Buy Call on the China market

Jim Rogers, investment guru, issued a “buy call” recently on the market in China. The mainland’s benchmark CSI index is decreased by more than 50% from its peak in October. Experts wonder if the market has finally hit bottom.Technically and fundamentally analyzing a market is a dual-effort that is considered to be the most effective form of analysis. Pressure builds from inflation, and the stronger currency and rising interest rates and hindering Shanghai and Hong Kong exchange. Fundamentally, however, China has an expansive economy.

Higher interest rates in China would damage the majority of the market, especially financial firms. The yuan’s value has risen 6.5% compared to the US dollar. This strengthening is however harming Chinese exports. On the other hand many Chinese companies are benefiting from the new strength because it makes manufacturing such things as oil, steel, and copper cheaper and therefore turning more of a profit.

The government in China hasn’t raised interest rates this year, mostly because it already raised them six times last year. Inflation was at around 8.1% for the first five months of the year. Gains made in the consumer price index slowed this to 7.7% in May, while in February it was 8.7%. According to a Bloomberg report May was the record month for the past three years for rises in producer prices.

On a more technical side, things are a little better. Markets in China are fading since the October high. This fade is similar to the fade shown by US technology, but worse. This is because individual investors in China are behaving with more anxiety, apparently from lack of experience. This seems to be even more of an issue than it was in 2000 regarding technology.

Between 2005 and 2007 China exhibited a huge market run-up. The Shanghai market rose nearly 500% during that time. Indicators during this time showed a short sell of the market.

Even with this result of a fundamental and technical analysis, it is not necessarily recommended that investors stay out of China. One should consider stocks in sectors that are unphased by the business cycle that exhibit a strong rising secular trend in cases like this. A sector that seems to next to immune to the business cycle in this case is health care. As China attempts to make its economy more private the system is becoming dismantled, and that is the problem. China spends only 6% of its GDP on healthcare. This is even lower than Japan and the US, and in the US the amount (14%) is commonly criticized for being far lower than Canada and European countries.

Ill Chinese citizens are forced to pay their healthcare upfront, and there is a serious shortage of doctors. Citizens without funds are not permitted to receive treatment even in emergency cases. The cost of medical insurance is too high for low and even many middle class citizens. Furthermore, hospitals and pharmacies have been raising prices of medicines up to 20x cost. Often drugs are ridiculously overprescribed, and thus the medical system is being turned into a profit center. Over half of what patients in China pay for healthcare goes to pharmacy. Many people are resorting to bribery to get proper care.

To keep this situation from getting worse, the Chinese government is going to have to significantly increase spending on healthcare.

Biofield signed a deal to provide new breast cancer technology to a Chinese healthcare network and has gained technical strength in doing this. More of these opportunities are going to reveal themselves in China, and it is predicted there will be a great number of them with time. 

Biotech in general is good in China, in addition to healthcare. Stock here is not driven by the business cycle but instead is reliant on media and pharmaceutical advancements.

The US Food and Drug Administration agreed with China to open three offices, in China, this year. A significant portion of US biotech is going Chinese, due to lower costs in development, testing, and drug research. The regulations are also less stringent, which speeds up the whole process.

This isn’t in support of swan diving into healthcare and biotech investment, but the propects are promising nonetheless. Some things need to give in the Chinese economy and healthcare system, the causes are there and the effects will be revealing themselves very soon.

Japan’s battery shares jump on electric car hopes

Shares of Japanese car battery makers shot up this week as investors expected growing concerns over global warming and persistently high oil prices to boost demand for electric cars.

Japan’s largest car battery maker GS Yuasa Corp (6674.T: Quote, Profile, Research) rose 6.9 percent on Wednesday, adding to a 16 percent gain in the previous two sessions. Furukawa Battery (6937.T: Quote, Profile, Research) soared more than 40 percent this week.

The rally started on Monday on news that Japan’s postal services system is looking to switch its entire fleet of about 21,000 short-distance delivery vehicles to zero-emission electric cars starting this business year. [ID: nT252637]

GS Yuasa has set up a joint venture with Mitsubishi Corp (8058.T: Quote, Profile, Research) and Mitsubishi Motors Corp (7211.T: Quote, Profile, Research) to produce lithium-ion batteries, a type of batteries used for electric cars. The joint venture plans to start selling them in the year starting April 2009.

“We plan to sell (the batteries) to other carmakers, and automakers both in Japan and overseas have shown interest in them,” said Masanori Kitamura, GS Yuasa spokesman.

Market participants said battery makers have joined the growing list of environment-related stocks, an increasingly popular category that includes makers of non-fossile burning power plants such as nuclear reactors. “Battery (shares) are quite strong, basically because hybrids and electric cars are going to be big from now,” said Koichi Ogawa, chief portfolio manager at Daiwa SB Investments.

“Oil prices may fall, but they’ll still stay at a pretty high level, and people are feeling the need to reduce carbon.”

Oil has retreated from record highs, but stayed far above $100 a barrel.

But some battery makers were puzzled by the steep rise in their share price, saying there were no fundamental factors to back up the move.

Officials of FDK Corp (6955.T: Quote, Profile, Research) said they were surprised to see their firm’s share price double in just three days.

“We are not working on lithium-ion batteries for electric cars. We don’t have any car battery business,” said Shigeaki Niida, spokesman of FDA, a maker of dry cell batteries.

“We were happy on the first day (of the rise) since our shares had been moving in a low range. But we are confounded to see it keeps rising on day two and three.”

— Reuters

Financial Blueprint for Korea

Korea must overcome the language barrier in order to become a financial powerhouse like Luxembourg or Hong Kong, Lee Young-tak, president of the Institute for Global Economics, said.

Lee, who served as a vice minister at the Ministry of Education, emphasized the importance of foreign languages for the financial industry. He said a friendly atmosphere should be created for foreign nationals. “It’s something that should be accomplished on a long-term perspective,” he said in an interview with The Korea Times. Lee gave some tips regarding how Korea could rise to become a financial powerhouse.

“Korea must resolve the problems of an unfriendly atmosphere for foreigners and the language barrier. People’s foreign language skills are essential for the country to become a financial powerhouse,” he said, pointing out that people from Luxemburg are multilingual and those in Hong Kong speak good English.

Financial Hub Plan Viable

Lee said the government’s plan to develop the country into the Asian financial hub hasn’t made much of a notable achievement so far. “Indeed, there is a pessimistic outlook on the financial hub plan,” Lee said, citing a Korea Development Institute (KDI) survey in which only 44 percent of experts in the financial industry had a positive outlook on the plan.

Nevertheless, Lee was positive. He said Korea could have a competitive edge in the financial industry, and achieve the goal sooner than expected.

The biggest hurdle lies in manpower, according to Lee. Korea lacks financial experts both in terms of quantity and quality. He pointed out that Korea ranked 45th in terms of competitiveness of financial professionals, far behind Hong Kong at 11th and Singapore at 15th. It ranked even lower than China at 39th. “Despite continuous deregulation by the government, it doesn’t seem to have had that much of a positive effect on market players yet,” Lee said.

The former KRX CEO, however, saw potential in the capital market and manpower.

“Following the Capital Market Consolidation Act, financial firms will now be able to develop new financial products more aggressively.”

Lee also cited the IT infrastructure as one of the best in the world. Combined with this, Koreans’ adventurous characteristics made the KOSPI200 option transaction see remarkable growth, and the KOSPI200 futures transaction, become the world’s fifth largest. According to Lee, such new financial products will add to Korea’s growth potential.

Lee cited abundant capital on the buy side as a boosting factor of the capital market. “The National Pension, for example, amounts to 257 trillion won as of March 2008, almost doubling from 117 trillion won in 2003. The foreign exchange reserves also topped $260 billion, a huge increase from $155.4 billion in 2003,” Lee said. He added that investment funds also expanded to 291 trillion won from a mere 145 trillion won five years ago.

He expected manpower to improve, as many high-qualified people who have been educated overseas are returning to Korea. “The people’s dedication to education have definitely helped the country,” Lee said.

Deregulation Is Key to Success

Lee said deregulation should be at the center of the financial hub plan. “Korea needs thorough financial deregulation that is comparable to the Big Bang of the United Kingdom.”

He acknowledged a series of deregulation measures implemented by the government, but pointed out that regulations, either official or unofficial, are still increasing costs for the market.

Lee said the President Lee Myung-bak administration should focus on tax cuts and deregulation.
“The new administration took the right direction when it chose the financial industry as the core of its economic growth strategy,” Lee said. “To enhance the competitiveness of the industry, it should focus on tax strategy and deregulation.” He pointed out that global financial powerhouses are cutting taxes and deregulating in a bid to lure global capital.

Find Niche Market

Lee said Korea has reached a stage in economic development in which high growth is unachievable through manufacturing only. “The financial industry should work as the other wheel paring with that of manufacturing.” He said cutting edge financial technologies and cost cuts in financing could enhance the competitiveness of other sectors.

He pointed out that the ratio of financial assets to the world gross domestic production (GDP) tripled to 316 percent in 2005 up from 109 percent in 1980. “The financial industry has become a key engine for changes and innovation in the global economy,” Lee said.

“This is based on knowledge and information, and high value added. It is also an eco-friendly future industry.” He said the industry, whose productivity is limitless, is incomparable to any other industry in terms of job creation or domestic income creation.

He advised that Korea should work on the global niche markets. “Other countries are building up a competitive edge in the financial industry, focusing on the niche market.” He cited Luxembourg and Hong Kong as models for Korea.

Despite being small countries like Korea, they have successfully transformed themselves into international financial hubs through specialization and a niche market strategy. “Luxembourg specialized in euro bonds, establishing itself as a regional financial hub in Western Europe. It is now at the center of euro bonds and investment funds. Hong Kong turned into a global financial center by specializing as a monetary intermediary.” He said Hong Kong was very lucky as Japan was strengthening regulation and China was growing explosively.

Capital Market Consolidation Act

He said the Capital Market Consolidation Act would be a big step forward toward deregulation.

Lee was positive about the financial industry policies implemented by the former President Roh Moo-hyun administration. “The Capital Market Consolidation Act, modeled after the financial `Big Bang’ in the United Kingdom, set up the basis for the development of the financial industry.” He expected the act to be a catalyst for the development of the financial industry.

“However, there should have been concrete policy implementations and support. It hasn’t brought about notable accomplishments yet,” he said. Lee added that the financial industry needs a very concrete policy plan, deregulation, and extensive infrastructure, ranging from insurance, law and accounting to medical and education services.

He expected there to be heated competition in the market following the implementation of the act, adding that Korea needs global-scale investment banks most of all.

“Financial players should become bigger, and the easiest way to achieve this is through merger and acquisitions (M&A) between financial businesses.” He said, however, that there still seems to be negative views and systematic limitations regarding M&As in Korea.

A common Asian currency: Stronger financial resilience?

Asia is hit badly by the current recession in the United States. Investors are shying away, stock markets are down, thousands are losing jobs.

In this scenario, there is once again talk of evolving a common currency for Asia for safeguarding its financial stability. But there are many hurdles on its way.

One is the `hegemony’ of stronger states. Smaller Southeast Asian states feel threatened by China’s growing economic power and Japan’s isolationist economic policy. They also question whether the currencies of Australia and New Zealand should be included with India. Japan is not too comfortable with China’s emergence and the fact that the yen may be overshadowed by the yuan. India too has been so far cool to the proposal for a common ASEAN currency, holding that it would require more coordinated efforts on the parts of all the participants and removal of many political and technical obstacles.

Some argue that it is impossible to replicate the euro experience because Europe had sorted out the question of hegemony long before the question of a single currency was mooted. The ideal preconditions that existed in Europe prior to the introduction of the euro either don’t exist in Asia or are only emerging. There were several factors that bound the European nations together. They included high trade interdependencies, Common acceptance of basic political and social values, fairly even economic development and comparable living standards. Even with common objectives, it took half a century for Europe to achieve a single currency.

There are a few such binding factors among Asian countries.However, conditions for a common Asian currency are improving. The past few years have witnessed higher trade interdependencies in East Asia than ever before. Trade volume among the ASEAN countries has swelled. Trade between India and China increased manifold over the past few years. foreign remittances from Japan and Singapore are on the rise.

But efforts towards a common currency have to be preceded by a common single market. ASEAN has already initiated steps toward evolving a mechanism for exchange-rate stability for promoting financial stability in Asia. More steps remain to be taken toward creation of a unified currency structure in Asia.

The benefits of an eventual single currency are numerous. It will increase market transparency by making prices more easily comparable. Cross-border transactions will also become more attractive as market operators will no longer be exposed to exchange-rate risks, and costs associated with currency conversion will be eliminated.

Moreover, single currency will go a long way in promoting political union in Asia. But it will be a long-drawn-out process. Europe has worked towards political and economic integration for over 50 years before the birth of a single European currency in 2001.

Is Asia The Next Blue Chip?

Really, would you rather invest in the West, or Asia now? The US, as many lament with a sigh, is in trouble. The economy’s tanking; the property price crash has only just begun; the currency is a disaster; and equities aren’t even particularly cheap. Much the same is true of the UK, albeit less evident, and even the European markets we have long been keen on are beginning to look a bit bleak. Don’t touch them with a bargepole, say analysts at consultancy GaveKal: Europe is starting to experience “the full effects of higher taxes, higher interest rates and a higher exchange rate”. This is a combination that is “usually enough to floor even the toughest economy (which Europe is not)”.

So what’s an investor looking for a safe haven to do? Some analysts suggest buying and holding your gold ounces. But much of the rest of the market has a rather different take on things. Buy Asia, says GaveKal, and specifically “Asian equities and real estate”. Why? Because Asia’s economies and markets have now finally “decoupled” from the US - they have developed to the extent that they are no longer dependent on US growth to drive their own growth. This, say the bulls, is the dynamic behind the way the regions’ stockmarkets have entirely shrugged off the credit crunch: the MSCI emerging markets index is currently trading at an all-time high, while the MSCI BRIC index (which tracks stocks in Brazil, Russia, India and China) is now trading 6% above even its pre-crunch peak.

So exactly how real is this decoupling? Much of the data seems to back the idea. Consider the most recent trade numbers from the US. Exports are currently rising at more than 14% on an annual basis, while imports are rising at only 5%. Export growth is nearly three times import growth and total exports (which have long been around only half of total imports) now equal 70% of total imports. This, as Jim O’Neill of Goldman Sachs points out in the FT, “is almost unheard of in the US” and it tells us something absolutely vital to our understanding of the global economy.

Those who are bearish on global growth as a whole say that if the US consumer gives up the ghost (as he or she looks to be about to do) “the end of the world is nigh”. But these numbers - which show us that even as the US consumer is cutting back, the rest of the world is stepping up to the consumption plate - say it isn’t. “The world is changing” and global growth is no longer led by just the US. There are many other figures to back this up. In July the IMF raised its global growth forecast for 2007 from 4.9% to 5.2% on the basis, in part, that emerging markets’ economies were proving stronger than expected in the face of a weakening US.

On their forecasts China, India and Russia between them will now account for half of global growth this year. Then look at the actual consumption numbers in China: Chinese retail sales grew 17.1% in July and, says O’Neill, are now “contributing as much to the world” as those in the US. Brazil, Russia and India are seeing double-digit sales growth, too: add their sales to China’s and their consumer spending growth is around 10% - twice that of the US.

Overall, the Brics between them make up 15%-16% of GDP. That may be half that of the US but it’s growing a lot faster and that, say the bulls, is key. Do the numbers in the same way as the analysts at Goldmans and you will see that to July of this year the growth in consumption in the Brics contributed nearly 1% to global growth. In the US it contributed only 0.7%. The point? Incremental consumer demand from the Brics is greater than that of the US for the first time.

And that, says Hamish McRae in The Independent, is “a huge turning point” for the very simple reason that it suggests that even with a US recession “the world could conceivably keep growing”. Goldman is in full agreement on this one. “Our latest leading indicators show that if anything China’s (growth) might even be accelerating,” and there is nothing about that that looks as though it could change the country’s “major underlying longer-term positive dynamic force, namely, urbanisation”. Their conclusion? “Thank God for China.”

But is it really this simple? We write about Asia a lot in MoneyWeek and will happily agree that it is a very different place to the Asia of 1998. There are no more huge current account deficits and no more overvalued fixed currencies; corporate debt appears to be under control; growth is on an upward trend (about 5.5%), while inflation and interest rates are low (an average of 4.4% compared with a mid-crisis level of more than 15%) and better still, in the past five years most Asian countries (India aside) have been running current account surpluses - and healthy ones at that. However, none of this means that Asia is immune to US recession. It isn’t. Look at the numbers a different way - Michael Kurtz’s way, perhaps.

Kurtz, who is Bear Stearns’ equity strategist for Asia, doesn’t buy the decoupling story. Why? Primarily because we can’t really be sure of the extent to which local demand has actually risen across Asia. Much is made of the fact that China has become a growing destination for exports from the rest of the region, but a huge number of these exports don’t end their days in China. Instead, they just stop there to make their way up the value chain: they arrive semi-finished, get finished and are then “re-exported from China to developed markets”. So the fact that other Asian countries now export a lot more to China and a lot less to the US than they used to tells us nothing about Asian resilience to US recession. Note that Thailand’s exports have already dropped back: they grew at 18% in June but only 6% in July and August. Malaysian exports actually fell in June and July as weak US demand cut shipments of electrical and electronic goods.

It’s also worth pointing out, says Kurtz, that while consumption is rising fast in Asia and is contributing to global growth, “even in the richly populated economies of China and India its absolute magnitude is simply too small yet to offset any sizable US consumption slowdown”. Chinese total spending is only equivalent to 10.9% of US spending. And Indian spending in total is only equivalent to 5.6%. “There will eventually come a day when emerging Asia’s consumers punch in the same weight class as their developed world counterparts, but we’re not there yet.”

The basic point here is that it doesn’t matter how you cut it, Asia remains heavily dependent on exports and in particular on the overextended US consumer: the US still accounts for one fifth of Chinese exports. Sure, the impact of slowing American growth might be lower now than it would have been five years ago (when the general assumption was that every 1% change in US growth affected Asia by 2%) but it is still there and it hasn’t been, as Morgan Stanley puts it, “stress-tested” yet. Global growth has been great for years - we haven’t had such a good run since the early 1970s. But while the growth records of emerging economies are bound to beat those of the developed world, that hardly means they are now immune to the global business cycle - nowhere is. And we should also be careful not to buy too heavily into the idea that Asia is a completely changed place. Much improved, yes. But perfect? No. Morgan Stanley points out that although “abundance has bought stability and good growth to emerging economies, it has also brought complacency among policy makers”. Much of Asia still suffers from a lack of human capital, from inadequate infrastructure and in particular from an inadequate regulatory environment, with a lack of genuine competition. The latter should be of particular concern to equity investors as Joe Studwell points out in his latest book Asian Godfathers: a small group of billionaires control vast numbers of Asia’s listed stocks and are expert in making sure that the proceeds of growth accrue to some shareholders more than others.

None of this is to say that Asian markets won’t make fabulous investments over the long term: relative to markets in the west they almost certainly will. It is just to say that it might be premature to think that Asia will be a medium-term safe haven if the US really does go belly up. That said, there may be good reason to think that, despite the fact the decoupling argument doesn’t quite stand up for now, Asia may be a brilliant short term investment, too. In this week’s City View, Simon Nixon explains why investors should be able to make money on the region’s currencies, but Christopher Wood of CLSA also makes a good case for the region’s equity markets to perform well in the near future. As a result of Fed-led central bank easing, he says, the market will be looking for a new place to build a bubble. And given the near-consensus on decoupling, the obvious place for the “next bubble to form” will be in Asian and emerging market asset prices and “related commodity and natural resources plays”.

Vietnam’s Financial Scorecard

The stockmarket is down and ratings agency Fitch has cut the country’s sovereign rating from stable to negative – are we through with the bad news yet? Vietnam has been ducking punches of bad news lately. So it’s no surprise that ratings agency Fitch cut the country’s BB-minus sovereign rating from stable to negative, yesterday. The cut in the rating – which is three levels below investment grade – followed one by Standard & Poor’s earlier this month.

The reason for the poor scorecard: skyrocketing inflation, an increasing trade deficit, and a nose-diving stockmarket – the Ho Chi Minh City Stock Exchange’s (HOSE) index has fallen 55% this year. The stock exchange has been closed since May 27 because of what the exchange says is a technical problem but it will reopen today (May 30).

Vietnam’s annual inflation accelerated to 25.2% in May from 21.4% in April. And that’s up from March, when inflation hit 19.3%, which at the time was the highest level in more than 12 years.

The stockmarket, which has been on a meteoric rise for the past few years, had its worst first quarter in six years. The HOSE fell more than 44% during the first quarter. In February alone it slipped 21%, marking the largest drop since the August 2001 when it fell 34% in one month.

Gone are the heady days when retail investors would rock up on their motorcycles to make a quick trade before scooting over to the fastfood chain Pho 24 for a bowl of noodles.

But most analysts (if not retail investors on the street in Ho Chi Minh City) would say that the market was in need of a correction. For one, the IPO party wasn’t all that much fun. For example, when Vietcombank launched its IPO last December, it was narrowly oversubscribed. The starting price in the auction was Vnd100,000 ($6.33) per share but the average final price was only Vnd107,000. Only 90% of the deposited shares were actually paid for in the end. Similarly, when the largest beer producer in the country Saigon Beer-Alcohol-Beverage Corp (Sabeco) went to the market in February, the average winning bid was a mere Vnd70,003, a squeak above the Vnd70,000 minimum level. The registration rate was only 68%. The paid-up rate was less than 50%.

While companies began to struggle with their IPOs, the market was still deemed hot by outsiders. The IMF told regulators that they needed to slow things down, and regulators took the guidance to heart. They instructed banks to stop lending to speculators. Now, securities lending cannot exceed 3% of a bank’s total lending, nor can it exceed 20% of the bank’s chartered capital.

Meanwhile, inflation is exacerbating the stockmarket problem. The days of low-cost fuel, rent and noodles (which no longer cost Vnd24,000 a bowl at Pho 24) are gone.

Fitch points out that the policy response to inflation has been both too slow, as official pronouncements have not been followed up by immediate action, and too small, as real policy interest rates remain deeply negative even following their recent increase. The agency noted that accelerating inflation could pose risks to the stability of the banking system, which is highly dollarised by regional standards. Aggressive policy interest rate increases, however, could also threaten the banks, especially if there is a sharp deterioration in economic growth, with consequent negative effects on the quality of banks’ assets. Fitch indicated that the future path of inflation and the agency’s assessment of respondent policy initiatives to lower it, while avoiding a sharp economic correction, will be decisive factors in any further rating actions.

High hopes
But this doesn’t need to spell long-term gloom and doom for Vietnam. “The developmental challenges we have seen lately are not unexpected considering recent high rates of growth,” says Tom Nguyen, head of global markets at Deutsche Bank in Vietnam. “The government’s recent reduction of GDP growth to 7% is a step in the right direction as they attempt to strike a balance between growth and inflation. It will take some time but over the long term the compelling fundamentals that attracted investors – at even much higher valuations – will play out.”

Indeed, valuations need to come into line. Analysts and stockbrokers have long been saying that the easy money provided by the stockmarkets for state-owned companies wanting to list, has been unrealistic. Rather than forcing companies to improve corporate governance, train upper management and become more efficient, companies could slide by. Now belt-tightening has to happen.

But, as always, traders in Vietnam are focusing on the sunny side of things. As one analyst said in a note to investors yesterday: it’s “not quite as bad as usual here in Vietnam although it’s tough to tell given that the HCMC market is still closed with little clear idea of when it will re-open. We are looking for clarity on HOSE and positive steps from the government to alleviate the current macro concerns. Let’s hope they come!”

Key data show Japanese economy slowing

Japanese unemployment hit a seven-month high last month while industrial production and household spending fell, adding to evidence that the world’s second-largest economy is slowing down.

Industrial production declined 0.3 per cent in April, the government said, while unemployment rose 0.2 percentage points to 4 per cent and overall household spending fell 2.7 per cent.

“The data suggests the Japanese economy is moderating gradually but certainly isn’t falling off a cliff as it has done when other external slowdowns occurred,” said Glenn Maguire, chief Asia economist at Société Générale in Hong Kong.

Japan’s exports, which have held up well thanks to demand from emerging economies, are also showing signs of slowing down. Such a slowdown will take its toll on production and capital spending, and eat into overall growth.

The economy expanded at the slowest pace in three years in the first quarter (year-on-year) due to sluggish capital spending. However, consumer spending was surprisingly resilient, albeit dull, even in the face of higher energy and food prices.

The restrained consumer expansion offers a glimmer of hope that Japan will be able to weather an external slowdown better than it did in the late 1990s and 2001. But with higher prices, spending is unlikely to show any exuberance.

A few months of positive wage data suggest that demand for certain skilled labour is helping drive up salaries even though other recent figures suggest that employment demand is slowing.

“One of the key features of the Japanese economy at the moment is this strengthening in wages in the context of a weaker labour market,” said Mr Maguire.

“If that continues, which I think it will, then you won’t necessarily see the typical response, which is consumption weakening in line with the labour market.”

Japan’s April consumer price index, excluding fresh food, rose 0.9 per cent in April, slower than March’s pace, but that was due to the brief lapse in the fuel tax, which has since been reinstated.

Core consumer prices, excluding fresh food and energy, fell 0.1 per cent, confirming that rising prices were due to external factors. Tokyo’s May consumer price data showed core inflation of 0.1 per cent, government data showed.

Cracking Into Asia’s Money

When China’s three leading state-run banks finally felt confident enough to list their shares in 2006 and 2007, after years of losses from bad lending practices, the initial public offerings contained two common elements: big Western banks acting first as underwriters and second as strategic investors. What the government most wanted was an endorsement of quality that it felt could come only from the cream of global banking. It was prepared to offer the lucky few the chance to make billions of dollars, in exchange for sharing what it thought was their invaluable risk-management expertise.The offer of minority stakes was accompanied by a slight crack in the Great Wall that China has built around its highly sensitive securities markets. Last year Credit Suisse, Citigroup and Morgan Stanley all received enough encouragement from regulators to announce agreements with domestic securities firms for some form of tie-up. Meanwhile, China’s new sovereign-wealth fund spent $3 billion on a stake in the Blackstone Group, an American buy-out fund, hoping to learn lessons in finance from a master of the craft.

All of this came before the credit crisis sideswiped the big Western financial firms, costing hundreds of billions of dollars in losses, the jobs of senior executives (not to mention those of thousands of more junior employees) and, most important, their reputations for prudent risk management. Optimists in Europe and America say that acknowledging these losses is all part of the healing process. But in parts of Asia there is a chillier interpretation. There you can find the belief that Western banks have failed an important test of soundness and that their regulatory model is not to be trusted either.

As a result, Western bankers say they are greeted more coolly than they were a year ago-not just in China, but in Japan and South Korea too. They point to Seoul’s reluctance to endorse HSBC’s acquisition of Korea Exchange Bank as one sign of frostiness. In China attitudes are hardening publicly. Credit Suisse, Citi and Morgan Stanley have not yet had their deals approved, and other banks that had hoped to be next now wonder if the approval process has been quietly shelved.

Unlike in many developed markets where government decisions are clearly explained, a rejection in China often comes in the maddening form of absolute silence. But strong hints are emerging. A senior Chinese regulator recently described to this newspaper his view of big global investment banks in one unusually graphic word: “shit”.

There is particular scepticism about whether large Western banks, or their regulators, truly understand the risks associated with the mountain of derivatives on their balance sheets. Liu Mingkang, chairman of the China Banking Regulatory Commission (and a leading reformer), makes no attempt to conceal his doubts about bank regulation in America-and how flat-footed it was. “After the death, the doctor came,” he observes dryly. As a result, he indicates, China is likely to open up to international banks even more slowly than it has already.

Even as Western financial firms have fallen into disrepute, banks in emerging markets are treated as paragons of probity. Jiang Jianqing, chairman of Industrial and Commercial Bank of China, the world’s most valuable bank, recently talked down the merits of investment in American bonds and banks. His bank has refused invitations to invest in global firms. Instead it has bought a large part of Standard Bank of South Africa and controlling shares in banks in Macau and Indonesia.

Some of the reaction is an understandable response to genuine failures. China’s sovereign-wealth fund has lost plenty of money on its year-old Blackstone stake and on its investment in Morgan Stanley. But rather than viewing this as an education in the way an unrigged market works, or an opportunity to buy more at a lower price, it considers the investments an embarrassment. So far this year, China has not invested in any stricken Western banks; just in time, Citic, China’s leading securities firm, slipped out of a billion-dollar investment in Bear Stearns before it fell into the arms of JPMorgan Chase.

In many ways, these are nerve-racking moments for institutions that have put great store by China. The potential spoils are huge. According to Matthew Austen of Oliver Wyman, a consultancy, the Chinese banking and securities market generates $225 billion in revenues; he reckons that Western firms receive no more than 7% of this (and less than 1% if shareholdings in Chinese companies are excluded). The global firms would like to manage funds, raise capital and trade securities, including shares, debt and derivatives. All these activities are still heavily restricted.

They are not the only ones likely to be hurt by rising protectionism, however. Hank Paulson, America’s treasury secretary, was not just talking America’s book when he said that opening the Chinese financial system is “absolutely necessary” for China’s own long-term economic success. It would not only provide greater equilibrium to global capital flows, but would also bring more efficiency to China’s industry. Already, manufacturing firms in southern China are struggling to cope with the rising yuan, because there is no currency-futures market for hedging.

Similarly, Chinese firms are forced into inefficient financing arrangements. They can borrow from state-controlled banks at rising rates that may have little to do with their own creditworthiness, let alone what they plan to do with the money. Alternatively, they can join a long, bureaucratic queue to issue shares. Even the largest ones still rely on the state for permission to raise capital: Ping An, the second-largest insurer, recently pulled a vast secondary share offering after what was believed to be a quiet word from the authorities.

A state-driven financial market means state firms tend to do best. Financing for start-ups remains largely informal-loans from friends outside the financial (and tax) system-which stifles entrepreneurship. Worst of all, today’s system provides a truly rotten deal for Chinese citizens trying to put away money for retirement, for their children’s education or other personal needs. They are given a bleak choice of subsidising the financial system through deposits yielding less than inflation or speculating on highly volatile shares.

China’s financial firms are by no means model institutions either. A banking crisis, which began in the late 1990s and is still not fully resolved, cost $428 billion, according to the World Bank. In addition, billions of dollars were lost by state-controlled securities firms through unfunded “guaranteed” investment products and inept proprietary trading funded by money absconded from client accounts. China has never revealed the full cost of this disaster. Whatever the collective figure, it gives some perspective to the $335 billion or so of write-downs and credit losses thus far from the subprime crisis.

Clearly, Western banks have every reason to regret their losses. That may be one of the reasons they are not defending their methods more vigorously. Even in the West, where there is plenty of talk of regulation, they are keeping a low profile. Having got so far with China, however, bankers will be remiss if they let the misapprehensions fester. Western finance may be prone to cyclical excess, they can argue, but the state-sponsored model is even more so. At least when troubles hit Western banks, the recognition-and the healing-come far quicker.

Approving Glances on Asian Defensive Stocks

Telecoms, infrastructure and toll road companies are among the best defensive stocks for Asian investors who fear that the downturn since the start of 2008 is shaping up to be a full-blown bear market.Strategists and fund managers said utilities, traditionally seen as a low-growth safe haven in troubled markets, hold less appeal than in the past because of less favorable regulation and rising input costs.

“The sectors I would be focusing on would be telcos, pretty much across the space, and some infrastructure stocks, particularly the Chinese ones,” said Tim Rocks, equity strategist with Macquarie Securities.

The Hong Kong-based strategist said investors should favor infrastructure plays, particularly in China, including toll road operators Shenzhen Expressway and Zhejiang Expressway, and be wary of utilities.

“Regulatory regimes are generally tougher, so that companies aren’t being allowed to pass some price increases because countries are worried about inflation,” Rocks said.

“Even though they’re defensive in that their revenue line may not move that much, the problem is their costs are going up, so they may not be as defensive as it would initially seem.”

Asian telecoms carriers including Taiwan Mobile, Singapore Telecommunications, Globe Telecom in the Philippines and South Korea’s SK Telecom were other potential defensive plays, he said.

Investors are hunting for safe havens as Asian stock indexes have tumbled after Citigroup’s record loss and weak U.S. retail sales heightened fears of a U.S. recession that would cut global growth.

But investors who might in the past seek the stability and dividends of utilities need to take a closer look before buying Hong Kong utilities like CLP Holdings and Hongkong Electric, said Louis Wong, research director with Phillip Securities.

A recently revised Hong Kong regulatory agreement will lower the cap on potential returns “so their resilience or their function as a safe haven may be undermined,” he said.

The Hong Kong-based analyst instead favors infrastructure plays including China Communications Construction and China Railway Group which, he said, will benefit from multi-year, multi-billion dollar commitments China has made to communications and transport spending.

He also liked Hong Kong’s Link REIT, which rents retail outlets and parking spaces in the territory’s government-owned housing estates.

Apex Capital Management fund manager Tat Auyeung said he also held China Communications Construction, as well as Shenhua Group, China’s largest coal producer, because they are relatively immune to slowing global growth.

He also pointed to China’s top telecoms firms, China Mobile, China Unicom, China Netcom Group and China Telecom as likely to do better in a downturn.

“Conventional wisdom is to put the money into sectors where they have very little to do with the U.S. economy, more domestic-related names like infrastructure,” he said.

In India, stocks perceived as defensive include the locally listed arms of food and drug multinationals such as Nestle India, Hindustan Unilever and GlaxoSmithKline Consumer Healthcare, said Bhaskar Laxminarayan of Pictet.

The Asia chief investment officer of the Swiss bank, who declined to disclose its stock recommendations or holdings, said government-run banks like State Bank of India and Punjab National Bank were also seen as safe havens.

Given the continued risks to international banks and financial markets from the U.S. subprime meltdown and global credit crunch, investors may simply be better off moving to cash or other asset classes, said Kirby Daley, strategist with Fimat.

“Investors have to think outside the box in this period where we’re entering uncharted territory. Simply moving to defensive stocks or buying on dips in equities is not necessarily going to be prudent,” he said.

Yet some strategists think crowding into defensive stocks, if such a category exists, would be a mistake given this is where the herd is moving.

“Fear has taken over, and really what you should be doing is going and buying those high beta risky stocks that have been driven down very hard,” said Adrian Mowat, chief Asia equity strategist at JPMorgan in Hong Kong.

“I wouldn’t be giving people a list of defensive names,” he said. “It’s a hedge against a bull market, and you own equities because your expectation is equities are going to go up.”

Understanding Asian currencies

With the US dollar reaching new lows versus hard currencies, many are waiting for Asian currencies to catch up. Why hasn’t this happened, and will it happen? The short answer is: it might, but be patient and don’t bet your farm on it.

To understand Asian dynamics, let’s first look at Europe. Remember how many ridiculed European growth earlier this decade? A key factor was the refusal of the European Central Bank (ECB) to jump on the growth bandwagon. As a result, consumer savings went up in Europe, while they headed down in the US. While the US economy became increasingly dependent on credit expansion, consumer spending and inflows of money from abroad to support its current account deficit, the euro-zone was far more balanced.

Asian governments tend to be interested foremost in social stability through economic growth. As a result, Asia facilitated the growth in the US, providing what seemed liked an unlimited amount of cheap labor. A weak or fixed exchange rate versus the dollar was one of the means to provide competitive exports to the United States. Foreign direct investment (FDI) in Asia skyrocketed, and Asia produced - a lot. As the supply of Asian goods flooded US markets, prices of US consumer goods remained low. American consumers neither had to pay more for goods, nor could they really afford to as their real incomes were under pressure: American manufacturers had to accelerate their outsourcing to Asia to remain competitive, thus keeping a lid on US wage inflation.

Asian countries were in no mood to allow their currencies to float higher, as it was considered key to their competitive advantage. Almost solely focusing on production, the amount of goods and services sold to the US far exceeded what was bought. As a result, Asian countries started building up massive US dollar reserves.

With the US and Asia fostering growth at any cost, commodities got ever more expensive; someone had to pay to produce this global oversupply. Because of the immensely competitive environment within Asia, a lot of the margin pressure was absorbed through investment in ever more efficient and scalable production facilities. China emerged as a clear winner in this race to produce; China’s market share of Asian trade with the US exceeds 30% and is growing. China now has the managerial know-how, skills amongst the workforce and infrastructure to implement large-scale production facilities. No other country even comes close.

This scalability will be crucial because the American consumer is threatening to spoil the party. As American consumers are out of cash and access to credit is increasingly difficult, they might just be buying less of those Asian imports that they don’t really need in the first place. Asian countries are in a precarious spot because over-production at home has made them vulnerable to a slowdown. This vulnerability is exacerbated as downward pressure on the US dollar has increased: if Asian countries allow their currencies to float higher, exports to the US become even less competitive.

US cure won’t work
The “cure” advocated by US policymakers to pressure Asian countries and currencies won’t do the trick, though: the US would like Asian countries to stimulate domestic consumption to reduce the trade imbalance and thus ease the pressure on the currencies.

Some Asian countries, with South Korea taking the lead, are indeed starting to take measures to stimulate their domestic consumption as exports to the US abate. However, this may not help the US dollar: while Asians love many US brands, these tend to be manufactured in Asia. And it is unlikely that the US will produce, say, sneakers, and sell them to Vietnam. At the same time, some of the goods produced in the US that Asia may want, such as military and nuclear technologies, the US is reluctant to export.

One scenario is that some Asian countries may engage in competitive devaluation to continue to sell to American consumers. There is no sign of this yet, but the risk cannot be ignored, especially among those with weaker competitive positions. Another possibility is that Asian countries will count on intra-Asian trade and domestic consumption to pick up the slack from falling exports to the US. Indeed, intra-Asian trade has become substantial and the US will over time become a less critical trading partner. At this stage, however, much of intra-Asian trade still ends up on the shelves of Wal-Mart in the US as the final destination.

But there are more changes that influence the global economy: as of last summer, Asia no longer is an exporter of deflation, but of inflation. As it became ever more difficult to absorb the cost of higher commodity prices, Asian manufacturers were suddenly able to pass on higher costs. Aside from high commodity prices, the “unlimited” supply of cheap Asian labor suddenly isn’t so unlimited anymore: wages have been going up in many areas. While the migration to cities continues, factories are moving up the value chain to secure a viable business model and wage demands for more sophisticated jobs are steadily increasing.

China, again, is the best positioned: factories in the country are now moving to the regions where migrant workers used to come from. This bodes well for infrastructure investments within China but will also help develop the regions that were previously left out. We’re not suggesting China is without challenges: amongst others, transportation costs will increase as more remote areas are developed.

Within Asia, holding foreign currency reserves worth billions of US dollars, in the case of China worth over a trillion dollars, has also become a politically sensitive issue. While traditionally foreign currency reserves were considered a welcome cost to help build up the domestic infrastructure, ever more American-educated policymakers influence Asian monetary policy.

At first, the calls were to invest these reserves more strategically: investments to secure access to raw materials in North America, Latin America, Africa and Australia - in short, everywhere - have soared in recent years. But with the US dollar under pressure, pressure to invest these reserves more profitably have increased.

Sovereign wealth fund investments from Asia have made numerous headlines over the past year, some of them embarrassing to the managers: investing in Blackstone’s initial public offering only to see the investment plummet is bad publicity not welcome to senior policy makers at a sensitive time. While sovereign wealth funds will play a role in the global capital market, we expect that they will devote a lot of attention to domestic issues, such as investing in domestic banks where returns may be more stable and losses easier to keep from public scrutiny.

As inflationary pressures have risen in much of Asia, allowing currencies to rise would be an obvious solution. But what may be obvious to readers used to free-floating exchange rates, is a radical step to governments that cherish control. Ask any businessperson in Asia, and you will likely hear that they like fixed exchange rates. It’s far easier to conduct business not worrying about what your currency may be worth tomorrow.

However, as pressures may become too great at some point to ignore, some Asian governments have taken steps to prepare for greater exchange rate flexibility. While China gets most scrutiny for not moving fast enough to allow the yuan to appreciate versus the US dollar, the country has taken a very responsible approach by developing local expertise and markets to deal with great exchange rate flexibility.

Many have argued that China will allow its currency to float higher to combat inflation; others argue that China will only allow greater appreciation as a gesture of goodwill to the incoming US administration in early 2009. The wheels of politics grind slowly, but they do grind. Note that China is extremely wary of inflation as political unrest in the past was usually linked to inflation.

Japan warrants special attention. Japan is part of Asia, but unlike other countries in the region has a highly developed economy. Rather than inflation, deflation is Japan’s major concern. In the past, our view has been that the Bank of Japan (BoJ) will intervene should the yen appreciate too much. Currently, we have a special situation because there is a leadership vacuum at the BoJ. The outgoing governor retired, but parliament has not agreed on a successor. The deputy governor recently assumed the role of acting governor.

Just like at all central banks, officials are busy trying to contain the fallout from the credit crisis in the US. On this backdrop, the Japanese yen has been able to strengthen beyond what we would have deemed permissible to the BoJ in a more normal environment. However, we believe the Japanese economy can stomach a stronger yen. It remains to be seen whether and how the BoJ will act.

In the long run, Asian governments would be well served if they opened their markets further. Only if exchange rates are allowed to float freely will domestic bond markets have a chance to more fully develop. While the US may show the signs of a good thing taken too far, domestic bond markets are crucial in providing more stability to the local economies in the long run. The World Bank in conjunction with the International Monetary Fund is spearheading an effort to develop domestic bond markets in Asia; we applaud their efforts, but note that solid markets will take many years to build and require governments to cooperate.

Because Asian markets are not as developed, their markets remain vulnerable to fast money moving in and out of the region. Local stock markets make international headlines as thinly traded markets see large institutions leave during times of turmoil. Currencies also react, but typically with less volatility than the stock markets; currencies in Asia may also be influenced by activity of major corporations active in the country: the Indian rupee makes it to the currency headlines from time to time as large funds are shifted. Major currencies are also affected by the flow of funds, but the markets are huge and select players are unlikely to have a noticeable impact.

Asian currencies are subject to different dynamics from those affecting hard currencies. Hard currencies may be suitable for investors looking to diversify out of the dollar. Asian currencies are driven not only by fundamentals, but to a much greater extent also politics; this increases the risk in them, but also provides for opportunities. A basket of Asian currencies may be able to mitigate the risks associated with any one Asian currency.