Equity Strategy 2H 2010 & Asset Class Returns As At end-June 2010

Just passed the halfway mark. REITs finally took a hit, is this the beginning of the double dip. Do I believe in the double dip, yes of course. Only that the dip will be more restrained, not a significant or prolonged dip. Things move in cycles and like pendulums. Share prices are the same, they will sing to one side, over swing a bit and the correct. This is because the data are but collection of human behaviour, and masses will never react perfectly. They will chase a share price that is running until it overshoots, and attract sellers to come in. When the balance shifts to the other side, you will see it overshooting on the downside again.

June was another rough month for risky assets, although the losses were considerably deeper with U.S. stocks from a dollar-based return perspective. REITs also took a hit: for the first time since the opening months of 2009, real estate securities dropped by more than 5% for the second month running.

Bonds held up well in June. This is probably due to the threat of deflation taking a toll on investor sentiment, the safety of fixed-income (even at unusually low yields) attracted capital flows last month like moths to a flame.

US equity took the hardest hit in June. Was this an adjustment to the European crisis and the Euro crisis? Probably. Was it trying to discount a flattening of recovery, probably. Was it due to funds closing their books and squaring off positions and waiting for the right levels to reloan in 2H, absolutely.

But what we all should be focusing at is the YTD figures. Commodities are down by nearly 10% and foreign developed stocks have retreated by more than 13% in dollar terms—the steepest decline for the major asset classes on a year-to-date basis through June’s close. There has been some flight to reserve currency assets, but US equity did follow suit, much of its YTD losses came in the month of June alone.

So we are giving back all gains this year and more. Is this a risk aversion period? I think the sell in May rang true and it coincided with the Greek, Hungarian and Portuguese malaise, followed by the weakening Euro, which threatened demand for exports from the rest of the world.

China had to do a lot of braking in its domestic economy and the Shanghai index reflected that for the past 3 months. Now they have to contend with pressures to have a stronger yuan as well.

Some may cite the fact that many governments have piled on too much debt and that will come back to haunt us. Well yes, but not so soon. No one is going to put a gun to the US and ask them to lower their debts within the next couple of years. While the same seems to be happening in Europe, it is mainly a sovereign issue not a corporate issue.

We are actually still in the midst of a newly created liquidity bubble. Thanks to Bernanke and many of the other governments, we have printed and poured too much liquidity into the global financial system. We are also locked in with globally benign interest rates. Tell me what do the above ingredients make?

But why the recent pullback. Well, even when you are driving a Porsche, you are limited to how far and fast you can go if there is a traffic jam. Be sure, we have a highly powered underlying liquidity revving its engines. We just need the traffic to clear up a bit: Euro steadying a bit; unemployment growth flattening out but not down trending aggressively; corporates continuing to put out good quarterlies; etc.

I have changed my views on the Euro, I think it will stablise here 1.25-1.30 and not go any closer to 1.00 to the USD. Herein lies the key. The Euro crisis may have blighted our views too much. Look closer, most of Europe's top companies are benefiting strongly overall. We missed the picture that this is more a sovereign thing. Many of the companies are already getting an 18%-20% boost in receipts (added competitiveness) thanks to the weaker Euro - we all know that that is more than double the net margins of most companies.



European industrial production actually rose 0.8% in April much better than the average forecast of 0.5%. One of the better leading indicators of economic activity is cargo carriers, Fedex's recently reported that Europe is seeing solid activity, very much different from the picture the media would have us believe.

China may be the weak link in 2H. In addition to the yuan, the high interest rates, the yet to subside property bubble, we now have a snowballing labour issue. The Honda-Foxconn developments should ensure a cascading and rippling effect on all labour wage demands across China, watch it balloon in the coming weeks.

I think US equity and emerging markets equity will be quite positive for most of 2H2010. I see the Dow testing 11,500 and the FBMKLCI testing 1,450 before the year is over.

CLSA Strategy Report

Its been some time since I have read Chris Wood's strategy pieces. I like him quite a bit and his views are worth following. He is surprisingly bullish on Malaysia, Indonesia, the Philippines and China. I don't know enough about the Philippines, but I would rank my bullishness: 1) Indonesia 2) China 3) Malaysia 4) Thailand. Unlike Wood, I do like Thailand as well as I believe political uncertainty is the norm in Thailand.

Indonesia because of the Susilo's factor and the continued restructuring of its economy which will be a strong point in luring in long and short term foreign funds. China because of its deliberate liquidity pump priming, although I do see liquidity traps in second half of next year, it should first reveal itself in higher stocks and property prices. Malaysia because of its resource based, low rates, and this round of financial crisis did not hit private pockets that extensively (do read my piece on the stock market effects for Malaysia and how it has differed from the 90s experience).

I disagree with Wood when he said that deflation is a higher risk.

-------------------------------------

Rally will fail - The relief rally in Wall Street-correlated world stock markets should have one push higher. But it will fail in coming months amid renewed deflationary market action, as it becomes clear to investors that the Western world faces an extended period of structurally lower growth.

Deflation risk - Deflation, not inflation, remains the predominant risk in the West, as it follows the same mix of monetarist and Keynesian policies which have caused Japan to suffer 20 years of anaemic growth. But it will take time for these “orthodox” policies to be completely discredited.

Southeast Asia's emerging markets — Malaysia, Indonesia and the Philippines — should offer investors some of the best returns this year, given their strong corporate earnings and low interest rates, CLSA's equity strategist said in an interview yesterday.

Investors should steer clear of Thailand and Taiwan, which are riddled with political uncertainty, Christopher Wood told Reuters. He has a "zero" weighting on Thailand for his relative return portfolio, even though the index is at a five-month high.

"I'll get more bullish on Thailand if I see more local investors buying the market. Right now, all you see are locals selling," he said. "But if local confidence comes back, then there'll be a huge buying opportunity."

Wood, who joined CLSA in 2002, was top-ranked Asian strategist in financial publication Institutional Investor's annual survey in 2005 and ranked second last year.

Wood expects China's booming stock market, which has more than trebled since the start of last year, to rise further, even though it trades at an expensive price-earnings ratio of about 50.

"A full-scale mania in China shares is inevitable unless the government becomes a lot more aggressive, more than what it's been so far," Wood said, referring to the Chinese central bank's monetary tightening measures announced on Friday.

But Wood, in Singapore for a CLSA conference, said China should instead accelerate the listing of A-shares - off-limits to all but a few foreign institutional investors - and increase the supply of listed companies.

Wood prefers stocks that cater to domestic demand, such as consumer stocks, banks and real estate, but warned that commodity stocks could falter, if the US economy slows.

In other asset classes, Wood said investors are best off buying Singapore hotels , "the biggest no-brainer in Asian real estate" as average room rates are still lower than those of international hotels.

He said investors should also buy the Singapore dollar amid a private banking boom in the city-state, adding these customers might use the Singapore dollar as a reference currency on their accounts, if they lose confidence in the US dollar.

"The Singapore dollar is a fantastic long-term currency story. It's basically cheap," Wood said. "It makes no sense for the government to try and artificially hold it down."

Investors who want to hedge risk should "short" US securitised consumer and corporate debt, as this is cheap, Wood said.Asian stocks are not overvalued, despite their recent record-breaking rallies, but could face a downturn if credit spreads rise, Wood said.

"What's overvalued to me is credit spreads, not stock markets," he said. "To me, the risk in the world is credit spreads rising, in which case, there will be collateral damage in stock markets."

His views contrast with some fund managers and strategists who have voiced concern that record-setting Asian markets, particularly China, Singapore, South Korea and Indonesia, have climbed far beyond their proper valuations. MSCI's measure of Asia Pacific stocks excluding Japan has risen about 12% so far this year, compared with an 8.4% rise in the MSCI World index over the same period.

Gold remains essential insurance for those investors who want to hedge the systemic risks caused by the increasingly panicky responses of Western policymakers to growing deflationary pressures in their debt-burdened economies. Such longer term risks include the discrediting of fiat currencies and hyperinflation.

— Reuters

p/s photos: Fasha Sandha

Imaginative Investing

The Art Of Transcendental Business Projection

We can do all the number crunching and spreadsheet analysis, blah-blah, but will that ever get you the 3-bagger or 5-bagger over a period of 3-10 years. 3-bagger refers to 300% net returns from your initial investment. Journalists or those with 20/20 hindsight vision will always tout the scenario that if you had invested US$10,000 in Genting, Berkshire Hathaway, Microsoft, Intel, etc... 10 or 15 years ago, you'd be ... close to Nostradamus (dead and unbelievable).

Maybe we don't need a 300% return over 5 years, maybe all we want is a stock that will gain 20%-30% a year, even then 2-3 years down the line will see us doubling our money at least. That should be pretty good. But we don't want to do endless homework and research to get there. Well, there is a way, and that is what I call (my creation) Imaginative Investing.We are blessed with faculties to be able to appreciate nuances in behaviour. We can always point to a kid and say with authority, "That kid will grow up to be a brat, useless piece of shit". We form predictive comments in our own sphere of consciousness and deductive powers. This goes on and on, some things we can be good at, others not very much - e.g. If I strike the lottery, I will donate half to charity (ain't gonna happen cause you don't even buy lottery).

Of course, not everyone will be brilliant in using Imaginative Investing technique (send me now US$300 and you will get a money back 30 day guarantee...) as it has a lot do with your basic IQ to start with. I mean, we can only work with what we have, you know.

OK, I jest, here's the more serious stuff... Imaginative Investing is about thinking and filtering companies with the intention of seeing where they will be 2 or 4 years down the road. Sounds simple enough, but just as simple as predicting a beautiful teenager that she will turn out to be a beautiful girl in 5 years time. Our imagination and projection of a company's road into the future will carry with it many factors, which we may not be able to put down on paper, but we can feel it in our guts. It has to do with either the industry the company is in (industry enlarging); its ability to protect its margins or even a cartel-like operation; its cadre of strong, visionary and prudent management; maybe their product will find great acceptance or be the market leader; etc... Naturally these things are the same stuff that analysts will go through when writing their reports, but trust me, somehow, these nuggets get lost along the with the clinical prose, standard recommendation, rows of rows of figures, etc...

As ludricous as it may sound, just gve yourself some space and time as you read through the papers, slow your breathing, close your eyes, focus on the name of the stock, ... of course you must know something about the stock in the first place (I'm not Madam Zathura for heaven's sake) or a market semi-professional (i.e. adept at losing money professionally but given no credit for it)... then try and visualise the company's business, earnings, how the company will be one year down the road, two years down the road... how they will get there, will they get there, what will they be... will they be tripling their net profit then. These imaginative quests has the ability to correct each hypotheses by themselves. If you start thinking of a silly proposition, such as NST doubling its share price in 3 years... your inner voice will laugh at you. Its amazing but if you respect your inner voice, it can tell you a lot of stuff man! These projections are self censoring, it will be able to take in all the news items, corporate announcements, financial tidbits, uselesss financial blogs like this one, etc... to form the basis for censuring projections.

Somehow at the back of our minds, we can see a certain product or business that will continue to flourish, or an expanding market share, or a way forward to dominate their respective markets ... it is harder to justify those visions on numbers projection alone.

I did not examine the financial numbers of the following companies closely, but they all look like 3-baggers or even 5-baggers in 3-10 years time (in my imaginative transcendental portfolio). I will also rate them out of 10 points as an indication of their potential - the higher the better.

MALAYSIA
Air Asia (9/10)
Pos Malaysia (6/10)
Transmile Group (9/10)
Uchi (7/10)
Genting/Resorts World (7/10)
D&O Ventures (8/10)
Faber (6/10)
Sunrise (6/10)
Wah Seong (8/10)
IOI Corp (6/10)
Scomi Engineering (6/10)
Scomi Marine (9/10)

SINGAPORE
Capitaland (6/10)
Hyflux (7/10)
Singpost (7/10)
Keppel Land (6/10)
OSIM (8/10)
Hong Leong Asia (8/10)

I somehow know the bulk of my Singaporean readers will crucify me and alert me to their own picks... but these are my Imaginative Investing Picks, do NOT quote research/financials of these companies to me. I just know where they are, I have read about what they do, have been doing, and my assessment of the platform they are on, the ability to leverage and scale up.... in my mind. Maybe some of you would like to share you II picks too.

HONGKONG
China Mobile (6/10)
Li & Fung (9/10)
Cafe de Coral (6/10)
Cosco Pacific (7/10)
China Oilfield (6/10)