Left Brain Right B - the DBS Vickers Securities Equities Research

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Regional Equity Strategy 4Q 2009 Strategy Overview: Asia Equity demand is there. No doubt, restocking won’t last forever (it’s a zero-sum game over several quarters). We thus expect above-average GDP growth in Q3 and Q4 will give way to slower growth of 2.5% – 2.75% over the course of 2010. Economic normalization is being aided by normalization in financial markets. Equity markets are at 2009 highs, risktaking is resuming and Libor spreads over expected policy (OIS) rates – a key proxy for how frozen credit markets have been since Aug07 – are now back below pre-crisis levels. US – three month libor and spread over OIS percent 6.0 5.0 4.0 3.0 2.0 1.0 3m libor (LHS) Spread over 3m OIS (expected policy rate) (RHS) Back to pre-crisis levels basis points 0.0 0 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Fed Economic and financial market normalization eventually bring normalization from the Fed. The Fed has begun to talk about its exit strategies and with the data coming as strongly as it is, it won’t be long before the Fed has to walk the talk. The main, indeed the only thing holding the Fed back from implementing an exit strategy right now is labor markets. Jobs continue to be shed from the economy at a rate of about 215k per month. Although this is far less than the peak of 740k job losses back in Jan09, the unemployment rate remains high at nearly 10%. It would be unacceptable politically for the Fed to begin hiking while the unemployment remains this high and while jobs continue to be lost rather than gained. Continued job losses in the early stages of a recovery are normal and we expect nonfarm payrolls will not turn positive until about November. Other things equal, this is 400 350 300 250 200 150 100 50 when the unemployment rate should peak as well and start to fall thereafter. Historically, only when job growth has become well entrenched has the Fed begun to tighten policy. We continue to think that the second quarter of 2010 is the best target date for when the Fed is likely to begin raising interest rates. That would be early by historical standards. The Fed often waits a year or more after the unemployment rate starts to fall before raising rates. But we have never regarded this downturn as the garden-variety sort. Rather we have looked at it as “shell-shock” arising mainly from the panic associated with the Lehman Brothers debacle and have always expected the sharp upswing that is now under way. That upswing will continue, we think, leading the Fed to tighten well before it has historically. We expect 50bps of hikes in 2Q10 followed by another 50bps in 3Q10 and for rates to normalize / rise more quickly thereafter. Longer-term risks The ‘real’ recession in the US began with the collapse of Lehman Brothers a year ago. But if recession is over as Bernanke believes and it ended in June or July as the NBER will likely declare six months hence, the biggest financial crisis in 100 years will have engendered a 9 month recession. That’s about as short as US recessions come. It’s tempting to say that this was all a tempest in a teacup and that everything’s hunky dory nine months on. It’s not. Bailing out banks schmoozed the US through this crisis but that is not the correct lesson to take forward. Precisely the opposite. Bailing out banks at public expense is bad capitalism because it sews the seeds of a repeat crisis and for the simple reason that it’s unfair to the taxpayer. Good capitalism puts risk and reward on the same shoulders. Reform of financial markets is needed and until it is delivered risks will remain for a similar blowout in the future. It’s not a near-term risk, mind you; memories are not that short. But bailing out banks does not solve the problem and the biggest risk out there may be that people come to believe it is. Page 27
Regional Equity Strategy 4Q 2009 Strategy Overview: Asia Equity Hong Kong: Inadequate price adjustment (Chris Leung, chrisleung@dbs.com, extracted from “Economics – Markets – Strategy, 4Q09” dated 17 September 2009) • While a low-interest rate environment may be instrumental in driving a quick economic turnaround for Hong Kong, the strong inflow of liquidity from mainland China as a partial result of its lax credit policy may play even a bigger role. Downward price adjustment in the current downturn have been the mildest amongst other major crisis in the past decade • Unlike the 97/98 Asian Financial Crisis where asset prices endured a free fall, the quick turnaround in asset prices this time round has helped prevent the labor market from deteriorating rapidly. Following the credit crisis, unemployment was widely expected to climb in similar fashion to the Asian Financial Crisis. However, this did not materialize. Stabilization of the labor market has significantly reduced consumers' fears • The multi-year deleveraging process post-1997 and the concomitant buildup of wealth in the past decade have developed a strong cushion for Hong Kong against exogenous shocks. The rise in the current account surplus as a share of GDP from 4.1% in 2000 to 14.2% in 2008 is one solid indication of this wealth accumulation. Fiscal reserves as a share of GDP also exceeded 30% in FY07/08 before the onslaught of the credit crisis. Against this backdrop, the Hong Kong economy should be able to weather the storm, especially with support from the strong Chinese economy • In the near-term, both the Fed and the PBOC are likely to refrain from raising interest rates, not until they see sustainable domestic-demand recovery. Assuming growth of 10% (QoQ, saar) and 5% in 3Q09 and 4Q09 respectively, our real GDP growth projection for 2009 has been revised upward to - 2.4% YoY, from -6.5% previously. Growth should come to 5.5% in 2010 • Once China restores the appreciation bias on the CNY (possibly in 2010) inflows are likely to present the usual problems for local inflation Challenges ahead Like the rest of the world, Hong Kong has been counting on both the US and China to lead the global economy out of the woods. In the latest G7 meeting, policymakers pledged to keep monetary policy accommodative until they see sustainable domestic-demand recovery. The PBOC will refrain from raising interest rates too soon. A low-interest rate environment alongside previous wealth accumulation will continue to help support property prices. If the real estate sector was able to sail through the recent crisis, there is even less reason to expect a substantial downward correction now that the global economy is on a recovery path. If property prices do not adjust downward, other prices will remain sticky. Many are projecting that CPI inflation will return to the positive territory by the first quarter of next year. Once China restores the appreciation bias of the CNY, possibly in 2010, inflows will present the usual inflation problems for Hong Kong. However, wage/salary growth will likely be absent for at least two years. In fact, we will probably see downward adjustments in future payroll data, as suggested by the popular adoption of "no pay leave" by many business enterprises. Corporates must see earnings improve visibly before they will want to hire again. Salary growth will also only resume after corporate balance sheets improve. In the meantime, the financial burden will fall disproportionately on the middle class. Under our growth assumptions of 10% (QoQ, saar) and 5% in 3Q09 and 4Q09 respectively, our full-year GDP projection for 2009 now comes to -2.4% YoY , up from a previous forecast of -6.5% YoY. We expect the economy to grow a further 5.5% in 2010. However, these figures do not reveal the structural challenges ahead. Current Account balance % of GDP 16 14 12 10 8 6 4 2 0 Latest: 2008 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Page 28 “This report has been re-printed with permission from DBS Group Research (Regional Equity Strategy) of DBS Bank Limited” disclosures on page 37 of this report
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Left Brain Right B - the DBS Vickers Securities Equities Research

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