Yet, the risk is that if Western economies show signs of an accelerating recovery, market-driven interest rates will rise sharply, hurting leveraged investors in “credit”, while the higher cost of servicing debt will threaten the recovery. Yet, if economies do not sustain a growth rate acceptable to modern central bankers, then they will continue with their unconventional monetary policies so further encouraging asset bubbles.

This is the dilemma the central bankers have created by their now orthodox ‘unorthodox’ monetary policies and it remains far from evident to this writer that there is a painless way out, as argued here in many preceding Asia Maxima quarterlies. Yet, investors have also to operate in the context of the official narrative of the market consensus, and this is that the Fed is ‘tapering’ this year with a view to normalising monetary policy sometime in 2015 by raising interest rates for the first time since June 2006.

If this is the consensus expectation, it remains the case that the Fed at its June FOMC meeting lowered its forecast for real GDP growth for the fifth year in succession since this lukewarm recovery began in 2009. Thus, the Fed now estimates 2014 economic growth at 2.1-2.3%, down from the March projection of 2.8-3%. This would keep American real GDP growth in the same 2-2.5% range it has running at since the recovery began.

Such a continuing level of subpar growth will not incline an extreme dove like Fed Chairwoman Janet Yellen to want to start raising rates. Indeed, dovish comments by Yellen during the past quarter caused expectations of the first Fed rate hike to be pushed back by about three to six months to 4Q15, though expectations have of late been brought forward again to 3Q15. It is also highly unlikely that Yellen would have begun tapering this year, given the relatively soft data, if former chairman Ben Bernanke had not already launched the tapering process at his second-last Fed meeting in December.

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The consensus view

The Fed lowers growth forecast



Still, if Yellen has a doveish bias, it is also the case that history shows that there is a well-established tendency for financial markets to test a new Fed chairman in the first few months in office. Given the almost eerie sense of calm, if not complacency, hanging over markets as reflected in record low volatility measures, the suspicion is rising that such a test may be approaching.

Catalysts for market-driven scares are, by their nature, almost impossible to predict with recent newsflow from the Middle East a reminder that geopolitical events can always trigger shocks in terms of, say, a spike in the oil price. Such an oil price spike to, say US$120/bbl and higher, would likely trigger an inflation scare in markets, even though its impact would ultimately be deflationary. Still there is one area where a market driven ‘inflation scare’ is becoming increasingly plausible even if it is in the continuing context of the secular deleveraging trend still engulfing the Western world. That is if there is suddenly evidence that wage increases are finally getting traction in the USA.

Brent crude oil price

Source: Bloomberg

The point to note here is that such a tightening in the US labour market is possible, if not probable, if America’s declining labour-force participation ratio is structural, not cyclical. This declining participation rate has attracted growing focus in recent years with more unemployed Americans leaving the workforce than found a job in 48 out of the past 49 months (see following chart). It has also become the subject of a lively debate among economists about whether this phenomenon is cyclical or structural. Yellen, an academic economist specialising in the labour market, remains firmly of the view that it is cyclical and has reiterated as much of late. Yet, many others, including this writer, are more persuaded by the argument that it is structural as America has entered the European dynamic, where rising government benefits reduce the incentive to work at the lower end of the labour market.

If this sounds a dry academic subject, it has become critically important for markets. For if the declining participation rate is indeed structural, then there is less slack in the labour market than the Fed currently believes, which means, more than five years into an economic recovery in America, that sooner or later wages should get traction.

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A test for Yellen?

America’s declining labour force

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Unemployed Americans who found jobs or leaving the labour force

Note: Data measures the labour force status flows from "unemployed" to "employed" or from "unemployed" to "not in labour force". Source: Bureau of Labour Statistics

While this traction is not yet really visible from the all-important average hourly earnings growth data, such evidence should be forthcoming in the not too distant future if the structural argument is correct. If so, it could have significant market impact in the context of ultra-low volatility, where leverage has been piled on in the world of credit in the pursuit of yield. Sudden evidence of wage pressures in America would certainly trigger a hue and cry that Mrs Yellen has been wrong in her analysis of the labour market and that the Fed is ‘behind the curve’. Monetary tightening expectations would come forward sharply in time, the US dollar would rally and there would be a real risk of a repeat or worse of last year’s so-called tapering scare hitting, this time, not only emerging-market debt, but also all other credit instruments where investors have put on the ‘carry’.

US bond market average daily trading volume

Note: Data up to May 2014. Source: SIFMA

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The pursuit of yield



Such an unwind would also be aggravated significantly, as was certainly the case in last year’s tapering scare, by the fact that, as a result of post financial crisis regulatory initiatives, the ‘sell side’ does not have anything like the same inventory of debt securities to ‘make a market’. This can be seen in the somewhat ironic situation that while debt issuance has been exploding, most particularly issuance of low credit quality debt, secondary market trading volume in debt instruments has declined significantly - just as has also been the case in the foreign exchange market.

Thus, US bond market average daily trading volume, including Treasuries, agency securities and corporate bonds, has fallen from US$894bn in 2010 to US$721bn in the first five months of 2014 (see previous chart). While average daily currency trading volume on the ICAP-owned EBS platform, one of the main venues for the global FX market, declined by 42% YoY to US$73.5bn in May (see following chart).

Average daily FX trading volume on the EBS platform

Source: ICAP

US pending home sales index and total existing home sales

Source: CLSA, National Association of Realtors

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The “sell side’s” lack of inventory

Declining trading volumes



There is, therefore, scope for significant market dislocation which would feed, via fixed income, into the world of equities if investors started to discount nearer term Fed tightening. Still, this does not mean that such a sign of rising wage pressures in the USA would signal the sudden transition from a deflationary era to an inflationary one. For an interest-rate hike at the short end, or even the perception that monetary tightening is coming much sooner than previously expected, and any resulting related back up in long-term interest rates, is likely to prove deflationary, in the sense that an economy like America’s with continuing high debt levels, will prove ultra-sensitive to the impact of higher interest rates, as was demonstrated last year in terms of the US housing market’s stalling in the face of higher mortgage rates (see previous chart).

Indeed the housing market has not really revived since then, despite the decline in mortgage rates seen in the first half of this year as a consequence of the Treasury bond rally. In this respect, it has become increasingly evident that the rapid recovery seen in US housing in 2011 and 2012 was driven primarily by investors not end users, as those with capital to deploy arbitraged the spread between low financing costs and high rental yields.

The same financing dynamic has been behind the significant rise in US corporate debt post the financial crisis, as corporates have used the cheap funding costs available to finance share buyback programmes to boost their ‘return on equity’, the formula against which many executives continue to be compensated. Thus, S&P500 share buybacks surged by 23% QoQ and 59% YoY to US$159bn in 1Q14, the highest level since 3Q07 when buyback activity peaked at US$172bn (see following chart).

S&P500 share buybacks

Source: Standard & Poor's

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The consequence of the above is that any monetary tightening scare, or related ‘inflation scare’, is likely to prove short lived. In this sense, evidence of rising wages pressures, if such a development occurs, will likely turn out to be ‘late cycle’ confirmation that the US economic recovery, which began in 2009, is nearing its end, not its beginning.

And, in such a macroeconomic context a dove like Yellen will want to accelerate quantitative easing, not end it. That is unless there starts to be more vocal opposition from within the Fed, from Congress and from the executive arm of the federal government to what by now should be seen as the obvious negative consequences of what has been aptly described by CLSA’s Australian bank analyst Brian Johnson as ‘QE-ternity’. See the Australian country section on page 42.

Still, if this would be a development to applaud, it also remains unlikely. Much more likely is that the policy-making establishment in such a context will look to expand quantitative easing with the result that the distinction between monetary policy and fiscal policy will become ever more blurred. For, with the Fed already owning 22% of outstanding Treasury bonds and buying over 70% of net Treasury debt issuance since the beginning of 2013 (see following chart), without seemingly nasty inflationary ramifications, QE advocates in a continuing low growth world will increasingly be tempted to argue that central banks should buy all government debt and simply cancel it. Indeed, such arguments can already be heard in some quarters.

Fed buying of US Treasuries and increase in Treasury debt outstanding

Note: Fed buying data up to 18 June, Treasury debt outstanding data up to May 2014. Source: Federal Reserve, SIFMA, CLSA

Meanwhile, as the market consensus for now focuses on continuing tapering and normalisation of US monetary policy next year, ECB boss Mario Draghi has spent most of 2014 preparing the way for quantitative easing in the Eurozone, as he has increasingly drawn attention to falling inflation pressures in the Eurozone. On this point, Eurozone CPI inflation fell from 0.7% YoY in April to 0.5% YoY in May, the lowest inflation rate since November 2009 (see following chart).

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Draghi’s QE preparation



Eurozone CPI inflation

Source: Eurostat

In the June ECB meeting, Draghi announced a series of measures, including negative interest rates (see following chart) and a new version of the LTRO known as ‘targeted longer-term refinancing operations’ or TLTROs, which amount to going as far in the direction of quantitative easing as possible without actually ‘doing it’. This probably sets up the ECB for a formal move to quantitative easing by the end of the third quarter, with Draghi whetting risk-seeking investors’ appetite with his announcement in June that the ECB has decided to intensify ‘preparatory work’ related to its proposed outright purchases of asset-backed securities where the debt securitised could be Eurozone SME debt.

ECB key policy interest rates

Source: ECB

The above pending development clearly marks the exact opposite of the anticipated normalisation of monetary policy in America. Still Draghi has been building the case carefully for more unorthodox monetary policy initiatives in the Eurozone because of his awareness of German sensitivities. Still, having successfully floated the ‘QE’ balloon and not been visibly shot down by opposition in Germany, he is now preparing to launch it with the rational acceptable to Berlin being that inflation threatens to decline to well below the ECB’s formal target of 2%.

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The ECB buying asset-backed securities?



Eurozone and PIIGS current account balance

Note: PIIGS = Portugal, Italy, Ireland, Greece and Spain. Source: ECB, Datastream, CLSA

In the meantime, it is also the case that the deflationary pressures are the natural consequence of the Eurozone’s decision, led by Germany, to implement a macroeconomic adjustment within the context of a fixed exchange-rate system, where the adjustment is made by a decline in internal costs and a restoration of internal competitiveness. This process at work can be seen in the Eurozone’s still rising current account surplus (see previous chart), primarily triggered by weakening domestic demand, and the related resilience of the euro as well as the dramatic collapse in periphery bond yields, which now appear to be in the process of converging with German bund yields. Thus, the Spanish 10-year bond yield declined below the 10-year US Treasury bond yield last quarter, with the yield spread falling to a negative 3bp on 9 June and was only a positive 13bp at the end of 2Q14 (see following chart). As for the spread with the 10-year German bund yield, it was only 142bp at the end of last quarter, down from a peak of 639bp in July 2012.

Spanish 10-year government bond yield spreads

Source: CLSA, Bloomberg

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Converging Eurozone bond yields



So Draghi is now trying to mitigate this adjustment process with his own reflationary initiatives. But the political realities mean he has to engage in continued double talk. Thus, Draghi still described inflation expectations as being ‘firmly anchored’ at the June meeting, while the ECB officially forecasts headline inflation to be 1.1% in 2015, even though it has just lowered its 2014 forecast from 1.1% to 0.7%. But such conflicting signals should be ignored, since the reality is that monetary policy in the Eurozone is likely to become ever more unconventional.

Meanwhile, in another major economy already committed to the world’s most aggressive quantitative-easing policy, namely Japan, there has been relative conservatism displayed by the Bank of Japan (BoJ) in terms of a failure to launch new unorthodox monetary policy initiatives during the first half of this year. This reflects the fact that the Japanese central bank hopes that a further expansion of monetisation will not be necessary, given the massive BoJ balance-sheet expansion that has already taken place. The Bank of Japan’s total assets have increased by ¥92tn or 56% since Governor Haruhiko Kuroda launched the aggressive quantitative easing programme back in early April 2013 to ¥257tn or 53% of GDP on 20 June (see following chart).

Bank of Japan total assets as a percentage of nominal GDP

Source: CLSA, Bank of Japan, CEIC Data

The acid test for Japan will come in the coming quarter. There will be two areas to focus on. The first is whether the economy proves resilient to the impact of the sales-tax increase at the start of April. The official BoJ view is that the economy will recover in 3Q after an annualised 4% QoQ decline in the second quarter caused by the sales tax hike. The second point is whether inflation starts to decline again once the impact of last year’s yen devaluation falls out of the data on a year-on-year basis, as it will do from May on. In this respect, while the BoJ focuses on core CPI in terms of its formal target, the critical inflation data point to monitor is so-called ‘core-core’ CPI, which excludes both food and energy. This is because core CPI includes energy, which has been distorted by higher imported energy bills as a result of the continuing shut down of Japan’s 48 nuclear plants.

True, nationwide core-core CPI inflation, adjusted for the sales tax hike effect by the methodology proposed by the BoJ, slowed from 0.8% YoY in April to 0.5% YoY in May. But, more encouragingly, Tokyo’s adjusted core-core

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The BoJ stance

Japanese inflation data



inflation picked up from 0.4% YoY in May to 0.5% YoY in June, after slowing from 0.6% YoY in April (see following chart). If core-core CPI inflation can remain at around current levels for the next six months, that will encourage expectations that Japan is finally emerging out of deflation.

Japan and Tokyo core-core CPI inflation (adjusted for sales tax hike effect)

Note: Adjusted for the sales tax hike effect by the methodology proposed by the Bank of Japan. Source: CLSA, Bank of Japan, Statistics Bureau

This is not as unlikely as might be imagined as evidence continues to mount that Japan’s labour market is tightening as a consequence of natural demographic pressures, amid growing focus on labour shortages, not only in the construction sector, but also in growing number of service sectors. Thus, the working-age population has been declining for the past 19 years while, for related reasons, the working-age female participation rate had its biggest increase on record last year. The working-age population has fallen by 9.1m or 10% from 87.26m or 69.5% of the total population in 1995 to 78.15m or 61.5% of the total in June (see following chart). Meanwhile, the female working-age labour participation rate rose by 1.6ppts in 2013 to 65%, the biggest annual increase since the data series began in 1968 (see following chart). This compares with 67.2% in the USA and 72% in the UK. If such pressures continue, it is entirely possible that Japan’s female participation rate could end up higher than in any other developed economy.

Japan working-age (15-64) population

Source: Japan Statistics Bureau

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Japan, US and UK working-age (15-64) female labour participation rate

Source: CLSA, Japan Statistics Bureau, US Bureau of Labour Statistics, UK Office for National Statistics

Meanwhile, if inflation does surprise by staying positive in Japan in coming months, it will present a problem of success for the Bank of Japan, in that it will need to start to send the appropriate market signal by allowing the yield curve to steepen gradually. But for now, BoJ buying has continued to keep the 10-year JGB yield at around the 60bp level, a central bank buying operation that has allowed growing selling of JGBs by domestic institutional investors. Thus, Japanese city banks’ holdings of JGBs have fallen by ¥34.3tn or 32% since the end of March 2013 (see following chart). While Japanese life insurers and public pensions sold a net ¥1tn and ¥1.85tn worth of JGBs in 1Q14, according to the BoJ’s latest flow of funds data (see following chart).

Japanese city banks' holdings of JGBs

Source: Bank of Japan

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Net buying of JGBs by Japanese life insurers and public pensions

Source: Bank of Japan – Flow of Funds Accounts

If the debate as regards the developed economies remains, from a financial-market perspective, dominated by the ebb and flow of initiatives in monetary policy, the dominant focus in the world of emerging markets remains on the structural challenges facing China as it continues to try to ‘rebalance’ the growth model away from investment to consumption in what is described by PRC officialdom as a process of ‘careful deleveraging’.

There is certainly a clear understanding among officials that implementation of structural reform requires a willingness to tolerate slower growth. This is why the central government has spent most of the year trying to resist calls for aggressive stimulus in the face of slowing growth, a deceleration better reflected in nominal GDP data than real GDP data. Thus, nominal GDP growth has slowed from 18.5% YoY in 3Q11 to 7.9% YoY in 1Q14 (see following chart). This reluctance to stimulate is despite a number of ‘fine tuning’ easing measures announced in the past quarter, in terms of the acceleration of some infrastructure projects and the tweaking of reserve requirement ratios for smaller banks.

China nominal and real GDP growth

Source: CEIC Data

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Source: CEIC Data

If one reason the authorities have so far been willing to resist aggressive stimulus is the reform agenda, the other is the more practical issue that so far there remains little evidence, if any, of strains in the labour market. In this respect, perhaps the most positive point about China today, amid the continuing focus among investors on the structural problems concerning SOEs, local-government debt and related problems in the banking sector, is that based on official data the private sector already accounts for about 80% of urban employment and that at least 90% of new job generation is currently generated by the private sector (see previous chart). It is also estimated that 13m jobs were generated in 2013, well above the official target of 10m.

In this context, it is clear that reform-orientated officials understand the importance of improving the operating environment for the private sector by reducing tax and regulatory burdens. On a related point, it is also the case that job generation can expand dramatically if a private-sector dominated services sector is allowed to flourish in urban areas, most particularly given China’s dramatic economies of scale. Indeed, China’s private sector-driven e-commerce boom is already a good example of this dynamic at work.

These positives are worth remembering. Still there is no doubt that there are some minefields to step through in coming quarters, given the looming overhang of maturing trust products discussed at some length here last quarter (see Asia Maxima - Financial osmosis, 2Q14). The hope is that the authorities will introduce some discipline into the system, in terms of imposing some losses on investors, without precipitating a full scale panic. Still, it is also possible that the maturing trust products are simply moved from retail hands to institutional owners, thereby, simply yet again, deferring a problem.

The reality remains then that China is engaged in a delicate balancing act between encouraging a more market-driven private-sector orientated economy which can generate job growth, while maintaining all important social stability. In the meantime, the two key critical variables for investors to monitor as regards China remain the residential property market, where the authorities are for now at least allowing a market-driven slowdown, and capital flows.

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China average new home price growth in four tier-one cities

Note: Average of new home price growth in Beijing, Shanghai, Shenzhen and Guangzhou. Source: National Bureau of Statistics

For now, while the property market is weakening and while there is some evidence of moderate capital outflows last quarter, the evidence on both fronts is not yet a cause for alarm. In the case of residential property, last year saw big price gains in tier-one cities so there is a base effect to incorporate into the data. New home prices in four tier-one cities fell by an average 0.1% MoM in May, the first month-on-month decline in two years. While on a year-on-year basis, new home-price growth in tier-one cities slowed to 9.9% YoY in May, down from 21.2% YoY in November 2013 (see previous chart).

As for capital flows, there was some initial evidence of renewed outflows last quarter, albeit not dramatic. Estimated hot money flows, measured as the change in financial institutions’ positions for forex purchases less the trade balance and net FDI, fell to an outflow of Rmb15bn in April and Rmb204bn in May, compared with a Rmb118bn inflow in March (see following chart).

China hot money flow estimate

Note: Estimated hot money flow = Change in financial institutions' positions for forex purchases - trade balance - utilised FDI + Outward direct investment. Source: CLSA, CEIC Data, PBOC

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Renminbi/US$ spot rate (inverted scale)

Source: Bloomberg, China Foreign Exchange Trade System (CFETS)

This trend will probably have been welcomed by the PBOC since the large hot money inflows seen in preceding quarters were seemingly driven by a desire to invest in high yielding renminbi-denominated wealth-management products. Indeed the desire to send a signal that this carry trade was not without risk was one reason why the PBOC engineered a depreciation of the renminbi in March by widening the daily trading band from 1% to 2%. As a consequence, the renminbi depreciated by 3.5% against the US dollar from its high reached in mid-January to a recent low reached at the end of April (see previous chart). But here again the PBOC is engaged in its own delicate balancing act since it will not want to see large capital outflows, which would lead to a contraction of liquidity, putting pressure on it to engage in more aggressive easing. That would counter its strategic goal to bring credit growth back more in line with nominal GDP growth, as was the case between 2003 and 2008 before the massive post-Lehman stimulus.

In this respect, there remains a continuing focus among investors on the volatile monthly bank lending and social financing data in China. The point to note is that, when looked at from an annualised basis, the trend is clearly slowing. Thus, renminbi bank-loan growth has slowed from 16.3% YoY in September 2012 to 13.9% YoY in May, while the growth in social financing outstanding has slowed from 22.7% YoY in April 2013 to 16.3% YoY in May. Still if this is arguably evidence of ‘careful deleveraging’, it is also the case that nominal GDP growth is also slowing, which means that the gap between credit growth and nominal GDP growth is not really contracting as much as would be hoped for the overall health of the system. Thus, renminbi bank-loan growth and the growth in social financing outstanding, are now still 6ppts and 8.4ppts above nominal GDP growth of 7.9%, down from a recent high of 7.8ppts and 13ppts reached in September 2012 and April 2013, respectively, (see following chart).

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China credit growth vs nominal GDP growth

Note: Outstanding social financing estimated as the sum of reported renminbi bank loans outstanding and the cumulative total since 2002 of all other social financing components. Source: CLSA, CEIC Data, PBOC

Meanwhile, there is a complicating issue as regards the massive explosion in credit in China in the years following the Lehman crisis, most particularly if measured by the ‘social-financing’ data series, which is the nearest thing in China to a broad credit aggregate. On this point, annual social financing volume surged from Rmb6.98tn in 2008 to a record Rmb17.3tn in 2013 (see following chart). Still, it is important to note that the estimates are that between one third to one half of the ‘new lending’ incorporated in this social financing data comprise maturing loans being refinanced, most particularly loans made to local government financing vehicles, which were the chief recipients of China’s 2009 post-Lehman Rmb4tn panic stimulus.

China annual social financing volume and increase in nominal GDP

Note: YTD14 = January-May 2014 for social financing and 1Q14 for GDP. Source: CEIC Data, PBOC, CLSA

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There are two ways to look at this phenomenon, one positive and one negative. The positive point is that the money lent has not been speculated away since it has gone into infrastructure, which will have some form of public utility, even if it may not be currently generating an adequate cash flow to service the debt, while at the end of the day local governments operate on the same balance sheet as the central government thereby reducing significantly the potential for a systemic crisis.

The negative point, of course, is that constantly rolling over the same loans is a negative drag on the economy, which is why it is logical that velocity has been declining ever since that 2009 post-Lehman stimulus. Thus, China’s money velocity, measured as the nominal GDP to M2 ratio, has fallen from 0.68x in late 2008 to an estimated 0.49x in May (see following chart).

China velocity of money (Nominal GDP/M2)

Source: CLSA, CEIC Data, PBOC

So, as ever with China, the story remains more nuanced than is suggested by the extreme bullish or bearish stances of many commentators. Meanwhile the positive point is that for now China, and the other emerging markets, have avoided the temptation to succumb to the allure of quantitative easing with their own monetary policies remaining orthodox.

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Section 2: Asia asset allocation Asia Maxima


Asia asset allocation There was a return to a more “risk on” mood last quarter. Asia and emerging markets were the best performers. The MSCI AC Asia Pacific ex-Japan Index rose by 5% in US-dollar terms last quarter, while the MSCI Emerging Markets Index rose by 5.6%. By contrast, the MSCI Europe Index rose by only 1.9% in US-dollar terms last quarter. This compared with a 4.7% gain in the S&P500 and, more positively, a 6.7% gain in Japan’s Topix in US-dollar terms. Overall, the MSCI AC World Index rose by 4.3% in 2Q14.

This performance raises the hope that the three-year period of emerging-market underperformance may have come to an end, though Asia and emerging markets are still slightly underperforming the S&P500 year to date and are performing almost in line with the MSCI AC World Index. The MSCI AC Asia Pacific ex-Japan Index and the MSCI Emerging Markets Index have risen by 5.5% and 4.8% respectively in US-dollar terms year to date, compared with a 6.1% gain in the S&P500 and a 4.9% gain in the MSCI AC World Index.

CLSA Asia-Pacific universe market valuations

PE (x)

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14CL 15CL 14CL 15CL 14CL 15CL 14CL 15CL 14CL 15CL 14CL 15CL AsiaPac ex-Japan 12.2 11.0 7.0 10.0 1.5 1.4 3.5 3.7 13.5 13.5 26.6 21.9

Japan 13.5 12.2 17.4 11.1 1.3 0.3 1.9 2.0 10.2 10.4 35.4 29.7

Australia 13.9 13.5 9.1 3.1 1.9 1.8 4.7 5.0 14.5 14.1 40.4 38.3

China 8.7 7.8 7.7 10.5 1.3 1.1 3.9 4.2 15.8 15.5 34.7 30.1

Hong Kong 12.9 12.5 6.6 3.4 1.2 1.1 4.2 4.0 10.6 9.3 16.2 14.1

India 16.8 14.3 13.4 17.4 2.5 2.2 1.5 1.7 17.4 17.8 46.1 37.7

Indonesia 14.5 12.9 11.0 12.4 2.8 2.5 2.5 2.8 21.1 20.6 21.7 16.4

Korea 9.9 8.3 9.5 20.3 1.0 0.9 1.3 1.6 11.0 12.0 15.0 7.8

Malaysia 16.9 15.4 6.8 9.6 2.2 2.0 3.0 3.2 14.0 14.2 19.7 15.8

Philippines 18.9 16.5 4.6 14.8 2.5 2.3 2.3 2.4 14.0 14.7 50.0 47.2

Singapore 14.0 12.8 (1.5) 9.5 1.4 1.3 3.4 3.6 10.3 10.6 34.3 35.1

Taiwan 14.7 13.3 19.8 11.0 2.0 1.8 3.5 3.9 14.1 14.4 (1.9) (8.3)

Thailand 13.1 11.4 5.9 15.4 2.0 1.8 3.4 3.8 15.9 16.7 53.6 43.2 Note: Based on CLSA universe of companies under coverage. Calendarised valuations in local currency terms. Source: CLSA evalu@tor

Still the continuing risk of more of a Fed normalisation scare, combined with the structural headwinds still facing China, mean that it continues to be risky to recommend an aggressive Overweight for Asia and emerging markets on a benchmark-related basis. But a Neutral position remains certainly justified, as was formally recommended here last quarter. The relative valuation case for Asia remains compelling, given that most of the gains in America and Europe last year were driven by multiple expansion.

The best guide to valuation remains the trailing PB ratio. Trailing valuations remain below the mean of the past 19 years. The MSCI AC Asia Pacific ex-Japan’s trailing PB is now 1.66x, compared with a mean of 1.83x over the past 19 years (see following chart). Similarly, the index is now trading at 13.1x trailing PE, based on companies with positive earnings. This compares with a trailing mean valuation of 14x since 1995. On a forward-earnings basis, CLSA’s universe of 868 Asia Pacific ex-Japan companies under coverage is now trading at 12.2x 14CL earnings, with a forecast ROE of 13.5%. This is based on 7% forecast earnings growth for 2014.

Return to “risk on”

Still Neutral emerging markets

Asia’s valuations



MSCI AC Asia Pacific ex-Japan trailing PB

Source: Bloomberg

Asia also continues to offer a certain defensive quality in terms of still-significant dividend support, even allowing for the cyclicality of some dividends. The CLSA Asia Pacific ex-Japan universe has a projected healthy 2014 dividend-payout ratio of 42%. A total of 49% of the stocks in the universe have a forecast 2014 dividend yield higher than the US 10-year Treasury bond yield of 2.53%, and 36% have a forecast dividend yield higher than their local 10-year government-bond yields (see following table). This is impressive. It is also important in a world of continuing zero-interest-rate regimes where investors have become increasingly focused on dividends as a driver of long-term equity outperformance.

Stocks covered by CLSA that yield more than local and US government bonds 10Y local

govt bond yield (%)

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T-bond

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Australia 3.5 140 83 59 110 79 China 4.1 128 32 25 66 52 Hong Kong 2.0 75 52 69 44 59 India 8.7 108 0 0 18 17 Indonesia 8.2 58 0 0 16 28 Korea 3.2 89 5 6 13 15 Malaysia 4.0 47 10 21 27 57 Philippines 4.2 44 5 11 12 27 Singapore 2.3 47 33 70 30 64 Taiwan 1.6 87 76 87 66 76 Thailand 3.8 45 19 42 27 60 Total - 868 315 36 429 49 Note: Based on stocks covered in the CLSA evalu@tor database. Source: CLSA

Japan has remained the odd man out in the Asian context in the past 20 years as it has mostly remained in deflation. Still, the positive point is that its equity valuations have long since discounted the long-term deflationary trend. This makes it an attractive market if investors start to hope, as for now is the case, that deflation can end. The market’s better performance last quarter reflected renewed confidence that deflation could be ending following foreign investors’ disappointment in 1Q14 that more aggressive monetary easing had not been forthcoming ahead of the sales tax increase. Meanwhile, the Topix dividend yield is still 125bp above the 10-year JGB yield of 0.57%. The Topix is also trading at only 1.23x trailing book, compared with a long-term average since 1993 of 1.64x (see following chart).

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Topix trailing PB

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The MSCI Japan is also trading at 14x trailing PE, based on companies with positive earnings, versus an average of 26.5x since 1995. A further positive is that the Topix’s dividend payout ratio is now 26%, up from 17% in 2004, while the forecast 2014 ROE for CLSA’s universe of 165 Japanese firms is 10.2%, up from 3.6% in 2009.

MSCI regional indices' performances, 2Q14

Note: Based on MSCI regional indices in US$ terms. Source: Datastream

For now the formal view is maintained to continue to recommend an Overweight stance in Japan in a global equity context, even though the Topix is up only 0.6% in US dollar terms year-to-date. This continuing positive stance is based primarily on the view that the Bank of Japan’s aggressive quantitative easing will lead to an asset inflation cycle, of which there is already evidence in the property market. The view remains that if deflation does end it will be a long-term positive for Japanese equities. But if it does not, there will be another round of Bank of Japan balance-sheet expansion which would also be equity bullish though also yen negative.

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MSCI regional indices' performances, Year-to-date 2014

Note: Based on MSCI regional indices in US$ terms. Source: Datastream

As for the asset allocation within the Asia Pacific ex-Japan relative-return portfolio, one longstanding feature has been a structural zero weight in Australian financial stocks, primarily because of their leveraged business models in a leveraged economy. This has resulted in a continuing major Underweight in Australia in the relative-return portfolio (see following chart).

CLSA Asia Pacific ex-Japan country asset allocation

Source: MSCI, CLSA

This allocation worked in the past quarter in the sense that Australia underperformed. The MSCI Australia Index rose by 1.8% in US-dollar terms in 2Q14, compared with a 5% gain in the benchmark MSCI AC Asia Pacific ex-Japan Index, despite a continuing strong Australian dollar. As for Australian financial stocks, which now represent 52% of the MSCI Australia and 13% of the MSCI AC Asia Pacific ex-Japan benchmark, they also underperformed last quarter rising by 2.3% in US-dollar terms.

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CLSA Asia Pacific ex-Japan recommended weightings

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asset allocation

Australia underperforms



The Underweight in Australia will be maintained. First, it remains the case that China is still trying to pursue “rebalancing”, which means limited upside at best for Australia’s China-geared resources sector. Second, the Australian dollar is still one of the world’s most overvalued currencies, though it ended the quarter 15% below its peak level against the US dollar. Third, the country’s household sector remains extremely leveraged with the household debt/disposable income ratio at 150%, compared with 104% in the USA and 131% in Britain.

Still, the Australian dollar is likely only to weaken materially from current levels if the Australian central bank cuts rates further, which is not yet anticipated by the market consensus. This will hinge in part on perceptions of China and in part on perceptions of the Australian domestic economy, which continues to suffer from the relative strength of the local currency.

As for asset allocation in the rest of the Asia Pacific ex-Japan relative-return portfolio, starting with Korea, the MSCI Korea slightly outperformed the benchmark in the past quarter, rising by 6.4% in US-dollar terms. This still makes Korea an underperformer year to date, having risen by 3.2% compared with the benchmark’s year-to-date gain of 5.5%.

Korea was maintained as a slight Underweight for most of last quarter. Korea’s low-beta macro status, in terms of its rising current account surplus and lack of credit excesses, makes the won an attractive currency in the emerging-market context. But a strong won is a negative for equities. A further potential negative for the stock market remains the vulnerability of its major exporters to a further weakening of the yen. In this respect Korea is a hostage to what the Bank of Japan announces. It is also the case that Korean export data shows scant sign as yet of a cyclical upswing. The other longstanding structural negative for the Korean equity market is a lack of dividend support.

MSCI Asia Pacific country performance, 2Q14

Note: Performance in US-dollar terms. Source: Datastream

India was the best performer last quarter, rising by 12.1% in US-dollar terms, on the BJP’s better-than-expected landslide victory in the general election. This makes India the best performer year to date, rising by 20.9% in US dollar terms.

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Slight Underweight Korea

India the best performer

Big Underweight in Australia maintained



India was maintained as a more than double Overweight last quarter. From a fundamental long-term perspective, India remains attractive as Asia’s most domestic demand-driven economy. There is also growing evidence that the economy has bottomed out while there are rising hopes that policies introduced by new Prime Minister Narendra Modi will serve as a catalyst to trigger a new investment cycle. India is discussed in more detail in the country section on page 54.

MSCI Asia Pacific country performance, Year-to-date 2014

Note: Performance in US-dollar terms. Source: Datastream

The MSCI Hong Kong slightly outperformed the regional benchmark last quarter rising by 6.7%. But it is still an underperformer year to date rising by 2.6%. Hong Kong is maintained as an Underweight because of the potential collateral damage to the local banking system from credit tightening in China and because the local property market continues to be impacted by the cumulative effect of a series of property-tightening measures. There is also a growing risk of potential tensions with mainland China over the so-called “Occupy Central” issue. The relative positives for Hong Kong are a stable currency and strong dividend support.

Thailand again slightly outperformed last quarter, rising by 6.5% in US-dollar terms. This makes it an outperformer year to date rising by 13.4%. Thailand was again raised to an Overweight last quarter after briefly going Neutral prior to the coup. The positives are relatively low valuations and hopes that the military government will kick start the economy. The market’s resilience this year has been all the more remarkable, given continuing heavy selling by foreign investors. But domestic institutions have remained consistent buyers.

Malaysia underperformed last quarter, with the MSCI Malaysia rising by 2.5% in US-dollar terms. This means Malaysia is an underperformer year to date, having risen by 1.6% in US-dollar terms. Malaysia is maintained as a Neutral weighting. There is domestic demand momentum, with continuing evidence of a government-driven investment cycle. The currency is stable while relatively expensive stock market valuations remain supported by government-affiliated domestic institutional investors.

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The MSCI Singapore underperformed slightly last quarter, rising by 4.1% in US-dollar terms. This means it is also an underperformer year to date, rising by 3%. Singapore is maintained as an Underweight because of the cumulative negative impact of a series of property-tightening measures amid rising property supply, as well as the growing evidence that credit growth has peaked after an extended credit cycle. The market’s main virtue remains the availability of attractive dividend plays in a strong currency.

The Philippines again outperformed last quarter, rising by 8.7% in US-dollar terms. This means it is an outperformer year to date having risen by 18.6%. The Philippines has also now outperformed the regional benchmark by 74% since the beginning of 2010.

MSCI AC Asia Pacific ex-Japan Index

Source: Datastream

The Philippine economy remains the best macro story in Asia, with overseas-worker remittance income and business process outsourcing (BPO) revenue continuing to drive the domestic consumption story, while there is also growing evidence of an investment cycle. Meanwhile, any monetary-tightening should be minimal with inflation under control and the country enjoying a solid current-account surplus. The longstanding nine times Overweight in the Philippines relative to the very low benchmark weighting is maintained, while the major risk remains relatively high valuations.

Indonesia was an underperformer last quarter, declining by 1% in US-dollar terms. But it is still an outperformer year to date, having risen by 19.7% in US-dollar terms. The Overweight was reduced to a slight Underweight during the past quarter because of growing evidence that the July presidential election is becoming very close with Jakarta Governor Jokowi’s lead in the polls declining substantially. The political situation is discussed in more detail in the country section on page 58.

Taiwan again outperformed last quarter, rising by 10% in US-dollar terms. This makes it an outperformer year to date, having risen by 11.3%. An Overweight is maintained, primarily because of the improving prospects for the dominant tech components sector as a result of the continuing boom in tablets on the back of falling product prices. The tech sector currently

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accounts for 58% of the MSCI Taiwan Index. The tech sector’s leading companies also have a certain dividend support, making them comparatively defensive. The other positive is the growing opportunity for Taiwan’s services sector, particularly the banks, from hoped for liberalisation measures with China.

MSCI AC Asia Pacific ex-Japan relative to MSCI AC World Index

Source: Datastream

Last but not least, China again underperformed last quarter, rising by 3.5% in US-dollar terms. This makes it the worst performer year to date having declined by 2.6% in US-dollar terms. The hopes for reform stemming from the Third Plenum held in November were overshadowed by renewed evidence of cyclical slowdown and declining credit growth. China was maintained as an Underweight during the past quarter.

The main positive for China remains cheap valuations. CLSA’s universe of 128 Hong Kong-listed Chinese shares trades at 8.7x forecast 2014 earnings. Still, the investment story in this cycle remains complicated by the desire of the Chinese leadership to “rebalance” the economy, coupled with the structural risks posed by the surge in broad credit growth in recent years and the resulting need to deflate a credit bubble without triggering a systemic crisis. There is also now downside currency risk, given the adjustment in exchange-rate policy implemented in March. Meanwhile, the best long-term investment case for China is that pursuit of “reform” will lead to multiple expansion for Chinese equities as the SOE sector allocates capital more efficiently.

As for China’s A-share market, the Shanghai Composite Index rose by a marginal 0.7% in renminbi terms last quarter. The index is still down 3.2% year to date and ended the quarter still 2.5% below its 200-day moving average (see following chart).

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Shanghai A-share market



Shanghai Composite Index

Source: Bloomberg

Finally, an out-of-the-index bet is maintained in Vietnam. This bet did not work last quarter with the Vietnam Stock Index declining by 3.4% in US-dollar terms. But the index is still up 13.2% year to date, which makes it an outperformer. This follows the 20.5% gain in 2013 when Vietnam was the second-best performer in Asia after Japan.

Vietnam Stock Index

Source: Bloomberg

The above asset allocation is for relative-return investors. The regional thematic Asia ex-Japan long-only absolute-return portfolio, free from the tyranny of benchmarks, is shown in the following table. This portfolio is not trying to outperform a benchmark, but simply attempting to make money, though it is important to note that the portfolio has not been allowed to own cash since its inception at the end of 3Q02. This naturally limits the options considerably when regional markets decline. The portfolio is measured by taking one or two mostly liquid stocks for each theme selected.

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Asia ex-Japan long-only portfolio



Asia ex-Japan thematic equity portfolio for long-only, absolute-return investors

Themes Weight (%) Stock picks

Asean auto dealer 3 Kolao Holdings

Australia gold mining 5 Newcrest Mining

China internet hosting 4 21Vianet

China internet media 5 Tencent

China online retailer 5 Vipshop

China online-offline travel company 3 Ctrip

India banks 15 HDFC Bank (5%), IndusInd Bank (5%), ICICI Bank (5%)

India cement 4 Grasim Industries

India consumer 3 Titan Industries

India housing finance 7 HDFC (4%), GRUH Finance (3%)

India media 4 Zee Entertainment

India property 3 Prestige Estates

India search engine 3 Just Dial

Philippines banks 10 Metrobank (5%), BPI (5%)

Philippines consumer 5 Universal Robina

Philippines media 4 ABS-CBN

Singapore dividend plays 5 SATS

Taiwan tech component makers 4 MediaTek

Thailand cement 4 Siam Cement

Thailand property 4 Land and Houses

Note: Readers should refer to the relevant CLSA research reports for detailed analysis & disclosures. Source: CLSA

The long-term performance of the Asia ex-Japan thematic portfolio remains for now respectable. Since its inception at the end of 3Q02, the portfolio has risen by 758% in US-dollar terms, compared with a 236% increase in the MSCI AC Asia ex-Japan and a 140% increase in the S&P500 (see following chart). This means the portfolio has risen by an annualised 20.1% since inception, compared with an annualised 10.9% increase in the MSCI AC Asia ex-Japan and an annualised 7.8% gain in the S&P500.

The portfolio again outperformed the regional index last quarter rising by 12.9%, compared with a 6.2% gain in the MSCI AC Asia ex-Japan. This means the portfolio has outperformed substantially year to date, having risen by 23.7% compared with a 5.1% gain in the regional index. The outperformance was primarily driven by the 39% weighting in Indian stocks, which amounts primarily to a bet on Modi.

The portfolio, which aims to invest in the best long-term stories, remains predominantly invested in domestic-demand names. The main country bets are India and emerging Asean, which represent 39% and 30% of the portfolio respectively. The portfolio continues to be primarily geared to the domestic story. There is also a practical limit to what can be done to hedge the long-only Asia ex-Japan portfolio, given the lack of cash options.

Thematic stock picks

Long-term portfolio performance

Short-term portfolio performance



Thematic portfolio performance relative to the MSCI AC Asia ex-Japan

Note: Asia ex-Japan thematic portfolio for long-only, absolute-return investors. Not including dividends paid. Source: CLSA

As a matter of historical record, it was officially recommended in mid-2007 that owners of the Asia ex-Japan portfolio should short Western financial stocks as a necessary hedge, given the relatively high-beta nature of the portfolio and the severe collateral risk facing Asian stocks by the unwinding of the Western credit bubble. This recommended hedge was narrowed in May 2010 to shorting only European financial stocks because the greatest systemic risk globally was by then in Euroland, centred on sovereign-debt concerns and European banks’ exposure to that sovereign debt. This recommended hedge was closed out on 16 January 2012 because of the upside risk posed by the then LTRO-driven “risk on” trade. The Euro Stoxx Banks Index is since up 62% in US-dollar terms from its 16 January 2012 level, while the Bloomberg European Financials Index is up 65% over the same period. No recommended hedge has, for now, been reintroduced.

Fundamentally, the domestic-demand bias of the Asia ex-Japan long-only portfolio will also be maintained since the view here is that, on a long-term basis, Asia ex-Japan will incrementally become much more of a domestic-driven asset class. Finally, it should be noted that the stated performance of the absolute-return portfolio does not include dividends paid. The performance comparison is made with the non-total-return MSCI AC Asia ex-Japan (ie, excluding dividends).

The absolute-return thematic portfolio for Japan, introduced on 17 March 2005, is shown in the following table. It marginally outperformed the Topix in the past quarter, rising by 6.4% in yen terms compared with a 5.0% gain in the Topix. This means the portfolio is also a slight outperformer year to date, declining by 2% in yen terms compared with a 3.1% decline in the Topix.

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Japan long-only portfolio



Japan absolute-return, long-only thematic portfolio

Theme Weight (%) Stocks Description Weight (%)

Real Estate 29 Mitsubishi Estate real estate company 9

Mitsui Fudosan real estate company 6

Sumitomo Realty real estate company 5

Sekisui House property developer 5

Daiwa House property developer 4

Transportation 4 East Japan Railway railway company 4

Autos 9 Isuzu Motors truck maker 5

Toyota Motor automaker 4

Machinery 13 Keyence optical-sensor maker 4

Fanuc industrial robot maker 3

Nabtesco precision gear manufacturer 3

Mitsubishi Heavy heavy machinery maker 3

Consumer 17 Sugi Holdings drugstore operator 4

Tsuruha Holdings drugstore operator 6

Seven & I convenience-store operator 4

Lawson convenience-store operator 3

Airport 3 Japan Airport Terminal Haneda airport operator 3

Financials 13 Sumitomo Mitsui Trust specialist financial institution 5

SMFG national bank 4

Zenkoku Hosho mortgage guarantee company 4

Healthcare 6 Ship Healthcare medical equipment distributor 3

Nihon Kohden medical equipment manufacturer

3

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Taisei general contractors 3

Source: CLSA

From a longer-term perspective the Japan portfolio is up 57.4% in yen terms and 62.4% in US-dollar terms since inception, while the Topix has risen by 5.9% in yen terms and 9.2% in US-dollar terms over the same period (see following chart). This translates into an annualised gain of 5.0% in yen terms since inception, compared with a 0.6% annualised gain for the Topix. Again, the portfolio may not own cash. As with the Asian portfolio, the stated performance does not include dividends paid and the performance comparison is made with the non-total-return Topix. The Japan portfolio is a combination of domestic-demand names and exporters, though with the major bet remaining on domestic-driven asset reflation plays.

Performance data



CLSA Japan thematic portfolio’s performance relative to the Topix

Note: Performance in yen terms. Source: Datastream, CLSA

The global portfolio for US-dollar-based long-term global investors, such as pension funds, is shown in the following table. The portfolio remains dominated, as it has been since inception, by the weightings in physical gold bullion and unhedged gold-mining stocks, which still account for 50% and 20% of the portfolio respectively. There was no change in the portfolio last quarter.

Recommended long-only asset allocation for US-dollar-based pension funds

Weight (%) Investment Type

50 Physical gold bullion

30 Asia ex-Japan equities, weighted according to the long-only thematic portfolio

20 Unhedged gold mining stocks Source: CLSA

The gold bullion price is up 10.1% in the first half of 2014. This follows the 28% decline in 2013, the biggest annual drop since 1981. While the unhedged gold mining index outperformed bullion, rising by 21.6% year to date. Despite the continuing risk posed by consensus expectations of a normalisation in Fed policy, a long-term bullish view is maintained on gold bullion with the price target continuing to be set at a minimum of US$3,360/oz. This view is maintained because the view here is that central banks will not be able to exit from unconventional monetary policy in a benign manner and will remain committed to ongoing balance-sheet expansion. Such policies ultimately threaten the stability of the current fiat paper money system.

The above asset allocation means that the global portfolio is still set up for a long-term dollar-debasement trade, which could also be a fiat-currency debasement trade, given the growing resort to aggressive quantitative easing extending beyond America, most notably in Japan but also increasingly likely in the Eurozone. The fundamental view here remains that it is much easier to enter unorthodox monetary policy regimes than to exit from them. This view is maintained despite investors’ growing confidence that American monetary policy will normalise. Indeed, the longer-term risk is that unorthodox monetary policy spreads from the developed world to the emerging world, though hopefully such an outcome can be avoided.

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Such a failure to exit from unorthodox monetary policy in a benign manner is likely to culminate in the collapse of the US-dollar paper standard to the benefit of gold-bullion owners, given the likely (and, indeed, increasingly visible) attempts by the relevant monetary authorities to try to reflate their way out of the problem. It should also again be emphasised that the investment in gold is viewed as insurance, not as a short-term trade. This is a long-term portfolio, which seeks to balance the long-term risks and opportunities in the current global context.

Gold bullion price

Source: Bloomberg

NYSE Arca Gold BUGS Index/gold-bullion price ratio

Note: The NYSE Arca Gold BUGS Index is a modified equal-dollar weighted index of 16 unhedged gold-mining stocks. Source: Bloomberg, CLSA

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Japan: Inflation stress test Asia Maxima


Japan: Inflation stress test Despite a disappointing start to 2014 for the Tokyo stock market, there are legitimate grounds to hope that Japan is emerging from its long-running deflationary trend. Consider, for example, growing evidence that the Japanese labour market is tightening. Labour shortages have extended beyond the well-known area of construction workers. Thus, a recent Nikkei poll of restaurant operators in Japan shows that 85% of the respondents had a harder time finding workers in fiscal 2013 than in the previous year, up from 60% in FY12 and 40% in FY11. Meanwhile, Fast Retailing President Tadashi Yanai said last month that he wants to convert about half of the staff in domestic Uniqlo outlets into permanent staff within the next 12-18 months. This comes as the latest land ministry data released at the end of June showed that the jobs-to-applicants ratio rose from 1.08 in April to 1.09 in May, the highest level since June 1992.

Index movement

Source: Datastream

As for the prospects for inflation, the data for April and May is distorted by the sales-tax increase. But the latest data is certainly not bad enough to force the Bank of Japan (BoJ) to move proactively. Thus, nationwide core CPI inflation, excluding fresh food, rose from 1.3% YoY in March to 3.2% YoY in April and 3.4% YoY in May, while “core-core” CPI inflation, which excludes food and energy, rose from 0.7% YoY to 2.3% YoY and 2.2% YoY in the same periods. True, stripping out the sales-tax-hike effect using the methodology proposed by the BoJ, nationwide core-core inflation slowed from 0.8% YoY in April to 0.5% YoY in May. But the adjusted Tokyo core-core inflation picked up from 0.4% YoY in May to 0.5% YoY in June.

The next few months of inflation data will be critical as the impact of last year’s yen deprecation drops out of the data. As for the impact of the sales-tax increase on domestic demand, it does not for now look as bad as might have been expected. April retail sales were almost in line with expectations, falling by 4.3% YoY compared with a consensus forecast 3.3% YoY decline, and were down only 0.4% YoY in May. Meanwhile, a Nikkei poll of the 100 top retailers conducted at the end of April shows over half of the respondents believe the post-sales-tax hangover will be over by the end of May, with another one-third expecting it to be concluded by the end of June.

This is why the real test for the Bank of Japan’s policy, in terms of both inflation and retail sales, will come in the third quarter of this calendar year, by when the Japanese central bank is also expecting a renewed rebound in activity. If this is not forthcoming, pressure will grow for renewed central bank activism.

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Growing labour shortages

Inflation data

Third quarter stress test



Meanwhile, from a stock-market standpoint, it is a positive signal that the Topix is now 11% above its 2014 low, even though the US 10-year Treasury bond yield is near its 2014 low and the yen is still 3.5% above its weakest point in 2014 relative to the US dollar. For if the Japanese stock market is to emerge successfully from deflation and enter a sustained bull market, as opposed to an unsustainable boom-bust asset-inflation cycle, it needs to break the correlations with the 10-year Treasury bond yield and the yen-dollar exchange rate which have been in place since the bursting of the bubble in 1990.

For now BoJ Governor Kuroda remains confident his policy is working. If his optimism proves warranted, and inflation is seen to be taking hold, it will raise a problem of success for the BoJ. That is, the central bank will need to start allowing the yield curve to steepen gradually, by reducing central-bank buying of JGBs at the long end, to send a market signal that the policy is working. Meanwhile, the latest Japanese flow-of-funds data shows public pension funds sold a net ¥1.85tn of JGBs in 1Q14, selling allowed by ongoing BoJ purchases of JGBs. This was the biggest net selling of JGBs by public pensions since 2Q12.

Amid much scepticism on “Third Arrow” structural reform, Prime Minister Shinzo Abe unveiled an economic-reform package in late-June aimed at revitalising the Japanese economy. The plan calls for lowering the effective corporate tax rate for Japanese companies from the current 35.6% to the 20s over several years starting in fiscal 2015, among other things. From a narrow stock-market perspective, the plan also calls for companies to increase their ROEs to global levels. This follows the setting up in January of the JPX-Nikkei 400 Index, comprising 400 high-ROE Japanese stocks. The aim here is again to encourage companies to boost ROE, with 40% of the qualifying criteria for inclusion in the index dependent on ROE. The three-year average ROE of the index constituents was 11.1% in FY13, compared with 5.7% for the Topix. The Osaka Exchange also announced in June that a JPX-Nikkei 400 futures market will be launched on 25 November. Meanwhile, so far this year, 245 Japanese corporates have announced share buybacks worth a total of ¥2.6tn, up 44% YoY, according to Bloomberg.

Finally, the other positive is that Abe’s popularity rating remains for now relatively resilient. Thus, the latest Kyodo News poll conducted in June shows that Abe’s approval rating remained at 52%, 18 months after taking office. This is high compared with most prime ministers in the last 15 years most of whom did not even last that long. But one who did, Junichiro Koizumi, had a 60% support rating after 18 months in office.

CLSA Japan universe trailing price-to-book

Note: Horizontal lines denote mean and +/- 1sd. Source: CLSA evalu@tor

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Japan job offers to applicants ratio

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Japan and Tokyo core-core CPI infliaton (adjusted for sales tax hike effect)

Note: Adjusted for the sales tax hike effect by the methodology proposed by the Bank of Japan. Data up to May 2014 for the nationwide index and June 2014 for Tokyo CPI. Source: Statistics Bureau, Bank of Japan, CLSA

Japan retail sales growth

Source: Ministry of Economy, Trade and Industry (METI)

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Topix and yen-dollar exchange rate

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JPX-Nikkei 400 Index relative to Topix

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Australia: Mining and housing paradox Asia Maxima


Australia: Mining and housing paradox The Australian economy continues to show a combination of tepid domestic demand combined with ongoing evidence of a steep decline in mining-sector capex. On the domestic-demand side, retail-sales data have been week during the past quarter. Thus, retails sales rose by only 0.2% MoM in April, down from 1.1% MoM in January. While on a 3M/3M basis, retail-sales growth has decelerated from 2.2% in January to 1.3% in April.

Index movement

Source: Datastream

As for mining-sector capex, new investment fell 8.7% QoQ in real terms in 1Q14, marking the second consecutive quarterly decline and the biggest decline since 2Q09. Still, a compensating factor was continuing strong property-related investment reflecting ongoing strong demand from foreigners, predominately Chinese, for Australian property. Real dwelling investment rose by 4.7% QoQ and 8% YoY in 1Q14. While the latest building-approvals data show that private houses approved rose by 16.5% YoY in April. Australia’s Foreign Investment Review Board reported in March that the Chinese had invested A$5.9bn in Australian property during the fiscal year ended June 2013, up 42% YoY.

Chinese property demand, filled by mainland developers pre-selling developments in China, is the main catalyst behind a renewed surge in domestic home prices. The RP Data-Rismark Home Value Index rose by 10.7% YoY in May, with home prices in Sydney rising by 16.6% YoY. It is not, however, reflected in a big pick up in mortgage lending domestically, as a consequence of anaemic income growth and continuing high household debt in aggregate, even though there has been significant deleveraging in recent years. Thus, housing loans rose by 6.2% YoY in May, while the quarterly wage-price index growth, which measures hourly pay rates, excluding bonuses, slowed from 3.8% YoY in 2Q12 to 2.6% YoY in 1Q14, the slowest year-on-year growth since the index began in 3Q97. The household debt-to-disposable-income ratio has fallen from a peak of 153% in 3Q06 to 150% in 1Q14, compared with 104% in the US and 131% in Britain.

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S&P/ASX200 200-day moving average

Tepid domestic demand

Mining sector capex declines

House price surge



Meanwhile, the Australian central bank has remained on hold. Still, the continued relative strength of the Australia dollar makes it likely that the next move will be a rate cut not a rate hike, even though this is not what money markets are currently discounting. The Australian real effective exchange rate has risen by 66% since bottoming in March 2001 and is now 14% above its long-term average since 1964. Yet the cash-rate futures are now discounting a 25bp rate hike in late 2015. On this point, so long as Australian short-term rates are a positive 2.5%, and most of the rest of the developed world is at zero, or near zero, it is a major support for the Australian dollar to the chagrin of the Reserve Bank of Australia (RBA), which now understands that currency strength poses a risk for the economy, given the likely secular decline in mining-sector capex.

Meanwhile, Australian bank stocks, like the Australian dollar, continue to be beneficiaries, in terms of their valuations, of what CLSA’s Australian bank analyst Brian Johnson has aptly described as the “QE-ternity” trade (see CLSA research Australian Banks - G.O.A.T.: Are they really the greatest of all time?, 2 June 2014). This is primarily because the Australian banks’ average dividend yield of 5.4% remains attractive to equity investors in a world of zero rates. Indeed, Johnson describes Australian banks, which represent 9.4% of the MSCI Asia Pacific ex-Japan Index, as one of the biggest valuation bubbles globally. On this point, note that dividend payout ratios are running at more than 70%. The ‘bubble risk’ for Australian banks is asset quality, given significant writebacks in recent years and the resulting lack of loan losses cover. Thus, major Australian banks’ loan-loss charges peaked at 76bp of gross loans in FY09 and have since declined to only 18bp in 1HFY14 ended 31 March.

It is, therefore, clear that the biggest risk to Australian bank shares, aside from a deterioration in the domestic credit cycle, is a QE-exit. But for now, investors have no conviction that it is about to occur. Meanwhile, Australian bank shares, and also other Australian equities, also continue to be supported by the compulsory 9.25% of Australian salaries flowing into superannuation schemes, resulting in an estimated A$1bn flows into equities every week.

CLSA Australia universe trailing price-to-book


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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

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Bank stock valuations



Australia retail sales growth %MoM

Source: Australian Bureau of Statistics

Australia mining sector new capex growth

Source: Australian Bureau of Statistics

Australia RP Data‐Rismark Home Value Index

Note: Average dwelling prices in eight capital cities. Source: RP Data

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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

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400420440460480500520540560580600620640660

(8)(6)(4)(2)02468

10121416

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(% YoY) %YoY Index (RHS)

On the way down . . .

. . . Also on the way down

China-driven surge



Australia wage price index growth

Note: Total Hourly Rates of Pay Excluding Bonuses. Source: Australian Bureau of Statistics

Australia real effective exchange rate

Note: Inflation-adjusted trade-weighted exchange rate. Narrow index comprising 27 economies. Source: BIS, CLSA

Australia system credit growth and nominal GDP growth

Source: Reserve Bank of Australia, Australian Bureau of Statistics

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Relatively feeble recovery

China: Conflicting signals Asia Maxima


China: Conflicting signals The easing of reserve-requirement ratios late last quarter has again raised hopes that more aggressive stimulus is coming in China. But this still remains more a case of fine tuning than real stimulus, most particularly as cuts in the reserve-requirement ratio do not necessarily lead to more credit growth so long as banks are constrained by numerical limits on their loan-to-deposit ratios.

Index movement

Source: Datastream

The sense, therefore, is that the current PRC leadership remains intent on resisting calls for overt aggressive stimulus measures, a position that is likely to be maintained so long as the employment market remains stable and exports are not collapsing. Meanwhile, the latest data from China has raised hopes for more of a cyclical uptick with PPI deflation easing from 2% YoY in April to 1.4% YoY in May. Yet, the all-important property market is still in a market-driven downtrend with the weakening price trend now reaching tier-one cites. Thus, new home prices in four tier-one cities fell by an average of 0.1% MoM in May, the first decline in two years, according to the National Bureau of Statistics. It is also interesting that, in a sign of growing cautious sentiment among developers, land sales have slowed dramatically. Land purchases by a panel of 26 listed developers that CLSA’s China Reality Research tracks declined by 50% YoY in volume terms and 60% YoY in value terms in May.

True, there will be more ‘fine tuning’ examples of easing in coming months. But for now the Chinese leadership seems more committed to trying to change behaviour than its predecessor. In a parallel and related development, the Party’s anti-corruption campaign remains in full swing in terms of investigations and detentions of senior officials with the campaign lately moving from the oil sector to the energy sector. This raises a larger point. This is that in an economic model, significantly driven by public sector-related investment activity, anti-corruption campaigns have a potentially contractionary economic impact beyond the obvious political issues raised.

The attitude of investors towards China remains schizophrenic. On the one hand they want to see reform, on the other hand they want to celebrate any signal that easing is at hand. This reflects the reality that investors, be they Chinese or foreigners, have become hypersensitive to policy signals in terms of signalling inflection points in the Chinese market. This is particularly the case as regards the property market, given its critical importance both in terms of serving as collateral for the banking system as well as being the major source of demand for the domestic economy. Thus, primary residential sales accounted for a record 11.9% of China’s GDP in 2013.

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Contractionary anti-corruption campaign



For now, the likelihood is that the economy will continue to slow as reflected in the deflationary signal of rapidly falling nominal GDP growth. Thus, nominal GDP growth slowed from 9.7% YoY in 4Q13 to 7.9% YoY in 1Q14, the slowest growth rate since 2Q09. Meanwhile, if the policymakers continue to tolerate ‘extend and pretend’ in the banking system, in terms of the rolling over or warehousing of problem loans, deflationary risks will continue to mount and velocity will continue to decline - as it has done since the onset of the post-Lehman stimulus in 2009. On this point, corporate bank-deposit growth slowed to a two-year low of 5.1% YoY in April and 5.6% YoY in May, while overall bank-deposit growth was also at a record low of 10.6% YoY in May, driven by the ongoing loss of bank deposits to higher yielding alternatives.

Meanwhile, there is one potential catalyst for more pronounced central-bank easing. That is renewed capital outflows. Estimated hot money flows, measured as the change in financial institutions’ positions for forex purchases less the trade balance and net FDI, fell to an outflow of Rmb15bn in April and Rmb204bn in May, compared with a Rmb118bn inflow in March. In the meantime, the property market and capital flows are the key areas to monitor in coming months, while investors wait to see the degree of the central government’s commitment to “reform”.

Another related point is that the deadline is now looming for the maturing of so-called trust products in the second half of this year and throughout 2015. This represents a potential stress test of the system, most particularly as it remains far from clear that it will be as easy to refinance maturing products as was the case previously. This is because the demand for trust products is cooling because there is more awareness of credit risk and also because of more interesting alternatives. The resulting slowdown in new issuance means that repayment pressure is likely to be rising later this year. Thus, data from financial data provider Wind shows that new monthly issuance of trust WMPs sampled by Wind has fallen from Rmb89bn in December to Rmb48bn in May.

The coming stress test for trust WMPs is best illustrated by the CRR estimate that Rmb3.5-4tn is coming due in 2014, of which more than Rmb2tn will be in the second half of this year. The ideal circumstance for those looking for a buying opportunity in China is for the authorities to allow some selective defaults, imposing some much-needed market discipline on the “shadow banking” sector, without provoking a wholesale panic out of every trust product where total assets under management reached Rmb11.73tn at the end of 1Q14, according to the China Trustee Association. If this is a delicate exercise, it should be possible for the authorities to pull off such a balancing act, most particularly as they appear to be fully aware of the problem.

CLSA China universe trailing price-to-book


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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

Slowing nominal GDP growth

Maturing trust products

Renewed capital outflows



China nominal GDP growth and PPI inflation

Source: CEIC Data

China average new home price growth in four tier-one cities

Note: Average of new home price growth in Beijing, Shanghai, Shenzhen and Guangzhou. Based on newly constructed commodity residential properties. Source: National Bureau of Statistics (NBS) - Survey of home prices in 70 major cities.

Land purchases by 26 leading listed developers in China

Source: China Reality Research (CRR)

135791113151719212325

(10)(8)(6)(4)(2)02468

1012

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(% YoY) (% YoY)China Producer Price Index (PPI) inflationNominal GDP growth (RHS)

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(000 m²) (Rmbbn)GFA (LHS) Trading value

Will the correlation hold?

Property prices start to decline . . .

. . . As land sales collapse



Shanghai Composite Index

Source: Bloomberg

China total and corporate deposit growth

Source: CEIC Data, PBOC

WMPs issued by trust companies sampled by Wind

Note: It tracked the new WMPs issued by 67 trust companies every month by collecting the public information. Source: Wind

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(Rmbbn) (%)Value issued Average yield (RHS)

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Weak deposit growth . . .

. . . As yields remain high on "trust" products

Hong Kong: A degree of tension Asia Maxima


Hong Kong: A degree of tension Perhaps the most interesting economic data point last quarter was a disappointing 9.8% YoY decline in Hong Kong retail sales in April. This served to crystallise growing concerns about a decline in spending by mainland tourists. Thus, CLSA’s economics team cut its 2014 retail sales growth forecast to 2%, down from 11%.

Index movement

Source: Datastream

The above follows growing evidence that Hong Kong is losing market share for mainland tourists to other locations, most notably Europe and America. This reflects a combination of factors including declining novelty value, a growing comfort with travelling longer distances and Hong Kong’s lack of price competiveness given still sky-high retail rents. The growth in mainland visitors has slowed from 24.2% in 2012 to 16.7% in 2013 and 13.1% YoY in May.

But there is another issue. That is growing news reports of increased tensions between mainland visitors and Hong Kong residents, with concerns increasing that mainlanders have put heavy strains on local public transport and health facilities. This has even led to suggestions that the quota for mainland visitors should be cut or that there should be an entry tax. However, this would have negative economic consequences, since CLSA’s economics team estimates that, for example, a 20% decline in same-day visitors from the mainland would lead to a US$1.7bn decline in tourism revenue for Hong Kong, equivalent to 0.6% of Hong Kong’s GDP.

So, quotas or entry taxes would seem unlikely given the economic impact. They will also not be welcomed by Beijing, most particularly as there are once again growing political tensions between Hong Kong and the mainland. These have centred on the so-called Occupy Central movement, a coalition of civil-society organisations threatening a campaign of civil disobedience in the form of taking over Hong Kong’s Central business district if Beijing reneges on its pledge to introduce the election of a chief executive by universal suffrage in 2017. The fear of the would-be demonstrators is that Beijing will set up some form of nomination committee it can control that would weed out undesirable candidates.

As ever, most people in Hong Kong value stability above all else. Still the situation is becoming more politicised, a fact reflected in the decision of China’s State Council to issue a White Paper on Hong Kong on 10 June. While this document acknowledges the context of the ‘one country, two systems’ formula agreed with Britain in 1984, it also asserts that China’s sovereignty, security and development interests have greater weight than Hong Kong’s autonomy, over which Beijing has the ‘power of oversight’.

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Hang Seng Index 200-day moving average

Declining retail sales

Mainland tourism story

“Occupy Central”

Beijing’s White Paper on Hong Kong



There is then the potential for an increase in political tensions if the proposals to be published soon by the Hong Kong Government are deemed unacceptable by the pro-democracy protestors. Meanwhile, the local economy faces both the slowdown in retail sales plus the continuing potential vulnerability of the local property market to any US interest-rate hikes. In this respect, Hong Kong residential-property prices remain remarkably resilient given the aggressive property tightening measures introduced in recent years. The Centa-City Leading Index of apartment prices has risen by 3.4% from its recent low reached in early March, and is only 2% below the all-time high reached in March 2013. Still the risk is clearly to the downside.

Meanwhile, property transactions have bounced off their recent lows primarily because of the pent-up demand. Weekly secondary sales in 35 residential developments monitored by Midland Realty have risen from an average of 65 units in 1Q14 to an average of 110 in 2Q14.

The past quarter saw the Hong Kong Monetary Authority (HKMA) provide more information on the details of the Hong Kong banking system’s growing mainland exposure. Hong Kong banks’ net external claims on mainland banks increased by 65% YoY to a record HK$2.48tn at the end of March, up from only HK$60bn at end-2009.

HKMA deputy chief executive Arthur Yuen noted in a press briefing in April that mainland-related customer loans, excluding trade-finance loans of HK$313bn, totalled HK$2.276tn at the end of 2013, of which 43% related to foreign bank branches in Hong Kong. He also noted that, including trade financing, the Hong Kong banking sector’s mainland-related loans totalled HK$2.59tn at the end of 2013, with half going to state-owned enterprises, 31% to the Chinese subsidiaries of international groups, and 19% to private enterprises in the mainland. The Hong Kong banking system’s rising mainland exposure is the natural consequence of the renminbi offshore market in Hong Kong. Renminbi deposits now total Rmb956bn or 12.5% of total Hong Kong bank deposits.

Finally, a potential positive for the Hong Kong stock market is that Beijing approved in April the development of a ‘through-train’ pilot programme to allow mutual stock market access between Shanghai and Hong Kong. The scheme, due to start in October, will allow individual investors to trade in each other’s stock market.

CLSA Hong Kong universe trailing price-to-book


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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

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Rising mainland exposure

“Through-train” pilot programme



Hong Kong retail sales value growth

Source: CEIC Data

Hong Kong growth in tourist arrivals

Source: CEIC Data, Hong Kong Tourism Board

Centa-City Leading Index

Note: Index of apartment prices in 100 private residential developments. Source: Centaline Property Agency

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Weekly secondary market sales of 35 active residential real estates

Note: Weekly secondary market sales in 35 residential real estates monitored by Midland Realty. Source: Midland Realty

Hong Kong banks' net external claims on banks in China

Note: External claims less liabilities. Source: HKMA

Renminbi deposits in Hong Kong

Source: Hong Kong Monetary Authority

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(Rmbbn) (%)

Bouncing off the bottom

Surging mainland exposure . . .

. . . As renminbi deposits have risen

India: Gujarat model on national stage Asia Maxima


India: Gujarat model on national stage The landslide victory of Narendra Modi last quarter has set up the prospect of a dramatic change in the way government works in India. Modi plans to run his chief-executive style of government through an “A-team” in the Prime Minister’s office with the individual ministers playing a secondary “B-team” role. This repeat of the Gujarat autocratic model on the national stage has become possible precisely because of the sweeping nature of Modi’s victory with the BJP securing an outright majority with 282 parliamentary seats in the Lok Sabha.

Index movement

Source: Datastream

The focus on growth and development will define Modi’s term in government just as it did his 12 years as chief minister in Gujarat where Modi succeeded in generating not only a lot of investment but also the flourishing of the agricultural sector by focusing on simple effective measures, such as improving irrigation. But if the Gujarat success is by now well understood, it is also the case that Modi has assumed power at a fortunate moment. For there is a lot of evidence that the Indian economy was already bottoming out after a three-year slowdown. Indeed, it could turn out that the overwhelming electoral mandate won by Modi marked the final removal of uncertainty, which will generate the confidence among businessmen to launch a new investment cycle as animal spirits are rekindled. Certainly, with the BJP being the first single party since 1984 to have an absolute majority in the lower house of the parliament, this government should last the full five-year term.

True, an investment cycle is not only about a revival of confidence, though psychology is a vital ingredient. It is also about balance sheets. Indian corporates have gone through an extended deleveraging cycle, though there is still a legacy problem in the banking system, in terms of not only Rs2.5tn of non-performing loans but also Rs3.2tn of so-called “restructured” loans, most of which are in state-owned banks. On this point, the new Indian leader will likely support a reorganisation of the state-owned banks by creating incentives for management to turn these enterprises into more entrepreneurial organisations.

But a new investment cycle in India has less to do with Modi. This is because actions initiated by the last Congress government in its final year in office have seemingly gone a long way to clearing the logjam in stalled investment projects. The two key developments here were the establishment in December 2012 of the Cabinet Committee on Investment (CCI) and the Project Monitoring Group (PMG) established in June last year.

The purpose of these entities is to focus on clearing bottlenecks in the investment process, most particularly where there are disputes between ministries. The formation of the CCI was an acknowledgement of this

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BSE Sensex 200-day moving average

Landslide victory

Focus on growth and development



institutional problem. Since then about US$35bn of stalled investment projects, more than half in the energy space, have been cleared. Since the average length of these investments is about five years, this translates into about US$7bn of investment a year. With the uncertainty of the election lifted, there is no real reason why this investment should not proceed.

But the other reason for renewed optimism on the investment cycle relates, not to stalled investments, but to the potential for new investments going forward. The key innovation here is the digitisation of the process. For example, the Ministry of Environment and Forests (MoEF) has agreed that all applications as regards forest clearance be digitalised from 1 July. This is important since 42% of the cases the PMG is handling relate to the forestry and environment ministry. In total, the PMG is looking at 437 projects, representing over US$300bn of investment, of which 150 projects worth US$92bn have been cleared, with 76% of them in the power sector.

From a macroeconomic standpoint, it is certainly hard to exaggerate the pent-up demand, given the investment slowdown in recent years. Thus, the growth in value of investment projects under implementation has fallen from 54% YoY in 1Q07 to 3.5% YoY in 1Q14, while new project announcements as a percentage of nominal GDP have plunged from 42% in FY08 to 3.5% in FY14. This collapse in investment growth was mainly “upstream” in terms of infrastructure and heavy industry. These are the areas which are now due to rebound strongly with all the beneficial multiplier consequences.

Although the investment downturn has been real investment, measured as gross capital formation including change in inventories, has still been around 34% of GDP in the last two years, despite hardly any investment in terms of infrastructure and heavy industry. Meanwhile, investors do not have to worry about the equivalent of China’s much-discussed over-investment problem. This makes India a virtuous self-fulfilling story when an investment cycle is under way, with the resulting high growth mitigating its macroeconomic weaknesses, such as chronically large fiscal deficits. Hopefully, Modi will impose some much needed discipline here with the full FY15 budget due around 11 July.

Another point is that it is not that evident that the investment cycle is so interest-rate sensitive. This is important, since inflation remains sticky as a result of the last government’s food subsidies and make-work schemes. Changes in these policies are more likely to be incremental than drastic. This is why investors in Indian equities should not expect interest-rate cuts for the moment. Meanwhile, though valuations have risen with the stock market’s rally this year, they are still at 10-year mean levels on a forward-earnings basis.

CLSA India universe trailing price-to-book


1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

Digitalisation of investment

approval process

Pent-up investment demand



India April-May 2014 general election results

Source: Election Commission of India

India real GDP growth

Source: CEIC Data

India annualised gross fixed capital formation as % of nominal GDP

Source: CEIC Data

BJP52%

BJP allies10%

Congress8%

Congress allies3%

ADMK7%

Others20%

Total 543 seats

0

2

4

6

8

10

12

1997 1999 2001 2003 2005 2007 2009 2011 2013

(% YoY)

22

24

26

28

30

32

34

1997 1999 2001 2003 2005 2007 2009 2011 2013

(%, 4Qma)

The decisive victory . . .

. . . Leads to hopes that growth has bottomed . . .

. . . And that investment has bottomed



Cumulative FII net equity investment and BSE Sensex

Source: Bloomberg

BSE Sensex one-year forward P/E

Source: CLSA

India bank credit growth

Source: Bloomberg, RBI

2,0004,0006,0008,00010,00012,00014,00016,00018,00020,00022,00024,00026,000

0

30

60

90

120

150

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Cumulative FII net equity investmentBSE Sensex (RHS)

(US$bn)

8

10

12

14

16

18

20

22

24

26

28

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

10Y average

81012141618202224262830

Jan

08Apr

08

Jul 0

8O

ct 0

8Ja

n 09

Apr

09

Jul 0

9O

ct 0

9Ja

n 10

Apr

10

Jul 1

0O

ct 1

0Ja

n 11

Apr

11

Jul 1

1O

ct 1

1Ja

n 12

Apr

12

Jul 1

2O

ct 1

2Ja

n 13

Apr

13

Jul 1

3O

ct 1

3Ja

n 14

Apr

14

(% YoY)

Foreigners keep buying equities . . .

. . . While valuation not so extended

Deleveraging

Indonesia: Close election race Asia Maxima


Indonesia: Close election race It has all been about the pending presidential election during the past quarter. The election, due to be held on 9 July, is looking like a very close contest. It is certainly the most fiercely contested presidential campaign in the country’s short post-Suharto democratic history.

Index movement

Source: Datastream

While stock-market favourite, Jakarta Governor Jokowi, is still leading in the polls, his lead is down to only 3-7 percentage points over rival candidate former general, Prabowo Subianto, based on some opinion polls conducted in June. Thus, a poll conducted on 1-10 June by Lembaga Survei Indonesia (LSI) shows Jokowi leads Prabowo by only three percentage points, with 19% of the electorate still undecided. Still, Jokowi’s lead has been cut by about 20 percentage points since March. The word on the street in recent weeks is that the momentum is with Prabowo as a result of superior organisation, greater funding resources and a “tough guy” image, with a certain appeal among poorer Indonesians, particularly in rural areas, yearning for a return to Suharto-style “iron fist” rule.

The above is of relevance to investors since a Prabowo victory would likely be negative for the stock market and the rupiah, both of which have certainly not yet fully discounted such an outcome. Hopes raised by Jokowi that energy subsidies will be phased out over a four-year period would diminish sharply leaving less room in the budget for much-needed infrastructure spending. Similarly, there would be less confidence that there will be long-overdue reform of the oil and gas sector, where Indonesia is on course, on present trends, to become a net importer of energy, including oil, gas and coal, by 2017. For more on this, read a CLSA research report published last quarter (Energizers - How sector reform is essential for growth, 5 May 2014 by deputy head of Indonesia research Jayden Vantarakis).

A Prabowo victory would also represent a continuation of the same old establishment politics dominated by the same old elite. This is evident from the divergent funding sources. Prabowo is relying on the usual methods, with big funding from corporate interests, whereas Jokowi has simply published bank accounts on the internet for individual supporters to pay money into, seemingly refusing all corporate donations, which always infer a certain reciprocal obligation.

With the election heating up, negative campaigning has also picked up, even though the formal one-month campaign period only began on 4 June. Jokowi has been portrayed in recent weeks by the opposition as a “closet Christian”

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,0005,500

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Jakarta Composite 200-day moving average

Looming election

Opinion poll data

Market consequences of Prabowo

Contrasting political style



and a “puppet” of PDI-P leader Megawati Soekarnoputri. While the Jakarta governor has been reluctant to get dirty, some of his well-connected supporters are fighting back. The former head of Indonesia’s State Intelligence Agency, Abdullah Mahmud Hendropriyono, stated in public in June that, as Prabowo’s former military superior, he had access to psychological tests which showed Prabowo to be “on the verge of schizophrenia”.

So this current Indonesian election is very different from what just occurred in India. Narendra Modi’s campaign was superbly organised, following a long period of planning. The opposite is the case in Indonesia. Jokowi only formally decided to go for the presidency in mid-March, and the organisational skills of his political parity, PDI-P, leave something to be desired judging by the disappointing outcome in April’s parliamentary election. By contrast, Prabowo, backed by his wealthy businessman brother Hashim Djojohadikusumo, has been planning this campaign for years and is desperate to win the presidency.

Meanwhile, the other issue in Indonesia is that the country’s macroeconomic problems may not be behind it. While last year saw 175bp of monetary tightening and a 21% decline in the rupiah against the US dollar, the renewed deterioration in the current-account deficit is a concern. The trade balance swung from a US$669m surplus in March and a US$1.1bn surplus in 1Q14 to a US$2bn deficit in April. It is also the case that aggregate credit growth remains surprisingly strong, running at 18.5% YoY. Within this aggregate, corporate lending remains robust running above 20% YoY, even though consumer-related lending has slowed sharply in response to higher interest rates. Thus, consumer loan growth has slowed from 50% YoY in 3Q12 to 10% YoY in April.

As a result total lending continues to grow well above nominal GDP, as it has done for several years. Thus, bank loans rose by 18.5% YoY in April, compared with 12% YoY nominal GDP growth in 1Q14. It is also not a positive that the Ministry of Finance was recently forced to revise its 2014 budget. The final approved budget revision calls for a Rp69tn or 21% increase in subsidy payments (mainly from a 24% increase in energy subsidies). This will be partly paid for by a 6% reduction in infrastructure spending. This is exactly not what is needed.

If these are cyclical concerns, ultimately the structural challenges facing Indonesia is that the origins of the boom in recent years was the surge in coal and palm-oil exports on the back of the China commodity story. This has now peaked. Going forward, new catalysts are required, be it a long overdue upgrade of infrastructure and a related improvement in logistics, or be it oil and gas reform.

CLSA Indonesia universe trailing price-to-book


0.51.01.52.02.53.03.54.04.55.05.5

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

Deteriorating trade data

Structural issue

Still strong credit growth



9 July Indonesian presidential election opinion poll

Note: Poll conducted on 1-10 June. Source: Lembaga Survei Indonesia (LSI)

Indonesia trade balance

Source: CEIC Data

Indonesia energy trade balance

Source: CLSA

Jokowi-JK42%

Prabowo-Hatta39%

Undecided19%

(3)

(2)

(1)

0

1

2

3

4

Jan

10

Apr

10

Jul 1

0

Oct

10

Jan

11

Apr

11

Jul 1

1

Oct

11

Jan

12

Apr

12

Jul 1

2

Oct

12

Jan

13

Apr

13

Jul 1

3

Oct

13

Jan

14

Apr

14

(US$bn)

(50)

(40)

(30)

(20)

(10)

0

10

20

30

40

50

03 04 05 06 07 08 09 10 11 12 13

14CL

15CL

16CL

17CL

18CL

(US$bn) Oil Gas Coal Energy trade balance

The election race is close . . .

While the trade balance is still not healthy . . .

. . . As energy fundamentals deteriorate



Indonesia bank credit growth and nominal GDP growth

Source: CEIC Data

Indonesia consumer loan growth

Source: Bank Indonesia, CLSA

Indonesia annualised palm oil and coal exports in US$ terms

Source: Bank Indonesia

0

5

10

15

20

25

30

35

40

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Indonesia bank credit growth Nominal GDP growth(% YoY)

0

5

10

15

20

25

30

35

40

45

50

FY07

FY08

FY09

FY10

FY11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

Apr

14

(% YoY)

0

5

10

15

20

25

30

35

3

5

7

9

11

13

15

17

19

21

Jan

06M

ay 0

6Sep

06

Jan

07M

ay 0

7Sep

07

Jan

08M

ay 0

8Sep

08

Jan

09M

ay 0

9Sep

09

Jan

10M

ay 1

0Sep

10

Jan

11M

ay 1

1Sep

11

Jan

12M

ay 1

2Sep

12

Jan

13M

ay 1

3Sep

13

Jan

14

Palm oil exports

Coal exports (RHS)

(US$bn, annualised)(US$bn, annualised)

Aggregate credit growth has not slowed much . . .

. . . But consumer credit growth has slowed more

The end of the commodity boom

Korea: Growing pressure to ease Asia Maxima


Korea: Growing pressure to ease One institution that will be relieved if Japan gets out of deflation in a healthy manner will be the Bank of Korea. For in a world of competitive devaluation, the won continues to behave like the emerging-market equivalent of the euro given Korea’s continuing macro characteristics of a rising current-account surplus, a low fiscal deficit, a normalised yield curve and a subdued credit cycle.

Thus, the won appreciated by 5% against the US dollar and 3% against the yen last quarter. While its annualised current account surplus has risen from 1% of GDP in late 2011 to 6.5% in May. The consolidated fiscal account, excluding social security funds, recorded a deficit of 1.5% of GDP in 2013. While the 10-year government bond yield is now 55bps above the overnight call rate and 49bps above the three-year government bond yield. As for the credit cycle, bank loan growth is running at 6.3% YoY compared with nominal GDP growth of 5% YoY.

Index movement

Source: Datastream

The new Bank of Korea governor, Juyeol Lee, did not cut rates last quarter. But there must be a growing temptation to do so given the continuing low level of inflation and given a flattening yield curve in recent months. CPI rose by 1.7% YoY in May, up from 1.5% YoY in April. But this remains well below the BoK’s inflation target range of 2.5-3.5% for 2014. The 10-year government bond yield has fallen by 58bps from a recent high of 3.75% reached in early December 2013 to 3.17% at the end of June.

Still, with the continuing won strength, and a real risk of a currency overshoot, the Bank of Korea will at some point be forced to ease aggressively in an environment where the Bank of Japan does another episode of QE. Indeed, Korea may even panic and become the first emerging-market central bank to venture into its own unorthodox monetary policy. True, no one is thinking about this at the moment. But what is evident is that Korean export data so far this year have not confirmed consensus expectations at the start of 2014 of a significant pickup. Thus, Korean exports fell by 1% YoY in May and were up only 2.6% YoY in the first five months of this year. This has global implications given there is an 85% correlation between Korean export data and global exports.

0

500

1,000

1,500

2,000

2,500

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Kospi 200-day moving average

Flattening yield curve

Weak export growth

Safe haven won



The continuing lack of a strong export recovery has not impacted the current-account surplus, and therefore the won, because of weak imports. Imports rose by only 2.3% YoY in the first five months of this year. As a result, the trade surplus increased by 7% YoY to US$15bn over the same period.

Meanwhile, from a stock-market perspective, earnings have continued to disappoint supporting the relative lack of enthusiasm for Korean stocks shown so far this year by foreign investor buying compared with some other Asian stock markets. Thus, foreigners sold a net 3.5tn won of Kospi stocks in 1Q14 but have since bought a net 5.7tn won in the second quarter. The 1Q14 earnings came in up only 2.7% YoY or 17% below consensus expectations. CLSA’s Seoul office is forecasting 11% earnings growth this year on a top-down basis and 20% based on analyst forecasts.

Amid the relatively lacklustre outlook, housing and construction-related sectors have enjoyed a certain momentum as the current government has moderated some of the long-running anti-speculative measures. But the property market has corrected over the past three months following the government’s announcement in February of its rental income tax enforcement plan which will tax property owners who rent out their apartments. Thus, Seoul apartment transaction volume declined by 17.7% YoY in May. While Seoul apartment prices have turned negative, falling by 0.28% since mid-April.

The relative buoyancy of the construction sector was clear from 1Q14 GDP data where construction was the key investment driver. Thus, real construction investment rose by an annualised 22% QoQ in 1Q14, while facilities investment declined by an annualised 7.3%. By contrast, real private consumption growth slowed for the second consecutive quarter to only an annualised 0.7% in 1Q14. Loan growth also remains tepid though, as already noted, slightly above nominal GDP growth.

CLSA Korea universe trailing price-to-book


0.7

0.9

1.1

1.3

1.5

1.7

1.9

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

Weak earnings growth

Property data

Construction pick-up



Korean won/yen exchange rate (inverted scale)

Source: Bloomberg

Korea annualised current account balance as % of GDP

Source: CEIC Data

Korea export growth

Source: CEIC Data

7

8

9

10

11

12

13

14

15

16

171994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

(1)

0

1

2

3

4

5

6

7

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

(% GDP)

(40)

(30)

(20)

(10)

0

10

20

30

40

50

2008 2009 2010 2011 2012 2013 2014

(% YoY)

Rising won . . .

. . . On back of rising current account surplus

A lack of export growth



Cumulative foreign net buying of Kospi stocks

Source: CEIC Data, Korea Stock Exchange

Korea bank loan growth and nominal GDP growth

Source: CEIC Data

Korea 10Y government bond yield and Bank of Korea policy rate

Source: Bloomberg

300

500

700

900

1,100

1,300

1,500

1,700

1,900

2,100

2,300

(60)

(50)

(40)

(30)

(20)

(10)

0

10

20

30

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Cumulative net buying of Kospi stocks by foreigners

Kospi (RHS)

(tn won)

0

5

10

15

20

25

30

35

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Nominal GDP growth Bank loan growth(% YoY)

1

2

3

4

5

6

7

8

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Korea 10-year government bond yieldBoK base rate (7-day repo)

(%)

No massive foreign buying

Continuing subdued credit growth

Flattening yield curve

Malaysia: More macro than micro Asia Maxima


Malaysia: More macro than micro The macroeconomic data continues to record robust growth. Real GDP growth accelerated in the first quarter, driven primarily by public sector-related investment while consumption growth remained robust.

Thus, real GDP rose by 6.2% YoY in 1Q14, up from 5.1% YoY in 4Q13. This is the strongest growth since 4Q12. Real gross fixed-capital formation rose by 6.3% YoY in 1Q14, and was up an annualised 12.4% QoQ. While real private consumption rose by 7.1% YoY, down slightly from 7.4% YoY in 4Q13. Export growth also picked up leading to an improving current account surplus. Exports rose by 18.9% YoY in ringgit terms and 11.3% YoY in US dollar terms in April, the strongest growth since October 2011. As a result, the current-account surplus rose from US$4.6bn or 5.6% of GDP in 4Q13 to US$6bn or 7.7% of GDP in 1Q14.

The fiscal position has also improved with rising revenues. The fiscal deficit fell to a six-year low of 3.9% of GDP in 2013, down from 4.5% in 2012 and a recent high of 6.7% in 2009. The government’s target is to reduce the fiscal deficit further to 3.5% of GDP this year and 3% in 2015. Federal government revenues rose by 10.6% YoY in the first four months of this year.

The only potential negative is a pickup in inflation to an average of 3.4% YoY in the first five months of this year, up from 1.6% in the same period last year, which is the natural consequence of the removal in subsides since last September. Still CPI inflation eased for the second consecutive month in May, edging down from 3.5% YoY in March to a five month low of 3.2% YoY in May. CLSA’s economics team expects Bank Negara Malaysia (BNM) to continue to hold rates steady in its 10 July policy meeting. But a 25bps hike in each of the two policy meetings in September and November is forecast, as inflation will trend higher as more subsidy cuts come through. These would be the first rate hikes since May 2011, lifting the policy rate from the current 3% to 3.5% by the end of 2014.

Index movement

Source: Datastream

If this is the macro picture, the micro picture is less appealing, driven by a lack of exciting bottom-up options and relatively high valuations. Malaysia continues to trade at a premium valuation to the region with these valuations supported by buying from government-related institutions. CLSA’s universe of

0

200

400

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800

1,000

1,200

1,400

1,600

1,800

2,000

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

KLCI 200-day moving average

Robust data

Fiscal improvement

Stock market valuations



47 Malaysian stocks under coverage trades at 17x 2014 forecast earnings, assuming 6.8% earnings growth, the second highest valuation in Asia after the Philippines. This compares with a 12x 2014 PE for the region.

As for foreign investors, they have been relatively inactive year to date. Foreigners sold a net RM6bn worth of Malaysian stocks in 1Q14 though they bought back a net 4.2bn in 2Q14. This compared with net selling of RM11.5bn in 2H13. By contrast, foreigners remain big holders of Malaysian government bonds which currently yield 4.0%. Foreigners owned 46% of outstanding Malaysian government bonds at the end of May, compared with foreign ownership of 23% in Malaysian stocks. This bond yield compares with a forecast average 2014 dividend yield of 3.0% for CLSA’s Malaysia equity universe. This same universe has a forecast ROE of 14% for 2014.

If the overall picture in terms of data looks relatively benign, the more insidious and troubling side to the Malaysia story was revealed in a thematic research report published by CLSA’s Kuala Lumpur office last quarter (Mr & Mrs Malaysia 2014, 5 May 2014). The survey of 2,500 families, conducted during February and March this year, reveals sharply contrasting attitudes between the races. The majority of Malays feel better off, while the minority Chinese, an estimated 24% of the population, are deeply negative. This reflects the reality that government support, from cash transfers to continuing affirmative action schemes, supports the Malays while the Chinese are deterred from much needed private investment by the continued existence of such schemes. It is also the case that the Chinese community is feeling more vulnerable, having supported the opposition heavily in the last general election held in May 2013. The survey results show that 53% of Chinese expect their financial position to worsen over next year, compared with only 37% of Malays. While 74% of Chinese fear the economy will deteriorate in the coming year.

The result is that the race is the key factor driving attitudes which, while not surprising, is also not healthy. The issue now is whether Prime Minister Najib Razak will use his strong position, in terms of his personal polling support running well ahead of UMNO’s, to pursue a more reform orientated agenda, given that another general election does not have to be held until 2017. But so far the record on this is mixed.

CLSA Malaysia universe trailing price-to-book


1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

Mr & Mrs Malaysia

Race driven



Malaysia real GDP, consumption and investment

Source: CEIC Data

Malaysia export growth

Source: CEIC Data

Malaysia current account balance

Source: CEIC Data, Bank Negara Malaysia

90

110

130

150

170

190

210

Mar

05

Jun

05Sep

05

Dec

05

Mar

06

Jun

06Sep

06

Dec

06

Mar

07

Jun

07Sep

07

Dec

07

Mar

08

Jun

08Sep

08

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08

Mar

09

Jun

09Sep

09

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09

Mar

10

Jun

10Sep

10

Dec

10

Mar

11

Jun

11Sep

11

Dec

11

Mar

12

Jun

12Sep

12

Dec

12

Mar

13

Jun

13Sep

13

Dec

13

Mar

14

Real GDPReal gross fixed capital formationReal private consumption

(1Q05=100, sea. adj.)

(15)

(10)

(5)

0

5

10

15

20

25

Jan

11

Mar

11

May

11

Jul 1

1

Sep

11

Nov

11

Jan

12

Mar

12

May

12

Jul 1

2

Sep

12

Nov

12

Jan

13

Mar

13

May

13

Jul 1

3

Sep

13

Nov

13

Jan

14

Mar

14

May

14

(% YoY)

0

5

10

15

20

25

0

2

4

6

8

10

12

14

Mar

98

Sep

98

Mar

99

Sep

99

Mar

00

Sep

00

Mar

01

Sep

01

Mar

02

Sep

02

Mar

03

Sep

03

Mar

04

Sep

04

Mar

05

Sep

05

Mar

06

Sep

06

Mar

07

Sep

07

Mar

08

Sep

08

Mar

09

Sep

09

Mar

10

Sep

10

Mar

11

Sep

11

Mar

12

Sep

12

Mar

13

Sep

13

Mar

14

(US$bn) Malaysia current account balanceas % of nominal GDP (RHS)

(% GDP)

Strong macro

Strong exports

Improving current account



Malaysia fiscal deficit as % of GDP

Note: Government Budget/target for 2014 and 2015. Source: Ministry of Finance Malaysia

Bank Negara overnight policy rate and CPI inflation

Source: CEIC Data, Bank Negara Malaysia

Cumulative foreign net buying of Malaysian stocks and KLCI

Source: CLSA, The Sun Daily, Bursa Malaysia

0

1

2

3

4

5

6

7

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

E

2015

E

(% GDP)

(4)

(2)

0

2

4

6

8

10

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Bank Negara Malaysia overnight policy rateMalaysia CPI inflation (%YoY)

(%)

1,500

1,550

1,600

1,650

1,700

1,750

1,800

1,850

1,900

0

5

10

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25

30

35

40

Jan

12Fe

b 12

Mar

12

Apr

12

May

12

Jun

12Ju

l 12

Aug

12

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12

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12

Nov

12

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12

Jan

13Fe

b 13

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13

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13Ju

l 13

Aug

13

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13

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14Fe

b 14

Mar

14

Apr

14

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14

Jun

14Ju

l 14

(RMbn) Cumulative foreign net buying of Malaysian stocksKLCI (RHS)

Improving fiscal

Stable interest rates

But no rush to buy by foreigners

Philippines: Macro positives Asia Maxima


Philippines: Macro positives The Philippines continues to enjoy one of the strongest (if not the strongest), domestic momentum stories in Asia, driven by ongoing remittances, the booming BPO sector and growing evidence of an infrastructure cycle. Cash remittances from overseas Filipinos grew by 5.8% YoY in US dollar terms to US$7.4bn in the first four months of this year, and were up 16.1% YoY in peso terms. While BPO revenues at US$15.5bn amounted to 67% of remittances in 2013, and are projected by the Business Process Association of the Philippines (BPAP) to reach US$18bn this year and US$25bn by 2016. This means that remittances and BPO revenues between them accounted for 14% of nominal GDP last year, representing the prime driver of the domestic demand story.

Index movement

Source: Datastream

Still, there also continues to be growing evidence of an investment cycle in terms of the reported GDP data. Thus, annualised gross fixed capital formation as a percentage of nominal GDP has risen from a low of 18.6% in 1Q12 to 20.6% in 1Q14, the highest level since 2Q04. Importantly, the past quarter has also seen some progress on President Benigno Aquino’s Public-Private Partnership (PPP) programme. Thus, the government held two successful bids in June for the P65bn LTR-1 Cavite Extension and the P35bn Cavite-Laguna Expressway. The first project is a 11.7km extension to an existing railway and the second is a new 47km highway.

This means there are now six more PPP projects with P69bn left to secure bids, based on the government’s target. The PPP Center said in December that at least 15 PPP projects will be awarded before Aquino’s term ends in June 2016, including seven completed projects. The presidential election is due to be held in May 2016.

If the election is perhaps the major medium risk, it is still two years away and therefore too early to become a consideration for stock market investors, most particularly as there is a lack of clarity on who the candidates will be. This means the major issues facing the stock market remain relatively high valuation and the potential, at least, for some marginal interest rate hikes. CLSA’s economics team is forecasting 50bp of tightening this year from 3.5% to 4%. Still the Bangko Sentral ng Pilipinas (BSP) has so far held its key policy rate at 3.5%, though it has

0

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2,000

3,000

4,000

5,000

6,000

7,000

8,000

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

PSEi 200-day moving average

Remittance and BPO data

Investment cycle evidence

PPP progress

Monetary policy



raised reserve requirements by 200bp to 20% since late March and increased the interest rate on the Special Deposit Account (SDA) facility by 25bp to 2.25% in June.

From a valuation standpoint the CLSA universe of 44 Philippine stocks under coverage trades at 19x forecast 2014 earnings and 16.5x forecast 2015 earnings assuming 4.6% and 14.8% earnings growth respectively. These relatively lofty valuations clearly create scope for a correction, most particularly if there is a monetary tightening scare. Yet, with headline CPI inflation at only 4.5% YoY and with a continuing strong current account surplus still running at 3.1% of GDP based on the latest data, any interest-rate increases, if they happen, will only be marginal. In this respect, perhaps the biggest risk, as with other interest-rate sensitive Asian stock markets, is an externally driven tightening scare similar to last summer’s “tapering tantrum”; when foreigners sold a net US$1.3bn worth of Philippine stocks between late September 2013 and early February. Since then, they have bought a net US$1.2bn between early February and the end of last quarter.

Finally, another positive macro signal is growing evidence of accelerating credit growth. This rose to 21.1% YoY at the end of May, up from 16.4% YoY at the end of 2013. This rising credit growth trend is the result of growing pressure on the Philippines’ long-conservative banks to lend, a pressure caused by the gradual unwind of the central bank’s Special Deposit Accounts, which have fallen from a peak of P1.9tn at the end of February 2013 to P1.1tn at the end of May. This has caused the loan-to-deposit ratio of the banking system to fall to only 62%.

The economy is, therefore, posed for accelerating credit growth at a time when NPLs are at a near record low of 2.2% and corporate leverage has declined to only 21%. Meanwhile, for now at least, credit continues to be extended across a broad range of sectors. Bank loans for real estate, utilities, the wholesale and retail trade and the manufacturing sector rose by 18%, 36.5%, 23% and 15.8% YoY respectively in May.

CLSA Philippines universe trailing price-to-book


0.6

0.9

1.2

1.5

1.8

2.1

2.4

2.7

3.0

3.3

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)


Credit growth



Philippines ratio of BPO revenues to remittances

Source: CLSA, BSP, BPAP

Philippines annualised gross fixed capital formation as % of nominal GDP

Source: CEIC Data

Cumulative foreign net buying of Philippine stocks

Source: Bloomberg

0

10

20

30

40

50

60

70

80

0

5

10

15

20

25

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

E

BPO revenues (LHS)Overseas remittances (LHS)BPO revenues / remittances

(US$bn) (%)

18

19

20

21

22

23

24

25

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

(% GDP)

(1)

0

1

2

3

4

5

6

7

8

9

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(US$bn)

The continuing domestic-demand drivers

An accelerating investment cycle

Foreigners turn buyer again . . .



Philippines bank loan growth

Note: Net of banks’ reverse repurchase transactions with the BSP. Source: CEIC Data, BSP

Philippines banking sector loan-to-deposit ratio

Note: Universal and commercial banks since 1999. Commercial banks prior to 1999. Source: CEIC Data, BSP

Philippines CPI inflation

Source: CEIC Data, Bangko Sentral ng Pilipinas (BSP)

(10)

0

10

20

30

40

50

60

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

(% YoY)

50

60

70

80

90

100

110

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

(%)

1

2

3

4

5

6

7

8

9

10

11

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(%) Core CPI inflation Headline CPI inflation

. . . As credit growth accelerates . . .

. . . As a consequence of an increased capacity to lend

Inflation rises from record low levels

Singapore: Affordability issue Asia Maxima


Singapore: Affordability issue There are growing signs that Singapore’s long-running tourist boom has peaked out. Retail sales value, excluding autos, declined by 1.5% MoM in April on a seasonally adjusted basis and was down 1.3% YoY. While perhaps more significantly, total retail spending contracted 9% YoY in April.

Index movement

Source: Datastream

The evidence suggests that the weakness in retail spending is stemming from tourism-related segments whereas domestic household consumption is underpinned by wage increase in what remains a tight labour market. Average monthly earnings rose by 3.2% YoY in 1Q14, following a 4.3% YoY increase in 2013. While total visitor arrivals declined by 5.2% YoY in April, the biggest fall since June 2009, and were flat in 1Q14. This follows 7% growth in 2013.

There are two main reasons for the decline in tourism. First, Singapore has become expensive. This is primarily because of the sharp appreciation of the Singapore dollar against other regional currencies in recent years. The Singapore dollar has appreciated against the ringgit, rupee, rupiah, baht, renminbi and yen by 6%, 45%, 35%, 10%, 5% and 22% respectively over the past five years. This makes Singapore increasingly too expensive to tourists from the region. Services-sector inflation is also an issue, even though it edged down from 2.7% YoY in April to 2.5% YoY in May.

The second reason is a trend similar to that experienced in Hong Kong, namely fewer visitor arrivals from China. Tourist arrivals from China, which accounted for 14% of total tourist arrivals in 1Q14, declined by 19.5% YoY in March and are down 14% YoY in 1Q14.

The overall result is that while total visitor arrivals are still growing marginally, per-capita spending by tourists is declining. Tourism receipts per capita have fallen by 11% over the past two year to a four-year low of S$1,510 in 2013. The Singapore Tourism Board (STB) estimates visitor arrivals to rise to 16.3-16.8m this year from 15.6m in 2013, with tourism receipts rising from S$23.5bn in 2013 to S$23.8-24.6bn. This implies a further decline in per-capita tourism receipts to S$1460 this year.

The above is interesting since it is reflective of a boom that has peaked. Moreover, it is hard to see what could happen to suddenly make Singapore better value barring an unlikely collapse of the currency. Certainly the government’s growing focus on restricting the inflow of foreign labour is only

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Straits Times Index 200-day moving average

Tourism slows

Expensive currency

Tourist data



adding to costs in terms of wage pressures and the like. Meanwhile, it is worth noting that the average cost of a hotel room in Singapore is now S$260, up from S$120 in 2004.

Meanwhile, the same picture of a boom that has peaked out and is now in correction mode is apparent from the residential market, where eight rounds of property tightening since September 2009 have finally succeeded in cooling speculative activity. True, primary sales excluding executive condominiums (ECs) rebounded 97% MoM to 1,470 units in May, the highest monthly volume since last June. But the fundamental problem remains that the government is unlikely to relax materially its property tightening measures unless there is a material correction in residential property prices.

So far this has not really happened. The private residential property price index declined by only 1.3% QoQ and 0.8% YoY in 1Q14. Home prices in both the core central region (high-end) and the rest of central region declined by 3.6% YoY in 1Q14, while prices in the outside central region (mass market) rose by 5% YoY.

Meanwhile, there is still a pending surge in supply, most particularly in the mass residential market, which is not due to peak out until 2016. Thus, total private residential property completions are expected to rise from 13,024 units in 2Q-4Q14 to a peak of 26,252 units in 2016, with completions in the outside core region rising from 4,940 units to 15,845 units over the same period. For such reasons CLSA’s Singapore property analyst Yew Kiang Wong forecasts a 5-10% decline in physical residential property prices this year.

The same evidence of a boom that has peaked out is evident in declining credit growth. Consumer lending is forecast to grow by less than 4% this year, which would be the slowest growth since 1Q07. Within this aggregate, both auto loans and mortgage loans were weak. Thus, car loans declined by 19.7% YoY in May, while mortgage loan growth has slowed to 7.3% YoY in April and 7.6% YoY in May, the slowest growth since June 2007.

From a stock-market standpoint, the Singapore market remains most attractive for its dividend plays and for the availability of regional proxies. The CLSA universe of 47 Singapore stocks under coverage trades at 14x 14CL earnings with a forecast ROE of 10%. This is the third-lowest forecast ROE in the region after Japan and Hong Kong. Meanwhile, CLSA’s Singapore dividend cocktail portfolio, which has a forecast dividend yield this year of 4.8%, has outperformed the benchmark MSCI Singapore Index by 39% since inception in July 2010 and also outperformed by 2% year to date.

CLSA Singapore universe trailing price-to-book


0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

2.5

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

Slowing credit growth


Property data



Singapore retail sales growth

Source: CEIC Data

Growth in Singapore tourist arrivals

Source: CEIC Data, Singapore Tourism Board

Singapore per capita tourism receipt

Source: STB, CEIC Data, CLSA

(15)

(10)

(5)

0

5

10

15

20

25

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(% YoY, 3mma)

(20)

(10)

0

10

20

30

40

2006 2007 2008 2009 2010 2011 2012 2013 1Q14

(% YoY) Total From China

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

E

(S$)

Slowing . . .

. . . Also slowing

Peaking out



Singapore residential property price %YoY growth by segment

Source: URA

Singapore pending private residential supply (under construction + planned)

Note: Excluding Executive Condominiums. Source: CLSA, Urban Redevelopment Authority

Singapore business and consumer loan growth vs nominal GDP growth

Source: CEIC Data, MAS

(40)

(30)

(20)

(10)

0

10

20

30

40

50

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Core Central Region Rest of Central RegionOutside Central Region

(% YoY)

0

4,000

8,000

12,000

16,000

20,000

24,000

28,000

2-4Q14 2015 2016 2017 2018 >2018

(unit) Core Central Region

Rest of Central Region

Outside Central Region

(10)

0

10

20

30

40

50

Jan

06M

ay 0

6Sep

06

Jan

07M

ay 0

7Sep

07

Jan

08M

ay 0

8Sep

08

Jan

09M

ay 0

9Sep

09

Jan

10M

ay 1

0Sep

10

Jan

11M

ay 1

1Sep

11

Jan

12M

ay 1

2Sep

12

Jan

13M

ay 1

3Sep

13

Jan

14M

ay 1

4

(% YoY) Business loansConsumer loansNominal GDP growth

Property prices are poised to fall . . .

. . . As supply builds . . .

. . . And as credit growth slows

Taiwan: Technology driven Asia Maxima


Taiwan: Technology driven The Taiwan equity-investment story has continued to be driven primarily by the profitability of the tech sector supplying components for the smartphone boom and other electronic niche-products globally. Tech earnings were up 26% YoY in the first quarter with growth driven mainly by gross-margin expansion. By contrast, earnings for non-tech sectors, excluding financials, were down 18% YoY.

Index movement

Source: Datastream

The tech sector also continues to attract foreign investors because of better balance sheets and strong dividend support. The 48 tech stocks covered by CLSA’s Taiwan office had a 12% net cash to equity ratio in 2013 and have a forecast dividend yield of 3.1% this year, which compares favourably with the yield on the 10-year Taiwan government bond of only 1.6%. From a valuation perspective, Taiwan tech stocks remain in line with the history. CLSA’s Taiwan tech universe trades on 2.2x trailing price to book and 15x trailing PE, compared with a 10-year average of 2.3x and 14.4x respectively.

As a result, foreigners have remained net buyers of Taiwan equities year-to-date, with last quarter seeing some rotation into more commoditised “downstream” names. Foreigners bought a net NT$205bn worth of Taiex stocks last quarter following net NT$79bn buying in 1Q14. The tech sector has also been helped of late by currency movements. In particular, the NT dollar’s 12% depreciation relative to the Korean won since late June 2013 has allowed Taiwan to take back market share from Korea.

The result of all of the above is that perhaps the main risk is that all the good news is in the price from a tech sector standpoint, with the sector now comprising 58% of the MSCI Taiwan Index. The obvious positive argument is accelerating end demand based on stronger recoveries in America and Europe. But this remains for now more a hope than a reality, with aggregate export growth barely rising year to date, though within that aggregate electronics exports have done better. Thus, total exports rose by only 2.1% YoY in the first five months of this year, while electronics exports rose by 12.9% YoY.

From a domestic-demand standpoint, the strong profits enjoyed by the technology sector have led to some pickup in sentiment, with consumer confidence now at a record high. Thus, the Taiwan consumer-confidence index rose by 1.99 points to 87.58 in June, the highest level since the survey began in 2001. Still this has not yet translated into a significant pickup in credit growth. System loans rose by 5.3% YoY in May, up from 5.0% YoY in April.

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Taiex 200-day moving average

Tech earnings

Tech sector’s valuation

Foreign buying data

Export data



Meanwhile, the main potential catalyst for Taiwan’s domestic story remains continuing expectations that the services pact, a part of the Economic Cooperation Framework Agreement (ECFA), will be passed by the Taiwan legislature prior to the end of the current quarter (3Q14). This is still likely even though the pact has been held up in the Legislative Yuan disappointing hopes that it would be passed by the end of the last quarter (ie 2Q14). Opinion polls continue to show support for the services pact running at 60%.

While the services pact is a bilateral one the proposed deal is much more interesting to Taiwanese companies, as they will get easier access to China’s much bigger market. CLSA’s Taiwan office believes that the three main quoted sectors to benefit will be banks, brokers and retailers. Most particularly, the banks are being given greater freedom to operate in southern China. Thus, Taiwanese banks and brokers will be able to operate under more liberalised rules in terms of opening up branches in central and southern China. The liberalisation of financial services under the agreement includes approving Taiwan banks setting up village and township banks and providing renminbi business to Taiwan entrepreneurs who invest in China from a third place.

It is important that the services pact is implemented by the end of the summer legislative session before attention turns to Taiwan’s domestic-election cycle. The routine legislative session ended on 31 May, with an extra session due to conclude on 4 July. But another session can be called, which will usually be in August, if the major bills fail to pass during the first extra meeting. While a presidential election is not due until January 2016, important local elections are scheduled for the end of this year. The so-called “seven-in-one” municipal elections will be held on 29 November for all directly-elected local-government positions, including the mayors of Taipei and other five special municipalities.

Meanwhile, the initial key liberalisation re cross-Strait and financial services occurred with the setting up of a renminbi offshore market in February 2013. Renminbi deposits in Taiwan rose by Rmb2.5bn in May to Rmb290bn at the end of May, or 3.9% of total Taiwan system deposits. This monthly increase is down from the peak increase of Rmb32.5bn in February, prior to the PBOC’s depreciation move in March. This renminbi depreciation prompted the Financial Supervisory Commission (FSC), the financial regulator, to tighten controls on Taiwan banks selling so-called “target redemption forwards” (TRFs), where the most popular product sold had been betting on renminbi appreciation. The FSC said in May that sales of TRFs are required to be approved by a bank’s board of directors before the product is launched. Banks should also introduce a stop-loss mechanism allowing customers to exit the investment contract. Renminbi-linked TRFs are estimated by the FSC at around NT$150bn.

CLSA Taiwan universe trailing price-to-book


1.21.41.61.82.02.22.42.62.83.03.2

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

ECFA’s services pact

Election cycle

Renminbi offshore market



Taiex Electronics Index relative to MSCI AC Asia Pacific ex-Japan

Source: Datastream

Cumulative foreign net buying of Taiex stocks

Source: CEIC Data, Taiwan Stock Exchange

Taiwan total export growth and electronics exports

Source: CEIC Data

90

95

100

105

110

115

120

125

130

Jan

09

Apr

09

Jul 0

9

Oct

09

Jan

10

Apr

10

Jul 1

0

Oct

10

Jan

11

Apr

11

Jul 1

1

Oct

11

Jan

12

Apr

12

Jul 1

2

Oct

12

Jan

13

Apr

13

Jul 1

3

Oct

13

Jan

14

Apr

14

Jul 1

4

(1/1/09=100)

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000

(500)(400)(300)(200)(100)

0100200300400500600700800

2007 2008 2009 2010 2011 2012 2013 2014

Cumulative foreign net buying of Taiex stocks

Taiex (RHS)

(NT$bn)

(40)

(20)

0

20

40

60

80

Jan

07

May

07

Sep

07

Jan

08

May

08

Sep

08

Jan

09

May

09

Sep

09

Jan

10

May

10

Sep

10

Jan

11

May

11

Sep

11

Jan

12

May

12

Sep

12

Jan

13

May

13

Sep

13

Jan

14

May

14

(% YoY, 3mma) Taiwan total export growth Electronics exports

A tech-driven market . . .

. . . As foreigners keep buying

A continuing lack of export growth in aggregate



Taiwan consumer confidence index

Source: CEIC Data

Taiwan system loan growth

Source: CEIC Data

Renminbi deposits in Taiwan

Source: Central Bank of Taiwan, CLSA

45

50

55

60

65

70

75

80

85

90

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(point)

(5)

0

5

10

15

20

25

30

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

(% YoY)

0

50

100

150

200

250

300

0

5

10

15

20

25

30

35

Mar

13

Apr

13

May

13

Jun

13

Jul 1

3

Aug

13

Sep

13

Oct

13

Nov

13

Dec

13

Jan

14

Feb

14

Mar

14

Apr

14

May

14

(Rmbbn) Monthly increase Outstanding (RHS) (Rmbbn)

Consumers are more confident . . .

. . . As loan growth stirs

Off the boil

Thailand: After the coup Asia Maxima


Thailand: After the coup The past quarter saw the political impasse brought to an, at least, temporary end by the announcement of a coup in May with Army head General Prayuth Chan-ocha taking over and the appointment of a technocratic group of advisors. The working plan is for a general election to be held around October next year but this has certainly not been confirmed.

Index movement

Source: Datastream

The coup has been met with a remarkable lack of street violence, in terms of protests and the like, suggesting it was well planned. The military was also quick to state it will start paying Bt92bn of debts owed to rice farmers, as well as to implement some of the former Yingluck government’s infrastructure projects, which had been stalled by the courts. This suggests growth should accelerate from the second half of this year. Thai real GDP contracted by 0.6% YoY in 1Q14, with private consumption and gross fixed-capital formation declining by 3% YoY and 9.8% YoY, respectively.

The probability for now is that the military will be successful in restoring a degree of temporary stability in the, at least, 16-month period that is likely to ensue before there is another poll. This is despite the fact that recent events have done nothing to resolve the fundamental divisions in Thai society, as reflected in the red shirt/yellow shirt divide. It should be noted that General Prayuth has full legislative and administrative power for now. The plan is to set up a National Legislative Assembly (NLA) selected directly by the military junta, a cabinet and National Reform Council by September.

Meanwhile, from an economic perspective, the military government has been quick to set up a new Board of Investment (BOI), which should pave the way for FDI approvals. On this point, FDI approvals plunged by 88% YoY to only Bt30bn in the first five months of this year. While the new BOI approved 18 investment projects worth Bt122.8bn, including both local and foreign investment, in its first board meeting held on 18 June. The largest project approved at the meeting was a Toyota car and parts manufacturing plant project, with an investment value of Bt51.5bn.

From a stock-market perspective, the news of the coup did not make great waves because the market had been incredibly resilient in the first four months of 2014, despite the growing uncertainty, most particularly given the

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

SET 200-day moving average

May coup

The military’s strategy

FDI data

Slowing credit growth



overwhelming evidence that the political problems have negatively impacted economic growth, as reflected in weakening consumption, investment and credit related data. Thus, the private consumption index and the private investment index declined by 0.3% YoY and 2.9% YoY in May. While Thai depository corporations’ private credit growth has slowed from a recent high of 17.5%YoY reached in September 2011 to 7.8% YoY in May.

The other point is that the market has held up, despite massive net selling by foreign investors, though there was some net buying between March and April. Thus, foreigners have sold a net Bt41bn worth of Thai stocks so far this year, after selling a net Bt194bn in 2013. They have now sold over the past 18 months more than what they bought in the four years between 2009 and 2012.

Part of the reason for this resilience is that local institutional investors have put spare cash to work in the first half of the year. Thus, domestic institutions have bought a net Bt42bn worth of Thai stocks so far this year. In this respect, it is also worth noting that domestic institutional investors receive significant inflows as a result of two tax-incentivised investment schemes set up in 2002 and 2004 by the first Thaksin government to encourage long-term savings. These are Retirement Mutual Funds (RMFs) and Long-Term Equity Funds (LTFs). A significant part of these inflows have to be invested in equities. For the Retirement Mutual Fund, individuals are obliged to make regular annual contributions for at least five years with a minimum of Bt5,000 per year but not exceeding 15% of taxable income or Bt500,000 (including contribution to provident funds), whichever is lower, and can only cash out without any penalty at the age of 55 or older. As for the LTFs, individuals can invest up to 15% of their taxable income or a maximum of Bt500,000 per year and use the proceeds as tax deductible. There is no requirement for regular contributions but investors must hold the investment for five calendar years to avoid penalties. Estimated net annual flows into RMFs and LTFs rose to Bt49bn in 2013 and have averaged Bt21bn since 2004.

Finally, from a valuation perspective, CLSA’s Thai universe of 45 companies under coverage trades at 13x forecast 2014 earnings, assuming 6% earnings growth with a forecast ROE of 16%. Meanwhile, CLSA’s economic teams forecast a rebound in Thailand real GDP growth to 2.7% in 2015, up from 0.8% in 2014. Public infrastructure spending should lift growth but the critical variable will be whether private sector investment will also revive post-coup.

CLSA Thailand universe trailing price-to-book


0.8

1.3

1.8

2.3

2.8

3.3

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(x)

Foreign selling data

Domestic investment schemes

Stock market valuation



Thailand real GDP, consumption and investment growth

Source: CEIC Data

Private consumption index and private investment index growth

Source: Bank of Thailand, CEIC Data

FDI applications approved by the Board of Investment

Note: Data up to May 2014. Source: CEIC Data, Thai Board of Investment

(20)

(15)

(10)

(5)

0

5

10

15

20

25

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(% YoY) Real GDP growth

Real private consumption growth

Real investment growth (GFCF)

(9)

(6)

(3)

0

3

6

9

12

(30)

(20)

(10)

0

10

20

30

40

2007 2008 2009 2010 2011 2012 2013 2014

Private investment index (LHS)Private consumption index

(% YoY) (% YoY)

0

100

200

300

400

500

600

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

5M13

5M14

(Btbn) Japan Other countries

Bottoming out?

Also bottoming out?

The impact of politics



Thailand depository corporations' private credit growth

Source: CEIC Data, Bank of Thailand

Cumulative foreign net buying of Thai stocks

Source: Bloomberg

Cumulative local institutions and retail net buying of Thai stocks

Source: Bloomberg

02468

101214161820

Jan

04

Jun

04

Nov

04

Apr

05

Sep

05

Feb

06

Jul 0

6

Dec

06

May

07

Oct

07

Mar

08

Aug

08

Jan

09

Jun

09

Nov

09

Apr

10

Sep

10

Feb

11

Jul 1

1

Dec

11

May

12

Oct

12

Mar

13

Aug

13

Jan

14

(% YoY)

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

(200)

(150)

(100)

(50)

0

50

100

150

Jan

07M

ay 0

7

Sep

07

Jan

08

May

08

Sep

08

Jan

09M

ay 0

9

Sep

09

Jan

10M

ay 1

0

Sep

10

Jan

11M

ay 1

1

Sep

11

Jan

12

May

12

Sep

12

Jan

13M

ay 1

3

Sep

13

Jan

14M

ay 1

4

(Btbn) Foreign net buying of Thai equitiesThai SET Index (RHS)

(150)

(100)

(50)

0

50

100

150

Jan

07

May

07

Sep

07

Jan

08

May

08

Sep

08

Jan

09

May

09

Sep

09

Jan

10

May

10

Sep

10

Jan

11

May

11

Sep

11

Jan

12

May

12

Sep

12

Jan

13

May

13

Sep

13

Jan

14

May

14

(Btbn) Domestic institutions Local individuals

Credit growth has slowed a lot . . .

. . . While foreigners have sold a lot of stocks . . .

. . . But domestic institutions keep buying

Appendix Asia Maxima


Appendix Economic indicators

2012 2013 14CL 15CL 2012 2013 14CL 15CL

Real GDP growth (% YoY) CPI inflation (% YoY, year average)

Australia 3.6 2.4 2.8 3.0 1.8 2.4 2.6 2.5

China 7.7 7.7 7.2 7.3 2.7 2.6 2.2 2.6

Hong Kong 1.5 2.9 3.9 4.1 4.1 4.3 4.1 3.8

India 4.5 4.7 5.2 6.5 10.2 9.5 7.5 6.4

Indonesia 6.3 5.8 4.8 5.6 3.9 6.1 7.1 6.0

Korea 2.3 3.0 4.0 3.7 2.2 1.3 1.8 2.8

Malaysia 5.6 4.7 5.6 5.1 1.7 2.1 3.7 4.9

Philippines 6.8 7.2 6.0 6.5 3.2 2.9 4.4 4.5

Singapore 2.5 3.9 5.0 3.9 4.6 2.4 1.9 2.0

Taiwan 1.5 2.1 4.5 3.6 1.9 0.8 1.4 1.3

Thailand 6.5 2.9 0.8 2.7 3.0 2.2 2.4 3.2

Current-account balance (US$bn) Current account balance (% GDP)

Australia (64.8) (48.7) (25.5) (14.0) (4.2) (3.2) (1.7) (1.0)

China 215.4 182.8 208.4 238.4 2.6 2.0 2.1 2.2

Hong Kong 4.3 5.6 14.5 13.2 1.6 2.1 5.0 4.3

India (88.2) (32.4) (45.1) (58.9) (4.7) (1.7) (2.2) (2.6)

Indonesia (24.4) (29.1) (17.8) (22.0) (2.8) (3.4) (2.0) (2.2)

Korea 50.8 79.9 92.7 82.9 4.2 6.1 6.2 5.3

Malaysia 17.7 12.6 17.9 18.8 5.8 4.0 5.4 5.3

Philippines 7.0 9.4 8.3 6.0 2.8 3.5 2.9 2.0

Singapore 50.1 54.5 64.3 64.4 17.5 18.3 20.3 19.1

Taiwan 50.7 57.7 69.3 72.1 10.6 11.8 13.5 13.2

Thailand (1.5) (2.8) 11.4 9.3 (0.4) (0.7) 3.0 2.4

Exchange rates versus US$ (year end) Policy interest rates (%, year end)

Australia 1.05 0.90 0.90 0.80 3.00 2.50 2.50 2.75

China 6.23 6.05 6.22 6.22 3.00 3.00 3.00 3.00

Hong Kong 7.75 7.75 7.76 7.78 0.40 0.38 0.38 0.80

India 54.4 60.1 62.0 64.0 7.50 8.00 8.00 8.00

Indonesia 9,670 12,189 11,250 11,000 5.75 7.50 7.75 7.00

Korea 1,075 1,056 1,000 1,050 2.75 2.50 2.50 2.75

Malaysia 3.06 3.28 3.26 3.31 3.00 3.00 3.50 4.00

Philippines 41.2 44.4 45.0 46.5 3.50 3.50 4.00 4.75

Singapore 1.22 1.27 1.24 1.24 0.38 0.40 0.43 1.00

Taiwan 29.0 29.7 29.8 29.8 1.88 1.88 2.00 2.13

Thailand 30.6 32.9 32.8 34.0 2.75 2.25 1.75 1.75 Note: Fiscal year beginning 1 April for India. Australian exchange rate quoted in US$/A$. WPI inflation for India. Policy rates - Australia: Cash target rate, China: 1Y savings rate, HK: 3M Hibor, India: Repo rate, Indonesia: BI policy rate, Korea: Call rate, Malaysia: Overnight policy rate, Philippines: O/N reverse repo rate, Singapore: 3M Sibor, Taiwan: Rediscount rate, Thailand: 1-day repo rate. Source: CLSA - Economics team’s forecasts



Market valuations

2012 2013 14CL 15CL 2012 2013 14CL 15CL

PE (x) Earnings growth (%)

Asia Pac ex-Japan 12.4 13.3 12.2 11.0 (1.1) (9.5) 7.0 10.0

Japan 23.0 15.9 13.5 12.2 13.3 45.4 17.4 11.1

Australia 10.0 15.1 13.9 13.5 (10.3) (34.5) 9.1 3.1

China 10.6 9.3 8.7 7.8 5.3 11.5 7.7 10.5

Hong Kong 13.7 13.8 12.9 12.5 (14.2) (0.2) 6.6 3.4

India 20.7 19.1 16.8 14.3 7.8 8.2 13.4 17.4

Indonesia 17.1 16.1 14.5 12.9 13.2 6.5 11.0 12.4

Korea 10.8 10.9 9.9 8.3 13.4 (0.6) 9.5 20.3

Malaysia 17.5 18.1 16.9 15.4 9.1 (3.0) 6.8 9.6

Philippines 21.0 19.7 18.9 16.5 10.6 7.3 4.6 14.8

Singapore 13.1 13.8 14.0 12.8 (5.8) (5.0) (1.5) 9.5

Taiwan 21.1 17.6 14.7 13.3 6.9 19.8 19.8 11.0

Thailand 14.2 13.9 13.1 11.4 19.1 2.4 5.9 15.4

PB (x) Dividend yield (%)

Asia Pac ex-Japan 1.8 1.7 1.5 1.4 2.9 3.2 3.5 3.7

Japan 1.5 1.3 1.3 0.3 1.6 1.8 1.9 2.0

Australia 2.0 2.1 1.9 1.8 3.9 4.3 4.7 5.0

China 1.7 1.5 1.3 1.1 3.4 3.9 3.9 4.2

Hong Kong 1.3 1.3 1.2 1.1 3.2 3.5 4.2 4.0

India 3.2 2.8 2.5 2.2 1.2 1.3 1.5 1.7

Indonesia 3.8 3.3 2.8 2.5 2.1 2.3 2.5 2.8

Korea 1.3 1.1 1.0 0.9 1.2 1.3 1.3 1.6

Malaysia 2.6 2.4 2.2 2.0 3.1 3.1 3.0 3.2

Philippines 3.1 2.8 2.5 2.3 2.1 2.2 2.3 2.4

Singapore 1.5 1.5 1.4 1.3 3.2 3.3 3.4 3.6

Taiwan 2.3 2.1 2.0 1.8 2.8 3.0 3.5 3.9

Thailand 2.4 2.2 2.0 1.8 3.0 3.2 3.4 3.8

ROE (%) Net debt/equity (%)

Asia Pac ex-Japan 13.9 13.4 13.5 13.5 30.5 30.8 26.6 21.9

Japan 7.4 9.9 10.2 10.4 44.8 41.1 35.4 29.7

Australia 13.6 13.7 14.5 14.1 41.5 42.7 40.4 38.3

China 16.9 16.6 15.8 15.5 30.5 37.1 34.7 30.1

Hong Kong 10.8 9.9 10.6 9.3 21.0 19.6 16.2 14.1

India 18.1 17.5 17.4 17.8 46.9 54.3 46.1 37.7

Indonesia 24.2 22.1 21.1 20.6 16.7 20.1 21.7 16.4

Korea 12.4 11.1 11.0 12.0 26.5 21.5 15.0 7.8

Malaysia 15.8 14.2 14.0 14.2 17.3 22.5 19.7 15.8

Philippines 15.8 15.1 14.0 14.7 41.0 48.1 50.0 47.2

Singapore 12.5 10.9 10.3 10.6 35.0 34.0 34.3 35.1

Taiwan 11.2 12.6 14.1 14.4 8.5 4.5 (1.9) (8.3)

Thailand 18.3 16.6 15.9 16.7 49.8 59.2 53.6 43.2 Note: Based on CLSA universe of companies under coverage. Calendarised valuations in local currency terms. Source: CLSA evalu@tor



MSCI regional and country index performance (in US$ terms)

(% chg in US$ terms) 2010 2011 2012 2013 2Q13 3Q13 4Q13 1Q14 2Q14

All Country (AC) indices

AC World 10.4 (9.4) 13.4 20.3 (1.2) 7.4 6.9 0.6 4.3

AC World ex-US 8.4 (16.1) 13.3 12.3 (4.2) 9.4 4.4 (0.1) 4.0

AC World ex-Japan 10.1 (8.8) 14.1 19.9 (1.6) 7.5 7.4 1.2 4.1

AC Europe 1.6 (14.5) 15.4 20.1 (2.5) 13.0 7.1 1.2 2.1

AC Asia Pacific 14.3 (17.3) 13.6 9.3 (3.7) 6.2 2.0 (2.4) 5.6

AC Asia Pacific ex-Japan 15.0 (18.0) 18.6 0.5 (8.6) 6.3 1.9 0.4 5.0

AC Asia ex-Japan 17.0 (19.2) 19.4 0.7 (6.3) 4.9 3.3 (1.1) 6.2

AC Far East ex-Japan 16.7 (16.8) 19.0 1.3 (6.3) 5.9 2.7 (1.8) 5.7

Developed markets indices

World (Developed) 9.6 (7.6) 13.2 24.1 (0.1) 7.7 7.6 0.8 4.2

World ex-US 6.2 (14.8) 12.8 17.8 (2.7) 10.7 5.2 0.1 3.5

World ex-Japan (Kokusai) 9.1 (6.6) 13.9 24.0 (0.5) 7.9 8.2 1.4 4.0

EAFE 4.9 (14.8) 13.6 19.4 (2.1) 10.9 5.4 0.0 2.9

Europe 1.0 (13.8) 15.2 21.7 (2.0) 13.2 7.5 1.5 1.9

North America 13.6 (1.6) 12.9 27.6 1.4 5.4 9.3 1.3 5.0

Emerging markets indices

Emerging Markets (EM) 16.4 (20.4) 15.1 (5.0) (9.1) 5.0 1.5 (0.8) 5.6

EM Asia 16.6 (19.1) 18.1 (0.2) (6.3) 4.5 3.6 (0.6) 6.3

EM Latin America 12.1 (21.9) 5.4 (15.7) (16.5) 3.6 (3.1) (0.2) 5.5

EM EMEA 20.9 (22.6) 17.7 (8.0) (9.8) 8.5 (0.2) (2.1) 3.6

BRIC 7.3 (24.8) 11.0 (6.3) (11.6) 7.9 1.4 (3.1) 6.2

Asia Pacific

Australia 10.0 (14.8) 16.4 (0.3) (14.7) 10.4 (1.7) 4.6 1.8

China 2.3 (20.3) 19.0 0.4 (9.1) 11.5 3.8 (5.9) 3.5

Hong Kong 19.7 (18.4) 24.4 8.1 (5.9) 8.1 3.0 (3.8) 6.7

India 19.4 (38.0) 23.9 (5.3) (6.2) (5.7) 10.1 7.8 12.1

Indonesia 31.2 4.0 2.4 (25.0) (8.1) (24.1) (5.0) 21.0 (1.0)

Japan 13.4 (16.2) 5.8 24.9 4.2 6.0 2.1 (6.3) 6.5

Korea 25.3 (12.8) 20.2 3.1 (10.0) 14.9 4.0 (3.0) 6.4

Malaysia 32.5 (2.9) 10.8 4.2 4.9 (3.9) 4.7 (1.0) 2.5

New Zealand 3.2 1.1 23.0 6.2 (10.4) 14.9 (4.5) 14.7 (2.3)

Philippines 30.3 (3.2) 43.9 (4.3) (9.3) (5.7) (5.1) 9.1 8.7

Singapore 18.4 (21.0) 26.4 (1.8) (7.6) 3.2 0.2 (1.1) 4.1

Taiwan 18.3 (23.3) 13.4 6.6 1.6 0.8 4.3 1.1 10.0

Thailand 50.8 (5.6) 30.9 (16.9) (9.6) (6.1) (10.5) 6.5 6.5

Continued to the next page



MSCI regional and country index performance (in US$ terms) (continued)

(% chg in US$ terms) 2010 2011 2012 2013 2Q13 3Q13 4Q13 1Q14 2Q14

North America

USA 13.2 (0.1) 13.5 29.9 2.2 5.2 9.7 1.3 4.7

Canada 18.2 (14.4) 6.7 3.3 (8.0) 8.2 3.5 1.0 9.3

Latin America

Brazil 3.8 (24.9) (3.5) (18.7) (18.4) 7.7 (6.2) 2.0 5.7

Chile 41.8 (22.1) 5.6 (23.0) (15.5) (5.6) (7.3) (2.9) 1.3

Colombia 40.8 (7.1) 31.6 (23.7) (15.1) 9.1 (11.5) 4.7 5.7

Mexico 26.0 (13.5) 27.1 (2.0) (11.7) (2.0) 7.0 (5.1) 6.2

Peru 49.2 (23.9) 15.5 (31.0) (28.4) (3.8) 2.9 4.2 7.6

Europe

Austria 7.3 (37.8) 22.6 10.9 (4.1) 18.3 2.8 (2.9) (1.8)

Belgium (2.2) (12.6) 36.1 24.6 (6.2) 13.5 7.6 2.3 3.5

Czech Republic (7.4) (11.3) (3.1) (14.9) (11.8) 13.3 (0.8) 7.6 0.1

Denmark 29.8 (16.8) 29.6 23.4 (4.2) 13.6 10.2 14.8 2.9

Finland 7.1 (34.2) 10.0 41.6 (1.6) 26.6 11.6 (0.7) 1.4

France (6.7) (19.3) 17.7 23.3 0.8 15.3 5.7 2.8 (0.1)

Germany 6.0 (20.1) 27.2 28.2 0.5 12.7 13.3 (0.5) (0.2)

Greece (46.4) (63.6) (0.8) 44.8 (12.8) 33.6 9.0 0.0 0.0

Hungary (10.7) (34.7) 18.7 (9.0) 9.3 (4.9) (6.3) (8.7) 1.5

Ireland (19.7) 11.4 3.8 38.9 (3.7) 16.4 11.3 13.1 (9.1)

Italy (17.6) (25.8) 8.6 16.9 (1.4) 19.0 10.5 14.6 (1.7)

Netherlands (0.6) (14.4) 17.2 28.5 1.3 14.4 8.4 0.9 (0.4)

Norway 7.4 (12.8) 13.7 5.3 (8.5) 8.6 5.5 1.8 6.6

Poland 12.6 (32.6) 32.1 (1.7) (5.8) 14.1 3.3 3.4 (2.3)

Portugal (14.6) (25.7) (0.7) 7.5 (3.6) 10.5 1.3 9.7 (4.8)

Russia 17.2 (20.9) 9.6 (2.6) (11.1) 13.1 0.2 (14.4) 9.8

Spain (25.4) (16.9) (3.3) 27.7 (1.5) 25.1 10.8 4.7 6.5

Sweden 31.3 (17.8) 18.7 21.4 (7.7) 15.2 5.2 1.5 (2.4)

Switzerland 9.8 (9.1) 17.3 23.8 (1.7) 9.4 4.3 3.9 0.6

Turkey 18.4 (36.8) 60.5 (28.1) (16.9) (6.7) (14.2) 4.6 13.5

UK 5.2 (6.1) 10.8 16.2 (3.3) 11.0 6.7 (1.8) 5.0

Middle East/Africa

Egypt 9.5 (48.8) 44.5 6.2 (11.4) 12.6 19.4 7.6 0.3

Israel 2.2 (29.8) (7.0) 8.0 (5.3) 1.2 5.7 17.8 1.6

Morocco 10.8 (18.8) (16.5) (7.1) (6.3) 0.1 2.1 5.6 (4.8)

South Africa 30.7 (17.3) 14.8 (8.8) (8.0) 7.9 1.7 3.8 4.0

Source: Datastream



MSCI Asia Pacific ex-Japan index relative performance

Japan

Australia

China

Hong Kong

Note: Performance in US$ terms. Source: Datastream, CLSA

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50

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MSCI AC Asia Pacific ex-JapanMSCI Japan

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2001 2003 2005 2007 2009 2011 2013

MSCI AC Asia Pacific ex-JapanMSCI Australia

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90

95

100

105

110

115

120

125

2001 2003 2005 2007 2009 2011 2013

(1/1/01 =100)

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100

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2001 2003 2005 2007 2009 2011 2013

(1/1/01 =100)

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2001 2003 2005 2007 2009 2011 2013

MSCI AC Asia Pacific ex-JapanMSCI Hong Kong

(1/1/01 =100)

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65

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2001 2003 2005 2007 2009 2011 2013

(1/1/01 =100)




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Indonesia

Korea

Malaysia


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2001 2003 2005 2007 2009 2011 2013

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(1/1/01 =100)

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2001 2003 2005 2007 2009 2011 2013

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(1/1/01 =100)

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2001 2003 2005 2007 2009 2011 2013

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(1/1/01 =100)

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2001 2003 2005 2007 2009 2011 2013

(1/1/01 =100)

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350

400

2001 2003 2005 2007 2009 2011 2013

MSCI AC Asia Pacific ex-JapanMSCI Malaysia

(1/1/01 =100)

70

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110

120

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140

2001 2003 2005 2007 2009 2011 2013

(1/1/01 =100)




Philippines

Singapore

Taiwan

Thailand


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2001 2003 2005 2007 2009 2011 2013

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(1/1/01 =100)

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130

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170

2001 2003 2005 2007 2009 2011 2013

(1/1/01 =100)

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2001 2003 2005 2007 2009 2011 2013

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(1/1/01 =100)

60

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2001 2003 2005 2007 2009 2011 2013

(1/1/01 =100)

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2001 2003 2005 2007 2009 2011 2013

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(1/1/01 =100)

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2001 2003 2005 2007 2009 2011 2013

(1/1/01 =100)

0

100

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500

600

700

800

900

2001 2003 2005 2007 2009 2011 2013

MSCI AC Asia Pacific ex-JapanMSCI Thailand

(1/1/01 =100)

100120140160180200220240260280300320

2001 2003 2005 2007 2009 2011 2013

(1/1/01 =100)



Change in IBES consensus earnings growth forecasts MSCI AC Asia Pacific ex-Japan MSCI AC Asia ex-Japan

MSCI Australia MSCI Japan

MSCI China

MSCI Hong Kong

MSCI India MSCI Indonesia

Note: Year ending 30 June for Australia, beginning 1 April for Japan. Source: I/B/E/S, Datastream

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Change in IBES consensus earnings growth forecasts MSCI Korea MSCI Malaysia

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Note: Year ending 30 June for Australia, beginning 1 April for Japan. Source: I/B/E/S, Datastream

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14

(%)2014 2015



Asian currencies against the US dollar

Australia

Japan

China

Hong Kong

India

Indonesia

Source: Datastream

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1997 1999 2001 2003 2005 2007 2009 2011 2013

(US$/A$) 70

80

90

100

110

120

130

140

1501997 1999 2001 2003 2005 2007 2009 2011 2013

(¥/US$, inverted scale)

6.0

6.5

7.0

7.5

8.0

8.51997 1999 2001 2003 2005 2007 2009 2011 2013

(Rmb/US$, inverted scale) 7.70

7.72

7.74

7.76

7.78

7.80

7.82

7.841997 1999 2001 2003 2005 2007 2009 2011 2013

(HK$/US$, inverted scale)

35

40

45

50

55

60

65

701997 1999 2001 2003 2005 2007 2009 2011 2013

(Rs/US$, inverted scale) 2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,0001997 1999 2001 2003 2005 2007 2009 2011 2013

(Rp/US$, inverted scale)



Asian currencies against the US dollar

Korea

Malaysia

Philippines

Singapore

Taiwan

Thailand

Source: Datastream

800

1,000

1,200

1,400

1,600

1,800

2,0001997 1999 2001 2003 2005 2007 2009 2011 2013

(won/US$, inverted scale) 2.2

2.7

3.2

3.7

4.2

4.7

5.2

5.71997 1999 2001 2003 2005 2007 2009 2011 2013

(RM/US$, inverted scale)

25

30

35

40

45

50

55

601997 1999 2001 2003 2005 2007 2009 2011 2013

(P/US$, inverted scale) 1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.91997 1999 2001 2003 2005 2007 2009 2011 2013

(S$/US$, inverted scale)

27

28

29

30

31

32

33

34

35

361997 1999 2001 2003 2005 2007 2009 2011 2013

(NT$/US$, inverted scale) 22

27

32

37

42

47

52

57

621997 1999 2001 2003 2005 2007 2009 2011 2013

(Bt/US$, inverted scale)

Asia Maxima


Notes

Asia Maxima


Notes

Important notices

02/06/2014

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Asia-Maxima-(Delirium)---3Q14-20140703