CLSA: GREED & FEAR : PRICE TO SALES AND SQUEEZED SHADOW BANKING

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CLSA: GREED & FEAR : PRICE TO SALES AND SQUEEZED SHADOW BANKING
Dated 23/11/2017



GREED & fear is still near-term suspicious of equity market direction with the American stock market remaining the main underweight, a policy which has so far worked this year from a relative-return standpoint.



The most egregious valuation data GREED & fear has seen of late is the dramatic divergence in tangible book values between the S&P500 and the Topix after excluding financial stocks. The divergence is, of course, the result of so many years of financial engineering in America. Another way of looking at the huge overvaluation of US equities, and removing the distortion to valuations created by the addiction to financial engineering, is to look at a simple price to sales ratio.



On the news of Frau Merkel’s failure to form a coalition government in Germany, GREED & fear’s base case is that the SPD after much cajoling will agree to form a coalition. Such a development would be good news for French President Emmanuel Macron. Investors should remain overweight European equities.



The squeeze on shadow banking in China has resumed with the PBOC’s announcement last Friday of new guidelines to tighten controls on asset management products. The new rules represent a coordinated approach between regulators, thereby preventing regulatory arbitrage. The main goals seem to be to ban implicit guarantees and to impose leverage limits. All this seems sensible and provides further support for GREED & fear’s view that the total issuance of wealth management products has peaked.



One point about the announcement is that financial institutions have until June 2019 to be in full compliance. Another point is that the new regulations do not seem to target financial products by internet finance providers and new consumer finance companies. Still the authorities have just issued new restrictions on online micro-lenders this week.



The renewed squeeze has led to a further spike in China government bond yields. This bond correction has in GREED & fear’s view nothing to do with growth and inflation concerns, or correlation with the US bond market, and everything to do with the renewed deleveraging campaign.



It remains remarkable how little collateral damage there has so far been on the real economy as a result of this squeeze on inter-financial sector claims. For now GREED & fearwill continue to give the PRC the benefit of the doubt and maintain the China Overweight in the relative-return portfolio.



A risk to GREED & fear’s continuing overweight in China is the growing impact of tightening in the residential property market. This is potentially significant since there is a long-term correlation between the MSCI China Property index and MSCI China. China's President Xi Jinping also showed no sign that he wants to end property tightening anytime soon.



The traditional correlation with the property sector, in terms of MSCI China, should decline with the dramatic rise in the importance of the internet names. The dynamic of the residential property market will also change in coming years as the government promotes the rental market in China’s biggest cities to address affordability concerns.



Rental housing in the PRC is likely to be the new tool to rebalance the residential property market, alongside sector tightening policies and so-called “shanty town” redevelopment in small cities. The increase in supply of rental houses may affect the price of “mass market” residential units but higher end property should not be impacted.



In India, the odds of the BJP winning the Gujarat election for the sixth consecutive time remain high. The spin of the Indian media is that if the BJP loses in the prime minister’s home state Modi will be “finished”. Still GREED & fear finds it hard to believe that the BJP will lose, though it is likely that its majority will decline from the victory won by Modi in the last poll held in 2012.



The Congress opposition under the still unconvincing leadership of Rahul Gandhi has made a strategic blunder. It is fighting the campaign on the national issues, such as GST and demonetisation. In so doing it is campaigning against Modi and his policies at the national level. The strategy seems to be based on the calculation that both demonetisation and GST have caused problems for small businessmen and traders, the traditional supporters of the BJP. Still Modi remains extremely popular.



One of the practical problems with the introduction of GST is that many smaller businesses were not prepared since many had been assuming that this reform would never happen. There is now a rush to comply since major corporates have indicated they will not deal with businesses which are not registered.



Investors need to ignore the short-term noise and focus on the long-term positive represented by the introduction of GST. In GREED & fear’s view it is correct to assume that most of the teething problems arising from the implementation of GST will be sorted within six to 12 months.



On the current Gujarat state election campaign, the opposition would have been better advised to have campaigned on local issues where an incumbent chief minister who is not Modi would be vulnerable. Instead by attacking Modi the Congress risks triggering a counter reaction since GREED & fear suspects Gujaratis are probably proud of the fact that their former chief minister is now prime minister.



If Modi remains well positioned, the rest of his first term in office is likely to be focused on generating jobs ahead of the April-May 2019 general election. This is one area where there has been a lack of progress; though the extent of the lack of employment generation is questionable given the inadequacy of employment data.



There are three areas where Modi hopes to generate job growth in the next 18 months. The first, and by far the most important, is in the ramp up of affordable housing under Modi’s “Housing for All by 2022” policy. The impact of this programme will not be immediate since GREED & fear hears it will take 12 to 18 months for property developers to draw up plans and commence construction in the affordable housing segment. The other areas where jobs should be generated are road building and textiles.



The pick up on the ground in affordable housing may not become really visible until late 2018. But the ramp up is definitely coming which is also why investors should look to buy any pull back in stocks geared to affordable housing. Affordable housing in India remains one of the most straightforward bull stories in Asian equites.



The impact of the Real Estate Regulation Act (RERA) has already shown up dramatically in the latest set of results announced by property companies. Most developers have seen a decline in sales and profitability as a result of the current slump in the sector. But those companies with strong enough balance sheets to meet the RERA requirement are flourishing.



All this means that, even if a private sector capex revival remains some way off, there will be an acceleration in economic activity in India in the coming 18 months driven by housing and infrastructure.



The interest rate subsidy for buyers of affordable housing is critical since, from the point of view of monetary policy, Indian borrowers continue to face relatively high real interest rates. This has helped support the rupee but it has also been one of the reasons why bank loan growth has been running below nominal GDP growth for the past four quarters.



The current consensus view in India is that interest rates have bottomed. Still with CPI inflation running in the last 14 months at only an average of 3.2% YoY it must be questioned whether inflation will reach the RBI’s forecast of 4.6% by next March. If not, then the RBI will likely be forced to re-address its current neutral stance on monetary policy.



In GREED & fear’s view there will be more rate cuts in India next year. This means that the 10-year government bond after its recent sell off has now become an interesting investment again, though the bond has rallied of late following the long overdue upgrade of India’s sovereign credit rating by Moody’s.🤘