Asia ex-Japan Strategy - A correction, not an inflection  :: Macquarie Research

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Asia ex-Japan Strategy
Caveat venditor
A correction, not an inflection
 Risk aversion is back again – for the moment – with this week‟s volatility in the
commodities and energy complex, but the medium-term outlook for
growth/reflation plays still strikes us as well-supported by both monetary
conditions and demand fundamentals. Another trading correction, another dipbuying
opportunity.

 Calling a precise bottom in this environment would be guesswork, but with the
Asia ex-Japan index at just 12.3x forward PER (amid positive overall 2011
consensus EPS revisions) – and with MSCI Asia ex-Japan Materials and
Energy both in the 11.0–11.5x range -- we would be comfortable buying beta
after as little as another 5% index downside (Figure 6, below).
Monetary accommodation + ongoing global expansion
 We only expect a concerted and more sustainable USD rally and a rockier
path for emerging markets once the prospect for a genuine US monetary
tightening becomes more clear and present. But at this stage, such risks
remain comfortably distant, in our view – a story for 2012 that markets may
not need to discount until, say, 4Q11 at the earliest. The coming June end of
the Fed‟s quantitative easing („QE2‟) exercise will not equate to the “start of
tightening” – and may yet even prove a windfall boost for equities if it
motivates asset allocators to reduce fixed income exposure, as we expect.
 Meantime, low/negative real interest rates remain the single most critical
variable still pointing lower for the dollar and higher for the „reflation trade‟
medium-term. The real Fed Funds rate, at -2.4%, is 120bp lower today than at
end-2010, and is almost certain to decline further in the second half as the
Fed continues to stand pat. China‟s real base lending rate, meanwhile, is just
0.7%, and the GDP-weighted real policy rate for all Asia ex-Japan has
similarly declined 22bp YTD (Figure 1). Even gold‟s correction this week has
taken it back only to mid-April levels (roughly US$1,480/oz.), still up 23% YoY.
 We also remain generally constructive on global demand expansion into the
second half, seeing 1) the 1Q11 US GDP pullback as a temporary „soft patch‟;
2) robust core European (especially German) growth largely undiminished by
the noise from sovereign flare-ups in the smaller peripheral euro-area
economies; and 3) China nearing the point at which it will be able to back off
from the credit tightening that has fuelled investor caution recently.
Your neighbour may be buying this dip
 In any case, as discussed separately in our May 6 Weekly Fund Flow Tracker,
the past week has by no means been a period of indiscriminate foreign
dumping of Asian stock: Although Wednesday (May 4) did see one-day
foreign net-selling of US$499m among the six Asian markets that provide
daily data (Korea, Taiwan, India + the TIPs), daily aggregate net-buying was
recorded Monday, Tuesday and Thursday – with cumulative week-to-date
buying in positive territory as of Thursday‟s close, at US$175m (Figure 5).
 In Hong Kong, admittedly, short-selling this week has risen back to highs
around 8% that have only been exceeded once in the two years since the
Global Financial Crisis. But the two previous post-Crisis instances of shorting
at these levels have prefigured HSCEI rallies averaging 20% and lasting
roughly 10 weeks (Figure 2).
 For investors willing to grasp the nettle and buy the latest market dip, we note
that the cheapest beta in Asia ex-Japan by sector (in terms of current forward
PER vs. 10-year average) is now found in Property, Capital Goods, Tech
and Transport