Friday, October 5, 2007

[MORGAN STANLEY] ASIA/PACIFIC MORNING MEETING SUMMARY & DOWNUNDER DAILY & ASIA/PACIFIC WEEKLY PREVIEW & FX PULSE

DOWNUNDER DAILY : COPING WITH DOWNGRADES - GERARD MINACK

To get bearish equities requires earning downgrades. As I've discussed before, I think we have an earnings bubble, not a PE bubble, and what will pop an earnings bubble is growth and earnings downgrades. The question is: how big do the downgrades have to be?
That's a pertinent question because, historically, equity markets have coped well with downgrades. In fact, the past 25 years has seen persistent earning downgrades with persistent equity gains. Exhibit 1 shows 3-month revisions to the one year-ahead consensus forecasts for S&P500 earnings per share and S&P performance.
Consensus forecasts have an astounding history of being wrong. Exhibit 5 (on page 2) shows the full history of IBES consensus EPS forecasts for the S&P500, with the initial forecast for each year set to 100. Forecasts were downgraded without exception every year up until 2005. Remarkably, the consensus forecasts were initially upgraded only twice, in 1990 and 2001, both of which proved to be recession years.
In that context, the recent history of upgrades is exceptional: 2005, 2006 and, it seems, 2007 were the first 3 years ever to see sustained upgrades. Why analysts turned from perennial optimists to perennial pessimists is unclear. It may be embarrassment, or the Spitzer blow-torch - or it may simply be that the cycle has been unexpectedly strong. Certainly, the link between revision to year-ahead forecasts and cycle indicators, such as the ISM index, has remained intact (Exhibit 2).
This raises one question, however: while investors may have been able to cope with downgrades when downgrades were the norm, will they be more sensitive to downgrades after four years of persistent upgrades? I don't have a strong view on this - I only flag it as an issue that will need to be tested.

ASIA/PACIFIC WEEKLY PREVIEW: HOW WOULD ASIAN CENTRAL BANKS RESPOND? - DENISE YAM

China - Sep Money Supply (Oct 9-16) & Sep Actual FDI (Oct 11-17): We expect that money supply (M2) growth in September may have slowed to below 18%YoY from 18.1% in August, reflecting a series of monetary tightening measures taken by the PBOC, including RRR hike and interest rate hike. A below 18% growth should contribute to managing inflationary expectations, as it would be representing a decline in money supply growth in two consecutive months. Looking ahead and based on our reading of the PBOC Monetary Policy Committee 3Q policy statement, we expect further rate hikes, faster appreciation of the Renminbi, and tighter credit in the remainder of the year. Actual FDI inflows in September may have been stable at about US$5 bn. With the economy awash with liquidity, policy implementation in practice has been biased against attracting capital inflows.
India - Aug Industrial Production (Oct 12): Industrial production growth reached 7.1% in July 2007 as compared with 9% in June 2007. Early indicators (two and four wheeler sales) point to 8-9% IP growth in August.
Indonesia - Monetary Policy (Oct 8): Depreciation pressures on the currency have stabilized post the US Fed's 50bps cut. Portfolio flows have normalized and the stock market has rebounded. However, inflationary pressures still remain firm. With the Central Bank having executed on the bulk of its monetary loosening, we believe it is likely to adopt a cautious wait-and-see approach and keep rates on hold for the time being. Further rate cuts would depend on continued recovery in risk-taking appetite, which would have an appreciation effect on the currency and in turn, exchange-rate pass-through to inflation.

FX PULSE: LA GRADNEUR - GLOBAL CURRENCY RESEARCH TEAM
G7: Any Gunpowder Behind the G7? In our view, the G7 is unlikely to make any meaningful changes to its statement at its upcoming meeting (19 Oct). Following the escalated rhetoric from European officials, we expect this may come as a disappointment and reinforce the recent trend of USD weakness.
USD: US Stagflation, Global De-Coupling and the Dollar. We don’t believe the US will fall into a recession, or that, when the US economy reasserts itself, inflation will be a risk for the global economy. We challenge the increasingly popular view that the US could fall into a recession and experience inflation. The dollar will likely stay on its back foot for a while, but investors should remember that the dollar is undervalued and ready to appreciate once the economy regains traction.
JPY: Japan Post Is Another Structural Headwind for JPY. The Japan Post privatisation programme will, we believe, have meaningful effects on the financial markets and JPY in coming years. The Yucho Bank and Kampo, two of Japan Post’s key entities, will likely sell JGBs. Kampo will likely raise its exposure to foreign securities and buy more equities. This will form another structural headwind for the JPY.
IDR: The Bad News Behind the Rally. The IDR may be rallying against the USD, but an inflation surprise has taken root in Indonesia. The policy response that Bank Indonesia (BI) now chooses will determine whether the IDR rally will be sustained or not.
ZAR: Beware of Politics. We maintain our cautious stance on the rand due to likely increasing political risk, still-lingering external imbalances and potentially little support provided by the expected SARB rate hike.