It's time to be canny in Asia

January 12, 2010  

"No doubt Mrs. Mugabe and the odd oligarch are rubbing shoulders in the developers' office, competing with faceless mainland corporations for bragging rights over the world's most expensive property."

By Mark Martyrossian

"China’s exports have to suffer with the Western consumer flat on his back. And the problem is that China is so dependent on exports." If we had $1 million for every time an investor laments in this way, our funds would be at capacity by now.

We reckon that net exports are currently contributing some 10% of the growth in the Chinese economy. Forecasts range between 8% and 16%. So it is a significant part of the economy, but it is not the major attraction that many people, who sit surrounded by products stamped "Made in China," seem to think. It has been a higher percentage in the last three years and has obviously fallen since the crisis of Q4 last year, but it has never been the critical factor in the China story.

The Chinese economic miracle has always been based on the domestic economy – consumption and investment have been the main drivers ever since Deng Xiao Ping got the show on the road at the end of the 1970s. China is a domestically-driven economy and the domestic sector has just had the biggest shot of adrenalin in history. Clearly government-led investment has been the major driver, but despite the obsession with "unhealthy" levels of savings, consumption is also playing its part, growing at a 15% to 18% annual pace. Given multiple drivers such as an increased willingness to consume by the younger generation, better retailers and shopping experience, rising incomes and increased availability of consumer credit, this will remain supportive for many years to come. So, while there may not be a lot of value in China’s stockmarkets just now, don’t fret about its economic growth.

Although we are similarly enthused by the Asian macro story in general, some short-term caution is probably in order. It seems increasingly consensual that the weak dollar/ strong everything else trade will continue to year-end, spurred by 'liquidity’ and the vested interests of the financial community. While this is by no means impossible, it looks to us more like a case of wishful thinking than any underlying positive economic dynamic. Try as we might, we find it very hard to square the longer-term damage done to the Western economies by the circa-10% rise in genuine unemployment (i.e., the series that does not churn jobseekers off the register when benefits run out) over the last year or so, the weak trend of wages, the ease with which employers can now actually cut salaries and benefits (a relatively new phenomenon in our view) and the catastrophic state of government finances all around the world and it is difficult to see anything other than an anaemic recovery. Yet market valuations—and in some cases stock prices themselves—are scaling recent highs, as if the events of the last 18 months were merely a bad dream. Being bullish when markets are priced for Armageddon is easy and normally correct. Staying bullish when valuations are well above long-term norms requires a bit more than hoping for a greater fool.

It seems de rigeur to analyse the future of the dollar in isolation these days, but as currencies are by definition valued relative to something else, it is worth considering one’s options. The unexploded financial bomb that is Central and Eastern Europe is not front-of-mind at the moment but is getting worse, not better. Ireland seems completely bankrupt. The Germans may talk about income tax cuts but they are putting VAT on sewage and heating bills and trying to disguise the true extent of their deficit. Italy and its Prime Minister defy serious commentary of any sort. Spanish unemployment is nearly 20%. Outside of the euro zone, sterling remains a disaster while the Swiss franc has attracted funds despite the impending demise of its tax-haven status, the prognosis for which has not changed by dobbing in Roman Polanski to the Feds (not Mr. Bernanke this time). The fiscal travails of the yen have been put into sharp focus by the revelation of Japanese government bond issuance now exceeding tax take and the inability of their best exporters to make any money. The yuan remains pegged to the dollar in all but name, the Brazilians no longer want your money at all and the New Zealand dollar seems a rather small vessel to park the world’s excess funds in, even if you are bullish on milk prices. In this context we are not as suicidal about the dollar as the consensus, and are cognisant of what a bounce in the dollar would do to risk assets of all sorts – equities, bond spreads, gold, Chateau Petrus, et cetera. It’s another reason for a more cautious near-term stance.

The Australian (and possibly Canadian) dollar does seem to offer the perfect haven of higher interest rates, a stronger economy and a commodity linkage. After a recent sojourn Down Under, our credit card bills are a testament to quite a lot of this being in the price already. As we approach parity with the U.S. unit, the pain of the manufacturing sector is escalating rapidly (viz. the recent decision by Bridgestone to cease manufacturing operations in Australasia), and the volte face of the investment community en-masse from 'just another bust Anglo-Saxon economy’ to 'the undiscovered jewel of the Orient’s backyard’ is bringing out the contrarian in us. We have hedged nearly all of our domestic Australian currency exposure as a result.

En route to Australia recently we spent some time in Hong Kong, and spurred by recent media coverage went to see some of the more high-profile recent property launches. 'The Masterpiece’ has a striking location in the middle of Tsim Tsa Tsui, but we were somewhat surprised to be shown what looked like a collection of unfurnished box rooms and told the price tag was $3 million. If it hadn’t had a view of the Peninsula’s helipad we would have assumed it was the maid’s quarters. This may appear cheap relative to the asking price of $13,000 a square foot that a penthouse on Conduit Road sports, but here we are in such rarefied territory that the buyers probably have agendas above and beyond looking for good-value property.

No doubt Mrs. Mugabe and the odd oligarch are rubbing shoulders in the developers’ office, competing with faceless mainland corporations for bragging rights over the world’s most expensive property. Now that $3 million seems to get you only a middle-of-the-range product, and real luxury kicks in above $50 million, we can understand the government taking the unusual step of commenting publicly on prices. They are not in a position to do much about it as tightening deposit regulations doesn’t work when the buyers pay cash—sometimes in suitcases—but it does point to likely changes in land supply policy. Given that the listed stocks are not cheap against physical property, and that the real estate itself is now looking very pricey, we remain wary of the sector.

There appears to be a lot more activity within private equity circles these days—and it is all about selling whatever is saleable. We note with interest a number of IPOs on the drawing board where the PE investors are selling out entirely, and where valuations look anything but cheap. On the basis that these sellers are a) entirely motivated by maximising proceeds, b) know a lot more about the asset than any buyer and c) have employed a lot of financial engineering to tart up the numbers, we would strongly advise potential investors to exercise extreme caution when looking at these opportunities. At the same time our recycling bin is groaning under the weight of prospectuses from a multitude of undifferentiated Chinese property companies all looking to tap the market. Again, not a good sign…

Mark Martyrossian is a partner at London-based Asian equity specialist Tiburon Partners.

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