**[investwise]** CLSA: Collateral Damage

 

CLSA Collateral Damage Christopher Wood (Austin May7, 2010) First, a point of sentiment. GREED & fear is often asked what is the consensus among investors. In GREED & fear's view there is no overwhelming consensus on equities. Continuing meetings in America this week reveal that there is a healthy two-way debate on US equities while the consensus bullishness on emerging market equities is by now much less pronounced than what it was at the end of last year. But where there is an overwhelming consensus is on US Treasury bonds. The consensus is of the view that it makes no sense to lend money to the US government for 30 years at a present rate of 4.4%. GREED & fear has a lot of sympathy with this view. But the question is still whether the 30-year Treasury bond yield drops to 2.5% again and the 10-year to 2% again, or even lower, before there is a supply driven surge in yields. The Break-Up of Euro, Greece, the motley nations called PIIGS and a bust of China Real Estate will negatively impact Australia, Brazil and China. But there will be major beneficiaries-Overweight India, Indonesia It is increasingly clear that Indonesia and India are the two Asian economies with the greatest potential to move to a higher level of sustainable growth over the next five years, with the key variable being the potential for a sustained infrastructure cycle. Clearly, the portfolio has always been heavily invested in India since its inception on 1 October 2002 and will remain so. The machine gun burst of tightening measures directed at the Chinese property market in recent weeks has begun to impact the global commodity trade and related stocks. The MSCI AC World Materials Index has fallen by 6% in US dollar terms so far this week and is down 10% since mid April. This is no surprise, as discussed here last week (see GREED &fear – PRC policy risk, 29 April 2010). Indeed it is the natural follow on trade from the negative head wind already seen in Chinese property stocks and to a lesser extent in Chinese bank stocks. The next potential area of vulnerability will be the derating of high multiple Chinese consumer stocks. In the meantime, the short term market focus will remain on the trend in China property transactions and prices. The latest data available this week points to a sharp decline in transactions. Thus, average daily residential sales in the 13 big mainland cities have fallen by 38% during the first five days of May compared with the average sales during 18-30 April, which was down 21% from the sales during 1-17 April. But the other area which in GREED & fear's view deserves more focus is the secondary market in residential property. With the mainland Chinese cultural dislike for buying "used" flats, the secondary market has been slow to develop in China though it has of late become increasingly active in the likes of Shanghai and Beijing. Still with many Chinese owning multiple flats, and with the Chinese government now sending signals that a property tax is in the works which would raise the holding cost of owning vacant property, there is clearly the potential for the secondary market to go "offer-only"; most particularly as GREED & fear now hears that government officials are being investigated for multiple ownership of properties. Meanwhile, GREED & fear expects that, sooner or later, the PRC will fill the gap left by a slowing private property market by announcing a far more comprehensive government subsidised scheme for low cost housing than currently exists, possibly on a Singapore-style HDB model or a Brazil-style model where developers would be told the profit margin they can charge. This will create a new growth story. On this related point, the government announced in March that it plans to build 3m flats of government subsidised housing for low-income families and rebuild 2.8m shanty houses this year. Still this is for the future. The current negative policy signals create continuing negative head winds for China-related equities. Still as this week's action in commodity stock makes clear, the risk is now that China-related concerns spread to other markets or sectors perceived as China geared. In this respect it is worth remembering that A shares and Chinese property stocks quoted in Hong Kong led, in that order, the recovery in world markets from the late 2008 credit crisis lows. The risk is that the sideways to down action in A shares and China property stocks since August last year could be viewed as a negative lead indicator for the global risk trade as a whole. The money will be deployed by adding two more percentage points to hopefully still low beta Malaysia and another percentage point to India where a declining oil price is a fundamental positive. As for the Asia ex-Japan long-only thematic portfolio, GREED & fear wants to reduce the beta a little. GREED & fear is therefore going to undo a change made here recently by re-introducing India's SBI into the portfolio and removing Yes Bank. The percentage invested in Indian financials will remain the same. In China GREED & fear is also now more comfortable owning life insurance companies than banks. In this respect, a three percentage point investment will be introduced in China Taiping Insurance, a growth story on life insurance, which will be paid for by shaving the existing investment in China Life. This is simply to diversify the sector bet. The recent rising newsflow about the China banking regulator investigating the collateral, if any, for Chinese banks' lending to local governments' special purpose vehicles (SPV) last year makes GREED & fear increasingly nervous, especially as a lack of adequate collateral is likely to lead to a demand for greater provisioning. There is also a rising risk that the SPV concerns feed into related property concerns. GREED & fear is, therefore, going to remove ICBC from the portfolio. It will be replaced by a four percentage point investment in Astra International of Indonesia and an extra percentage point to the existing investment in Indocement. The long-only portfolio has not had enough in Indonesia in the recent past. Any further correction in Indonesia caused by China related concerns will be used to increase positions in this market. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.   Nothing in this article is, or should be construed as, investment advice.

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