Goldman Downgrades China, Upgrades The Nikkei, As It Hikes Oil, And Other Non-Sequiturs
Following its just announced flip flop on oil, Goldman's "sellsiders" go ahead and not only cut Chinese growth prospects, but raise the Nikkei. So let's get this straight: Goldman raises its prices forecast for oil, even as it downgrades the primary driver of demand - China, and somehow the Japanese market, which suddenly is overreliant on natural resources for energy creation in the aftermath of Fukushima, is supposed to surge. Was this script written in Bollywood?
Anyway, for those with a sense of humor, here is the gist on China: "Recent data have been worse than we expected. The growth slowdown has been even sharper than we forecast, especially evident in April industrial production (which mainly reflected tighter monetary and fiscal policy, although some specific industries have seen supply-side constraints). In addition, inflation is not coming down as rapidly as we hoped. We now cut our 2011 GDP growth forecast to 9.4% from 10.0%. This partly reflects the lower-than-expected 1Q2011 GDP print (9.2% qoq ann.), but we have also cut 2Q2011,3Q2011, and 4Q2011 growth to 8.0%, 9.0%, and 9.3% qoq ann. from 8.8%, 9.5%, and 9.7% respectively. This is only very slightly above the last official consensus, which came before the disappointing April data, and so we are likely to be above the true consensus now. We expect annual average inflation of 4.7% (up from 4.3%), with a peak in yoy terms of 5.6% in June. We also nudge down our 2012 GDP growth forecast to 9.2% from 9.5%, reflecting in part the impact of higher oil prices. Although we maintain our annual average inflation forecast of 3.0% in 2012, we have a slight acceleration within 2012 as higher oil prices eventually get passed on more fully." Yet while this conclusion in and of itself makes some sense, the following from Goldman's Kathy Matsui in the Nikkei, regarding the firm's outlook on the Japanese stock market, confirms that whoever is coordinating the Goldman sellside push may have crossed the Tropic of Thunder: "Contrary to popular opinion, we believe the disaster will accelerate - rather than delay - Japan's exit from deflation. We see reconstruction demand and exports driving gross domestic product growth to an above-trend pace of 2.5 per cent in 2012...Market participants have argued for some time that it will take a cataclysmic event to drive structural change in Japan; now the world is watching." Bottom line: China down, Japan up, and oil far, far away. Sigh.
More from Goldman on Japan:
More than two months have passed since the March 11 Tohoku earthquake and tsunami. Since then, Japanese stocks have fallen 10 per cent, while global markets have risen 1 per cent. While we see Japanese equities range-bound over the next 3-6 months, we project a 15-20 per cent rally on a 12-month view.
Our near-term caution stems from three reasons. First, due to our more subdued growth outlook for the US and Japan as well as persistent yen strength, consensus earnings expectations for the full-year 2011 appear optimistic. Although one-fifth of companies chose not to release any guidance, those that did expect flat profit growth, while we forecast earnings per share (EPS) to fall 5 per cent.
Second, while power shortages and supply chain disruptions have begun to alleviate in eastern Japan, the nationwide electricity outlook remains uncertain. Since Chubu Electric Power (located in western Japan) recently suspended operations at its Hamaoka nuclear plant due to safety concerns, fears have risen that if other nuclear plants currently offline for inspections are unable to restart due to safety issues, this could lead to renewed power constraints for the rest of the country as peak summer demand approaches.
Third, following a 27-week buying spree, foreigners have purchased nearly $60bn of Japanese equities, surpassing their last buying wave between December 2009 and April 2010. With foreigners now "longer" Japan, we think significant positive surprises will be necessary to trigger further buying near term.
On a medium-term view, however, we expect the Topix index to rally back to the pre-quake high of 970 within the next 12 months, driven by supportive valuations and a 22 per cent EPS rebound fuelled by reconstruction demand and exports.
Compared with the 1995 Kobe earthquake when price to earnings multiples traded at 77 times, the full-year 2012 p/e currently stands at a more globally comparable 13 times. In terms of reconstruction, the government has approved a $50bn supplementary budget, and a second budget totalling $125bn is expected this summer.
Since the earthquake, the Bank of Japan has conducted sizeable fund supply operations and expanded its asset purchase programme by 14 per cent to $500bn. The BoJ has stated that, if necessary, it will take further steps to ease policy.
Contrary to popular opinion, we believe the disaster will accelerate - rather than delay - Japan's exit from deflation. We see reconstruction demand and exports driving gross domestic product growth to an above-trend pace of 2.5 per cent in 2012.
Since above-trend growth should narrow Japan's output gap, this - along with our medium-term forecast of firm commodity prices - should allow core inflation to turn positive as early as the current (April-June) quarter.
Furthermore, the earthquake has triggered a surprising surge in loan demand as Japanese companies shift from "just-in-time" to "just-in-case" inventory management and diversification-driven capital spending. Regional bank lending started growing in March, and that of city banks will likely follow. Positive inflation and loan growth should drive 10-year Japanese government bond yields up to around 1.9 per cent by the second half of 2012, resulting in a steeper yield curve.
As for the yen, while post-earthquake G3 intervention allowed the yen to depreciate temporarily, the combination of softer US macro data, dovish Fed statements, and a rally in US Treasuries have caused the currency to return to the Y80 level against the dollar.
Although some expect more intervention to come, we are sceptical. The Japanese authorities' rationale for intervening after the earthquake was to curb excessive currency volatility as well as speculation regarding repatriation. This time, however, the yen's rise has been gradual and driven more by dollar weakness than yen fundamentals. We expect yen strength to persist near term, although wider US-Japan rate differentials should drive the yen lower towards Y86 on a 12-month view.
Most investors have little doubt about Japan's ability to heal post this disaster. The more difficult question is what happens after the recovery? In our view, the government urgently needs to construct a post-recovery vision. Before the earthquake, there was serious discussion about Japan pursuing free-trade agreements such as the Trans-Pacific Partnership (TPP) and much-needed pension and healthcare reforms. Will Japan use this crisis as an opportunity to accelerate reforms or as an excuse to delay them?
At the minimum, the private sector is unlikely to wait for the government. Since the disaster has exposed the danger of concentration risk, firms previously reluctant to shift production offshore are now likely to accelerate such plans. With the strong yen boosting purchasing power, outbound M&A should expand from here.
However, to offset the inevitable effects of hollowing out, the government needs to actively promote growth strategies such as commercialising its leading edge alternative energy technologies, deregulating healthcare, boosting labour participation of females and immigrants, and implementing incentives to attract inward foreign direct investment.
Market participants have argued for some time that it will take a cataclysmic event to drive structural change in Japan; now the world is watching.
And Goldman's hit job of China:
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