Greater China Inflation: a double whammy:: Nomura

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􀁾 Action
The announcement today by China to raise RRR by 50bp after recently raising interest
rates and introducing price controls alongside HK’s introduction of a Special Stamp duty
highlights the deepening concerns of both authorities about an inflation spike. While the
RRR is designed to mop up excess liquidity resulting from the surging BoP, it will have
little effect on earnings or economic growth. The surprise move suggests that the
authorities have been behind the curve. HK appears to have somewhat pre-emptively
curbed further asset bubble inflation as real interest rates are set to turn sharply
negative by the end of 1Q11.


Anchor themes
While Asian central banks have been announcing capital controls to try and deter
overseas inflows, almost one third of the region’s companies on a market capitalised
basis have failed to deliver positive local currency returns. The polarisation in 2010
performance has left a group of large-cap quality companies behind.


Greater China Inflation: a double whammy

􀁣 Time for the blue-chips
During the past six months, investment styles have noticeably rewarded investors
in two extreme camps according to our quantitative analysis team. Change in
earnings yield (inverse P/E), a more fundamental valuation approach, has been
amply rewarded as an investment style, as have StarMine-predicted surprise
(analyst earnings surprise recommendations) alongside 12 month share price
momentum strategies (taking into account share price reversal).
However, sector performance has become even more concentrated. Despite the
recent equity market correction and with the exception of Australia, Asia Pacific
consumer goods and services have clearly trumped other sectors YTD. .

As Asian central banks counter the hot money inflows through capital controls such
as withholding taxes and China begins to check domestic inflation through price
controls, investors will need to move away from looking just solely at earnings but
also the threat of arbitrary regulation. This was reinforced by the tightening of antispeculation
measures by HK on Friday and has been a feature of China and
Singapore’s property market also this year. In one sense, investors will need to
discount two possible policy changes – one for the whole economy through
monetary tightening and the other through more indiscriminate micro-controls. Of
course, the authorities could just as easily remove subsidies to entice consumption.
Some sectors don't appear to have reflected that risk.

Asian consumer good stocks are now trading at slightly over 1.5 standard deviation
P/B and 0.8 P/E over their 10-year trend. They have moved to overvaluation vs
their global peers based on both P/B and P/E. They are beginning to look
expensive, in our view.

Ironically, 2011 may turn out to be the year to move away from the popular asset
and consumer names which appear in many cases to either face regulatory issues
(property) or are trading on elevated valuations.



Time for the blue-chips
“The HK Government has just announced another round of property cooling
measures. Although the market had expected something, the new measures,
especially the "Special Stamp Duty", were much harsher than expected. We expect
an immediate cooling effect on investors/speculators, and property transaction
volume should fall 40%+ in the near term. Investor sentiment on HK property stocks
is likely to sour, resulting in a near term 15% widening of NAV discounts. We prefer
landlords to developers”, Nomura HK property note, 19 Nov 2010
“The first freely circulating bank notes in Europe were issued by a man named Johan
Palmstruch. In 1656 he founded a private bank in Sweden called the Stockholm Banco.
However, half of its profits were payable to the Swedish Crown, and the Crown’s
chancellor of the exchequer kept a controlling watch on the cash flow. Standard
Swedish currency was then planted on clunky copper plates and as depreciating in
value. So with royal permissions Palmstruch began issuing paper ‘credit notes’ as a
transitional alternate currency. But he lent too much money and issued too many notes
he couldn’t redeem. This landed him before a royal judge who issued a death
sentence. He sentence was later commuted to prison”, Currency Wars, John K. Cooley
“YTD, we have seen a slowdown in earnings momentum – our Asian earnings momentum
index has declined to near its historical norm, from a peak at end-2009. Since September,
we have seen earnings upgrades rise marginally faster than downgrades. Consistency of
Asian factor performance has been affected by an ongoing swing in market sentiment. The
QE2 program and hot money inflows have increased investors' risk appetite and buoyed
Asian equities prices. Asian valuation multiples are expanding at a faster pace than
earnings revisions”, Quantitative Insight, 5 November, 2010
Asian valuations are expanding faster than earnings momentum. The recent surge in
share prices has not been accompanied by any change in earnings forecast on the
back of QE or any sea-change in exchange rates or currencies. Indeed, during the last
six months investment styles have noticeably rewarded investors in two extreme
camps according to our quantitative analysis team. Change in earnings yield (inverse
P/E), a more fundamental valuation approach, has been amply rewarded as an
investment style, as have StarMine-predicted surprise (analyst earnings surprise
recommendations) alongside 12-month share price momentum strategies (taking into
account share price reversal). Hence, the recent rally has reflected the major
investment strategies deployed by bottom up stock pickers who will look at earnings
surprises and value and also by leveraged money, who are more inclined to seek price
momentum as an investment strategy.
However, sector performance has become even more concentrated. Despite the
recent equity market correction and with the exception of Australia, Asia Pacific
consumer goods and services have clearly trumped other sectors YTD. On many
measures these are not cheap stocks anymore yet they do have in most cases pristine
balance sheets. The sector has been hot much like airlines as it reflects a distinct
Asian theme and stands in contrast to the demand side destruction running through
Europe and the US.
As Asian central banks counter the hot money inflows through capital controls such as
withholding taxes and China begins to check domestic inflation through price controls,
investors will need to move away from looking just solely at earnings but also the threat
of arbitrary regulation. This was reinforced by the tightening of anti-speculation measures
by HK on Friday and has been a feature of China and Singapore’s property market also
this year. In one sense, investors will need to discount two possible policy changes – one
for the whole economy through monetary tightening and the other through more
indiscriminate micro-controls. Of course, the authorities could just as easily remove
subsidies to entice consumption. Some sectors don't appear to have reflected that risk.


Asian consumer goods stocks are now trading at slightly over 1.5 standard deviation
P/B and 0.8 P/E over their 10-year trend. They have moved to overvaluation vs their
global peers based on both P/B and P/E. They are beginning to look expensive.
Ironically, 2011 may turn out to be the year to move away from the popular asset and
consumer names which appear in many cases to either face regulatory issues
(property) or are trading on elevated valuations.