CLSA's Chris Wood latest Greed and Fear is out, and in his latest discusses virtually all the critical issues that are at the forefront of investor minds, namely QE3, the next collapse in the GSEs courtesy of the current housing bubble, any signs of releveraging in the private sector, a potential rise of capex in corporate America (not sure where he is seeing this), insolvent states, Japan, which he thinks may be an reflationary alternative to gold (as Dylan Grice has claimed in the past) and last but not least, his disagreement with Goldman's take on China, which he believes is still an attractive investment opportunity.
Greed & Fear
There is now scope for the consensus to move away from GREED & fear’s view that the emerging market asset class will be the major beneficiary of the second version of quanto easing, just as it was of the first version. If that occurs it is likely to be reflected in growing hopes for a US economic recovery.
GREED & fear’s fundamental view remains that there will continue to be no Fed rate hike and that, sooner or later, Billyboy will be implementing a third wave of quanto providing American politicians allow him to do so.
If Billyboy succeeds in precipitating releveraging of the US economy he will for a time at least be treated as a hero until the subsequent collateral damage of his policies becomes obvious. Still GREED & fear has yet to come up with any hard evidence that releveraging is about to happen.
The one area where lending standards have been dramatically loosened since the crisis is Ginnie Mae-guaranteed Federal Housing Administration (FHA) loans. This will lead in due course to a new subprime mess for taxpayers to bailout. But for now the deterioration in FHA loan quality is being disguised by the rapid growth of loans in this area.
The latest quarterly Fed survey of senior loan officers does not show a marked easing in lending standards nor a pick up in demand for loans. GREED & fear also does not detect from domestic US invertors specialising in financial stocks any real optimism from a bottom-up perspective that banks are about to increase lending in a significant manner. Rather the expectation is that profits will continue to be derived from playing the spread and investing in fixed-income securities.
GREED & fear will continue to wait for concrete evidence before assuming private sector releveraging is occurring in the US economy. One potential piece of good news GREED & fear would bet on is an extension of the Bush tax cuts. Investors should assume this will happen, though it is not a given, since a deflated Obama is clearly ready to compromise on this issue.
The other most plausible piece of good news is evidence of a broadening out of capex beyond the hitherto cost-cutting motivated focus on high tech spending. More momentum on capex from a cashed up corporate sector is the best hope for the American economy. But even if that occurs, which is a big if, GREED & fear does not believe it will provide a solution to the socialised morass that is America’s housing market.
Another problem that may start to occupy more of the attention of financial markets is the condition of individual states’ budgets. The critical issue now is that the stimulus money from Washington is drying up. Where Republicans have gained control of state capitols they also plan to launch attacks on public sector workers who enjoy benefits increasingly no longer available in the cost-cutting private sector.
Successful releveraging would mean normalisation of US interest rates, which would in turn mean relative underperformance by Asia and other emerging markets. In such a macro context the stock market that would perform best globally would be Japan since the discounting of higher US short-term rates would mean a sharply weaker yen.
Investors who disagree with GREED & fear and believe QE2 will work should buy the Japanese stock market now. Similarly, those investors who do not believe it will work but think the market will think it will work for a while before hopes are dashed once again should also buy Japan now.
The investment in India’s IRB Infrastructure in the Asia ex-Japan thematic portfolio will be removed and replaced by Hyundai Motor. The investment in Shiseido in the Japanese portfolio will be removed with 2ppts added to Fast Retailing and 1ppt each to Unicharm and Mitsubishi Corp. The investment in East Japan Railway will also be removed with 1ppt each added to Canon, Fanuc and Mitsubishi Corp. As for the relative-return Asia Pacific ex-Japan asset allocation, the weighting in Korea will be increased by 1ppt to neutral with the money taken from India.
Despite the rising Chinese inflation data and the latest hike in Chinese banks’ reserve requirements, GREED & fear continues to recommend an overweight in China in the relative-return portfolio based on the assumption that the policy stocks, such as bank stocks and insurance stocks, are due a catch up trade with money rotating out of highly rated food and consumer stocks where profit margins are threatened by rising food prices. Chinese banks remain one of the few “cheap” areas left in blue chip Asia.
A remarkable development this week is World Bank President Robert Zoellick calling for the global monetary system to be reformed to include some linkages with gold. This is an important development since it is the first explicit acknowledgement by a mainstream American official that the global financial system needs some fundamental discipline.