OSK Macro Analysis Report: Investment outlook 2010

Think cautiously: hot money, asset bubble, inflation, policy exit, strong US$ ….

Global healing, not global boom

Global GDP had contracted by about 1% in 2009, the worst since 1982. Undoubtedly the world has started to heal in about June, and continues to bounce as China, Brazil, India and Southeast Asia are pulling relentlessly. While we believe the world will eventually heal all its deep-cut wounds caused by the financial turmoil of 2008, a full recovery is unlikely to be seen until the end of 2012. For 2010, we will have a global recovery, not a global boom. While the stock markets of Hong Kong and China are still in their party moods, we caution investors to think about the possible setbacks that will cause some really volatile swings for the markets.

Hot monies will depart

According to the Financial Secretary of Hong Kong, about HK$640bn of hot monies had flowed into Hong Kong the last six months. There were no sign of their departure so far, but if they do depart, the bull market will end without hesitation. Many said hot monies will stay in Hong Kong, as China is booming and assets/stock prices are still cheap. Our view is that their inflow had caused the HSI to double in about nine months. There are plentiful profits with the hot monies already, so the lure to depart is irresistible. Besides, their flows are hypersensitive to the policy changes and shifting relative attractiveness of the different markets. As such, by nature they won’t stay.

Asset bubbles will burst

While hot monies stay, asset bubbles are unavoidable in Hong Kong, mainly because the Chief Executive only listens to the major developers. Many young doctor and lawyer lovers had told him they can’t afford to buy a shelter to get married, but he said they should rent instead, or buy a tiny flat to start. We will not see public land sales resuming. As such, property prices will continue to rise. The asset bubble will burst when all young couples are marching on the streets on 1st July 2010, or when the hot monies suddenly leave and cause the market to collapse.

Inflation risk in China is back

The CPI in China became positive at 0.6% in November, after had remained at –ve 0.5% to –ve 1.8% in the previous nine consecutive months. We believe the CPI in China will likely be hovering at around 5% in Q3 2010, and the risk of reaching that earlier is high. Property prices are at historical peak in many cities. Fast rising rents will speed up the increases in consumer prices in every sector. The State Council’s work conference of 12th December urged local governments to stop property price rising by all means, and on 18th December, a new rule requires all developers to pay 50% of land cost when acquiring new land. Despite these, runaway property prices and rising inflation will hit both China and Hong Kong in mid-2010, in our view. With near-zero interest rates, all anti-inflation tools will not be very effective. As such, we alert that inflation will become a nasty issue in China/HK from Q2/Q3 2010.

“Policy exit” here and there

Given the globe will reach the flexing point of its recovery path during 2010, the central banks must withdraw the excessive liquidity from the system. Their “policy exit” may take different forms, and start at different times. Yet the end result will be the same: interest rates will go up, so as the mortgages and borrowing costs. Only by doing so, the G7 (and to lesser extent, China) can curb inflation expectation before inflation runs. As the “policy exit” is equal to high interest rate, equity markets will head south when the politicians are heated up with the debates of when and how to exit, a signal telling the stock market to contract, in our view.

US$ strengthening

The US$ had declined by 10-20% against most Asian currencies in 2009, causing gold price to reach over US$1200. The US dollar index of the Reuters was 89 in Feb and is now 77. In 2010, the US$ will likely strength instead of continue to fall, the US economy will finally start to recover and the number of new jobs will rise. A stronger US$ will lift the appreciation pressure from the RMB, and will also induce a majority of the hot monies to flow back to the US, causing severe swings in the HSI.

18.5% upside for the HSI

The HSI at 21,175 is now trading at about 17x 2009(est.) earnings. The consensus eps growth for HSI in 2010 is about 22% as of today. If the market sublimes to maximum bullishness again, the HSI could go for its historical forward peak p/e of 18 times, and hit as high as 27,800 in 2010. However, given the 5 afore-mentioned major cautions, we believe investors will exercise maximum care instead, pushing HSI to peak at 25,000 only. In fact, we could still see the HSI nudging up 5-10% higher from this level, but only momentarily. Within the HSI constituent counters, we believe the PRC banks have the best upside. We also like the developer stocks before the asset bubble burst.

Hot themes for the mid-caps

We believe coking coal, steel, cement, heath care, sportswear, green energy (car batteries and wind) are the hot themes from which we can identify many super outperformers in 2010. China’s infrastructure will boom in 2010, due mainly to the Rmb4 trillion rescue package of Q4 2008. Steel, coking coal and cement should be investors’ main focus in the next 6 to 9 months. As living standard improves, the sportswear and health care stocks will perform fantastically. We also believe the green energy companies will remain hot in 2010, including those involving in wind and solar energy, and those supplying the next generation batteries for cars.