Investment Intelligence - Emerging Market Opportunities

Energy Watch: As the financial crisis eases, an energy shortage lies ahead

2009-07-01T17:33:00.000-07:00

Energy Watch: As the financial crisis eases, an energy shortage lies ahead

Goldman Sachs Global Economics, Commodities and Strategy Research June 3, 2009

Commodities Energy Watch

As the financial crisis eases, an energy shortage lies ahead With a credit dislocation in timespreads reversed and the risk of breaching storage capacity reduced, we are raising our oil price forecasts. Because the recent rally was driven mostly by credit normalization, the market has not yet priced in an economic recovery.
The credit normalization rally before the economic recovery rally WTI prices rallied to our end-of-year target of $65/bbl by the end of May, as timespreads strengthened in the face of rising inventories. In our view, this unusual behavior, suggests that the rally was driven by the unwinding of pricing dislocations caused by the credit crisis and the avoidance of breaching storage capacity.
Because this rally has been largely a reversal of pricing dislocations, we view it as the prologue to the rally in WTI prices that we continue to expect will accompany the economic recovery. With the risk of further pricing dislocations reduced, we are omitting the prior anticipated price pullback from our forecasts and have raised our 3-month ahead price target to $75/bbl from $52/bbl.
From financial crisis back to energy shortages The recent rally in WTI prices is likely to be but the first stage in the oil price rally that we expect will accompany a recovery in economic activity. In all, we expect the rally we have just observed to be followed by three more stages, creating a four-stage rally in oil prices in 2009 and 2010:
2009H2: A cyclical bull market as the economy stabilizes and OPEC maintains cuts to draw inventories to 10-year average levels. We are raising our end of 2009 WTI price forecast to $85/bbl from $65/bbl.
2010H1: A structural bull market as long-dated prices rise to motivate renewed Non-OPEC production capacity investment while OPEC spare capacity returns to the market in an attempt to bridge the gap. We are raising our 12-month WTI price target to $90/bbl from $70/bbl.
2010H2: A likely return to energy shortages as dwindling OPEC spare capacity is likely unable to meet rising demand as Non-OPEC production growth is restricted by limited investment in oil production infrastructure. We are introducing an end 2010 WTI price forecast of $95/bbl.

Daily Economic Briefing

2009-07-01T10:12:00.001-07:00

We continue to make significant forecast changes. Revisions have been focused in the current quarter in Asia, reflecting a boom in IP growth. Last Friday, we raised our forecast for 2Q GDP growth in EM Asia to above 10%q/q, saar. Today we boosted our 2Q forecast for Japan to 4.5%. The main reason for the revisions is that Asian manufacturing output has boomed (probably about 35% annualized), in good part because of a surge in exports and because companies are liquidating inventory at a less rapid pace. There also are signs of stronger domestic demand in Asia. China stands apart, but data indicate that consumption is rising elsewhere as well (e.g., today’s reports on household spending in Japan and Korea). Inventory dynamics and a brighter forecast for the US and Europe (see below) suggest upside risk to Asian forecasts for 3Q as well.
• In the US and the Euro area, we revised down GDP growth for the current quarter, but up for the second half. Manufacturing output has yet to turn in these regions, where final sales are still falling (albeit much less rapidly) and the inventory adjustment remains intense (the US inventory dump is being exaggerated by developments in the auto industry). GDP is expected to lift in 3Q, however, as sales firm and companies destock less rapidly, following the pattern in Asia. Last Thursday we raised our forecast for US GDP growth to 2.5% in 3Q; today our Euro area team raised their 3Q forecast to 1.5% (from 0.0%) and their 4Q forecast to 2% (from 1.0%).
• The Conference Board’s index of US consumer confidence stumbled in June, falling from 54.9 to 49.3, after surging almost 30pts in the previous two months. The report tempered the more upbeat reading from the University of Michigan and stoked investor anxiety about the path of consumer spending.
• There were more hints that the slide in US house prices is moderating. The Case-Shiller index fell 0.9%m/m (sa) in April, on the heels of 2% declines in the previous seven months. The FHFA house price index more or less has stopped falling altogether. That said, barring an upturn in sales, prices likely will remain under downward pressure in the near-term from excess inventory. In the UK, the evidence for a recent stabilization in house prices is stronger (e.g., today’s Nationwide release), although our team remains skeptical of its staying power.
• The June business surveys continue to look upbeat, with today’s Japan PMI and Shoko Chukin indexes up solidly, along with the BoK’s survey in Korea, and US regional Fed surveys from Chicago and Milwaukee. Our manufacturing PMI is out tomorrow; there is a good chance the new orders index will top 50 for the first time since March 2008.

GS OVERNIGHT WRAP JULY1 - ROCK CLIMING: DJIA -0.9% @ 8447 | S&P500 -0.8% @ 919 | GOLD SPOT -1.4% @ $927 | CRUDE SPOT -2.3% @ $69.8

2009-07-01T10:10:00.000-07:00

HIGHLIGHTS
World Bank Zoellick - Economic recovery still uncertain
Kansas City Fed Hoenig - Taking on "too big to fail" key for reform
St. Louis Fed Bullard - Deflation risks easing but not gone
Chicago PMI for June rises to 39.9 from 34.9 – better than expected
US consumer confidence for June drops to 49.3 from 54.8 – weaker than expected
% Change 1-Jul-09 Last Trade Change % Change High Low YTD DOW JONES 8447 -82 -0.97% 31.06 -135 -3.75% S&P 500 919 -7.91 -0.85% 2.78 -14 1.78% NASDAQ 1835 -9.02 -0.49% 10.63 -19 16.36% RUSSELL 2000 508 -2 -0.46% 3.23 -4 1.77% FTSE 100 4249 -45 -1.04% 17.20 -63 -4.17% NIKKEI 225 9958 175 1.79% 216.83 111 9.54% ASX 200 3955 68.00 1.75% 68.60 0 6.25% NYSE Volume 1.32 b

Alamo Economic Actual Consensus Prior Revised From S&P/Case-Shiller Home Price Index Apr -18.12% -18.63% -18.72% -18.70% Chicago PMI Jun 39.9 39.0 34.9 -- Consumer Confidence Jun 49.3 55.3 54.8 54.9
US Market
U.S. stocks slid as a surprising drop in a gauge of consumer confidence sparked caution about the economy's recovery prospects, hurting industrial, technology and energy shares.
Among industrial stocks, shares of Caterpillar, a maker of bulldozers and excavators, slumped 4.7%, while on the technology front, IBM tumbled 1.4%.
Sliding oil prices gave investors a reason to sell some energy shares, with Exxon Mobil down 1.3% at $69.69. The S&P energy index fell 0.9% as risk aversion resurfaced after the confidence data and helped lift USD.
For the quarter the Dow rose 11%, the S&P rose 15% and the Nasdaq rose 20% while the VIX dropped 39%.
S&P still finished +15% for best quarterly performance since 1998…however US mkts took a dive on concern over the health of the consumer.
The consumer confidence had risen each month since Feb (increased by 30pts in past 4mths) but today's print suggests the shopper's enthusiasm appears to be leveling off. GS think the recent run-up in gas prices played a key role in this fall. But in combination with the personal savings rate rising to 15yr highs (last week)…alludes to a more frugal national attitude on spending (which shouldn’t really be viewed as a negative!!!).
In housing, home prices continued to fall in April, however the rate of decline slowed. Delinquency rates on the least risky mortgages more than doubled in the 1Q from a year earlier…
Prime mortgages 60 days or more past due climbed to 2.9%, from 1.1% at the same point in 2008.
Ford +2.3% bucked the trend of falling consumer stocks, after saying it has begun to capture market share following the bankruptcies of both GM and Chrysler.
AIG -13% after AGM where commented that impact of previous CDS sales may impact the business for longer than anticipated.
George Soros predicts a stop-go economy for the US, saying fears on inflation will drive up interest rates and choke off growth
Participants sent all 10 major sectors in the S&P 500 into the red following the release of the June Consumer Confidence Index, which came in at 49.3 to miss expectations and mark a decline from the previous reading. Meanwhile, the Expectations Index also missed expectations and declined from the previous reading.
Materials stocks were among the hardest hit sectors this session. They shed 1.3% as steel stocks (-1.8%) showed weakness after Schnitzer Steel (-12.2%) reported some disappointing quarterly earnings results and other basic commodities prices were weakened by a stronger dollar. The greenback's 0.4% gain helped send gold prices $10.30 lower to $927.65 per ounce and oil prices down 2.24% to $69.89 per barrel. Still, both the CRB Commodity Index and the materials sector gained roughly 16% during the second quarter.
Financials saw the best gains of any major sector during the second quarter. The sector shrugged off today's 1.1% loss to finish the quarter with a 44% gain.
Leadership from the financial sector helped the S&P 500 post a second quarter gain of 15% which marks a rebound from the first quarter's near -12% decline and the near -24% drop registered in the fourth quarter of 2008. Still, the second quarter rebound is the best quarterly performance since the fourth quarter of 1998.
Such strong gains have many market watchers calling for a pullback in stock prices. However, such consolidation could also be accomplished with stocks moving sideways for an extended period of time. To that point, the S&P 500 finished June flat; or up just one-fifth of a point, to be exact.
Bonds U.S. government bonds were slightly lower (10 Years 3.53% +5) as weaker stocks kept a floor under safe-haven Treasuries while thin trading conditions left the market choppy.
However bonds took a swift u-turn upon the release of the consumer confidence data and as equities fell, returning to pre-open levels. Corporate related flows of rate-lock unwind-buying also providing late support to the market.
Consumer confidence index fell to 49.3 in June from 54.8 in May. Forecasts were for a reading of 55.0 for the month. S&P/Case Shiller home price index dipped 0.6%(y-o-y -18.1%) which was far less dire than the 1.8% decline forecast.
Chicago PMI was slightly better than forecast at 39.9, though still indicating weakness. NY-NAPM index of current business conditions tumbled to 44.8 in June from 61.3 in May, while the six-month outlook index rose to 58.3 from 56.1.
Dow move last night

CCCP EUROPE FTSE: -45pts (-1%) DAX: -76pts (-1.6%) CAC: -53pts (-1.7%) Eco: UK GDP for Q1 -2.40% q/q and -4.90% y/y - lower than expected. UK GfK Consumer Confidence Survey for June -25 - in line with expectation. Mkt: Euro Stoxx -1.3%. Market was just a bit underwater for most of the day but collapsed in the last hour and half or so of trading when US consumer confidence and mortgage delinquency stats were disclosed.
Newsflow in UK wasn't that flash (sharper UK GDP decline, Swiss economy faltering, Lloyds 2k job cuts, HSBC chairman comments (said that the world financial and economic crisis is “far from over” two years after it began)) so market was doing well to hold ground initially.
UK economy shrinks most in 50 years and UK consumer confidence increased to the highest level in 14 months in June as shoppers became more optimistic that the recession is past its worst.
Swiss economy may have slowed further in Jun qtr - Switzerland’s recession probably deepened in the second quarter after the economy contracted at the fastest pace in almost 15 years in the previous three months.
Sectors: Banks +0.3%...Insurance -0.5%, Energy -0.5%, Retail -0.7%, Miners -1.6%, Airlines -1.7%
UK house prices rise for a second month U.K. house prices unexpectedly increased for a second month in June on Nationwide Building Society’s measure, adding to signs that the worst of the property slump is over. The average cost of a home climbed 0.9% to £156,442 after rising 1.3% in May, the mortgage lender said in a statement today. Economists predicted a 0.5% drop, according to the median of 16 forecasts in a Bloomberg News survey. From a year earlier, prices fell 9.3%, the smallest annual drop since July 2008.
Resources LME: Copper -2.6%, Aluminium -0.6%, Nickel -2.7%, Zinc -0.7%
Resources- Were all up for most of the day in London but collapsed in the last hour and half or so of trading when some disappointing U.S data (US consumer confidence and mortgage delinquency stats) hit the tapes. BHP -0.5% (ADR’s -1.2% to $33.95), RIO -2.2%, Anglo -2.7% & Xstrata -2.2%. In news, the FT reported that China and the world’s largest miners failed to agree on the annual price of iron ore by Tuesday’s deadline.
Oil- Tumbled from an 8 month high as U.S consumer confidence declined in June, indicating lower fuel demand. Oil dropped -2.2% after the Conference Board’s sentiment index unexpectedly weakened and delinquencies on the least risky U.S mortgages more than doubled. Oil also retreated on forecasts that U.S fuel supplies rose last week.
Commodities last night LME METAL PRICES ($/lb) Last Chg % Chg LME Aluminium 72.43 -0.46 -0.64% LME Copper 224.47 -6.07 -2.63% LME Lead 75.77 -0.62 -0.82% LME Nickel 693.59 -19.14 -2.69% LME Zinc 69.06 -0.50 -0.72% GOLD Spot $/oz 927.4 -13.30 -1.41% S&P 500 GOLD INDEX 96.22 -3.43 -3.44% S&P/TSX GOLD INDEX 2631.52 -75.24 -2.78% CRUDE OIL - Spot 69.82 -1.65 2.30% CRUDE OIL - 6M 73.13 -1.38 -1.85% S&P OIL & GAS INDEX 381.44 -3.03 -0.79%
COMMENTS Markets climbed the wall of worry this quarter. S&P500 records its best performance since 1998. Yet the month ends in a fizzle and those that chase moment whether in equities, FX or commodities – all are going home expecting trouble in the summer. The June performance for equities was lackluster – we see shares down almost 1% today and flat on the month, DJIA was down 0.6% for June. The 2Q S&P500 is up 35.9%. You can find a similar story in bond yields as they move from 2.5% to 4% in US 10Y or the USD as it moves from EUR 1.25 to 1.40. Yet today wasn’t about the data – which proved confusing to some as the Case-Shiller home price index showed a modest month-on-month improvement even while prices continued to be down 18% y/y. The consumer confidence got worse – and was well below expectations even as inflation outlooks went up and jobs proved harder to find. Net the downturn on the day whether it was in equities or commodities all proved to be joined at the hip again. Oil up 3% yesterday goes down 2% today. EUR goes from 1.4150 this morning to 1.40 this afternoon. Bonds moved lower most of the day as profits were taken ahead of a new month, more supply and some doubts about the ability of the FED to find a good exit and the US Treasury to hold back debt. The political story remains behind many markets and in the US the news came from the Senate with Minnesota finally getting a second Democrat Senator Franken and with it the 60 seat majority in the Senate – effectively filibuster proof. What have we learned today or this month? The constructive mood of expecting a cyclical recovery for 2H appears to be priced and the fat tails of failing off the mountain have been removed. As the speakers on the day underscored – things not getting worse doesn’t mean they are getting better. So we move from June to July with trepidation – like a rock climber reaching for the next rope and praying the anchor holds. Investors have a blind faith that they will make it to the next time – yet consumers have no such hope and there was the day. FX saw the USD gain on month-end flows and a return of doubt as risk on flipped modestly to risk off. The twist is that no one was concerned about a carabineer cracking or a rope snapping as we see another drop in FX volatility. The new outlook for summer is for modest ranges and quiet trends – leaving money with out momentum but also without the fear that has gripped most since last September. So investors are climbing the wall of worry as consumers watch anxiously pulling back from the next ascent until we see some confirmation that not worse means truly getting better. The overnight data set will be the first storm to survive with Tankan, Chinese PMI and Korean Trade all key parts for building out the view that the rest of the world will remain on track for a bounce as well. But expect the ISM, ADP and European PMIs to steal the show – all told being on the face of a mountain expecting a shift in weather is no place to expect calm. Perhaps we should be looking for another rope just in case.
CURRENCIES Cross Low High USD/EUR 1.4 1.4148 Close: 1.4042 JPY/USD 95.79 96.52 Close: 96.35 JPY/EUR 134.88 135.75 Close: 135.2947 USD/GBP 1.6422 1.6618 Close: 1.6465 GBP/EUR 0.8502 0.8536 Close: 0.8528 CHF/USD 1.0783 1.0891 Close: 1.0857 CHF/EUR 1.523 1.5268 Close: 1.5245 USD/AUD 0.8039 0.8156 Close: 0.8074 CAD/USD 1.1511 1.164 Close: 1.162 NZD/USD 0.6438 0.6535 Close: 0.6461
CURRENCY VOL Cross 1m RR 1m Vol 1y RR 1y Vol ARS/USD 5.0000 11.0000 15.0000 27.0000 AUD/USD 0.7000 17.7500 2.0000 18.0000 BRL/USD 4.6000 20.3000 5.6000 19.9000 CAD/USD 0.1000 14.1000 -0.0500 15.2000 CLP/USD 2.8 14.9 5.0 16.4 EUR/CHF -0.5000 5.3000 0.3000 4.6200 EUR/GBP -0.4865 11.1500 -0.7508 11.9000 EUR/JPY 1.899993 15.5000 5.149991 17.1500 EUR/USD -0.5700 12.8000 -0.6800 14.0000 GBP/USD 0.5500 14.2500 0.7000 14.5500 MXN/USD 2.7357 14.2209 5.7491 15.4973 USD/CHF 0.8700 12.4000 1.2300 13.2000 USD/JPY 1.999998 13.2500 5.099996 13.7000
FLOWS (Bonds, Equities, Commodities) US Bonds - 10 Yr UST Down 0-12+ at 96-22 -- YTM 3.525%. 30 Yr UST Down 0-17+ at 99-13 -- YTM 4.285%. DJIA Down 82.38 at 8447.00 (-0.97%) S&P500 Down 7.91 at 919.32 (-0.85%) NASDAQ Down 9.02 at 1835.04 (-0.49%). Gold Down 10.15 at 927.75 Oil Down 1.33 at 70.16.
NEWS GLOBAL
World Bank Zoellick - Economic recovery still uncertain. World Bank President Robert Zoellick said on Tuesday global financial markets have 'broken their fall' but urged caution, saying there was still a lot of uncertainty as the crisis shifts to developing countries. "There seems some opportunities for improvement on the financial market side but there is still great uncertainty about the scope and timing of recovery," Zoellick told reporters. "There are risks that could threaten the turnaround and I have emphasized the world needs to recognize that dangers will come in waves," he added.
USA
Kansas City Fed Hoenig-Taking on "too big to fail" key for reform The process needs to operate fairly and be free from political influence, or it could merely encourage new, risky behavior, Hoenig said in remarks prepared for a speech to the New York University Stern School of Business in New York. "It will not be realistic for any authority in any regulatory structure to oversee a system where incentives remain to take on excessive risk," Hoenig said. Management should be replaced at failed firms, Hoenig said. "Restructured firms must have new -- and more careful -- management and ownership." The policy-maker also decried a "dereliction of duty" among the top management of some financial firms in the lead-up to the financial crisis that helped trigger a global recession. "Far too few senior executives in these largest organizations believed it was their responsibility to understand the financial products their company was buying and trading in quantities of billions and trillions of dollars," Hoenig said. Hoenig, who is not a voting member of the U.S. central bank's Federal Open Market Committee in 2009, did not address the economic outlook in his prepared remarks.
St. Louis Fed Bullard-deflation risks easing but not gone. St. Louis Federal Reserve Bank President James Bullard said on Tuesday that the danger the United States suffer a Japan-style period of sustained falling prices had eased, but had not vanished altogether.” I think deflation risks are abating," he told reporters after a speech at a Global Interdependence Center event. He noted that inflation expectations implied by Treasury Inflation Protected Securities has recently risen back into positive territory, but said that financial markets still did not expect much inflation over the next couple of years. "I don't really think it has completely gone," he said. "If that leads to some sort of erosion, or even the appearance of an erosion, of the independence of the Fed, I think that could be very counterproductive in this environment," he said after giving his talk about monetary policy at the event. "We've got very large fiscal deficits. We've got the appearance...that the Fed is monetizing the deficit, pushing up yields. Anything that is going to erode the independence of the Fed is going to feed that expectation and drive yields higher. "So I think we are really in a delicate situation here as regards the independence of the Fed, and that is an important consideration going forward," he said in response to a question from the audience. "Without an exit strategy, expectations of high inflation may develop," Bullard said at the event, which was held at the Federal Reserve Bank of Philadelphia. "If expectations of inflation feed into today's long-term yields, those yields will rise today and hamper recovery prospects," he said in prepared remarks. "If that leads to some sort of erosion, or even the appearance of an erosion, of the independence of the Fed, I think that could be very counterproductive in this environment," he said. "We've got very large fiscal deficits. We've got the appearance...that the Fed is monetizing the deficit, pushing up yields. Anything that is going to erode the independence of the Fed is going to feed that expectation and drive yields higher. "So I think we are really in a delicate situation here as regards the independence of the Fed, and that is an important consideration going forward," he said in response to a question from the audience.
CFTC Chilton: Looking for signs of excessive speculation. "Yes, we're going to be looking at other commodities in the future and we're considering that right now, actually," Bart Chilton said in an interview with Reuters Television, noting "the energy complex, with specific emphasis on oil, is something we're very keen on." A recent jump in commodity prices could mean investors are betting on a recovery in the global economy. But other traders and analysts worry the fundamentals don't support such optimism and another bubble could be forming.
"Something is going on in these markets and it's our job to make sure it's nothing illegal. That there's not any overt manipulation to ensure that we can protect consumers so that they don't pay a high prices at the gas pump," said Chilton.
Chicago PMI for June rises to 39.9 from 34.9 – better than expected. Consensus was 39. New orders 41.6 from 37.3; prices paid 36.3 from 29.8; employment 28.9 from 25; production 39.3 from 38.1; Deliveries 43.1 from 43.
S&P Case-Shiller home prices for April -18.1% y/y – better than expected. Consensus was -18.5%. The 10 city index was -18% y/y. The April to March drop was -0.6% compared to -2.2% in March/February.
US consumer confidence for June drops to 49.3 from 54.8 – weaker than expected. Consensus was 55. Present situation 24.8 from 29.7; expectations 65.5 from 71.5; jobs-hard-to-get 44.8 from 43.9; 1Y inflation 5.9 from 5.6. Conference board called this “less negative conditions” ahead rather than “strong growth.
SSGA investor confidence index for June jumps to 115.5 from 108.5 – highest in a year. The global State Street Investor Confidence Index hit 115.5 this month from an upwardly revised 108.5 last month. The index has been above 100 -- the level considered to be neutral -- for three consecutive months, coinciding with most of the stock market rally that began in March. It has also increased every month since December. "Notwithstanding some concerns around the long-run sustainability of fiscal positions and the impact of quantitative easing on inflation, institutional investors continue to endorse the long-run outlook," said Ken Froot, co-developer of the index. Confidence was up most strongly in Europe, where the index rose to 95.0. Morale also improved robustly among North American investors, climbing 6.2 points to 113.6. In Asia, risk appetite was down slightly, with the index falling 1.3 points to 92.1. The data is extrapolated from movements in around $11.3 trillion of assets State Street holds as custodian for institutional investors.
EUROPE
Turkey Trade Balance for May widens to -3.5B – slightly wider than expected. Consensus -3.4B. Previous -2.5B.
CANADA
Canadian GDP for April -0.1% - ninth consecutive drop. This was as expected. Manufacturing output fell 1% - also the ninth drop – all linked to weaker exports. Energy sector fell 0.5% - third straight decline.
Canada Industrial Product Price for May declines to -1.1% m/m – worse than expected. Consensus -0.6% m/m. Previous -0.5% m/m. Canada Raw Materials Price Index for May rises to +2.2% m/m – higher than expected. Consensus +2.0% m/m. Previous -0.3% m/m, revised from -0.5% m/m.
ECONOMIC/POLITICAL EVENTS EXPECTED FOR WEDNESDAY: GS forecast Consensus Previous Wednesday, July 1: AUD and NZD 19:30 Australia AiG Performance of Mfg Index for June 37.5 21:00 Australia DEWR Skilled Vacancies for June -7.0% m/m 21:30 Australia Retail Sales s.a. for May +0.3% m/m 21:30 Australia Building Approvals for May +4.0% m/m +5.1% m/m -16.1% y/y 1:30 Australia RBA Commodity Index SDR for June -23.3% y/y 4:30 New Zealand PMI Manufacturing for June 46.1 45.4 4:30 New Zealand Index of Services for April -1.2% 3m/3m Japan 19:50 Loans & Discounts Corp for May +3.0% y/y 19:50 Tankan Lge Manufacturers Index for Q2 -42 -43 -58 19:50 Tankan Lge Mfg Outlook for Q2 -34 -51 19:50 Tankan Non-Manufacturing for Q2 -27 -31 19:50 Tankan Non-Mfg Outlook for Q2 -23 -30 19:50 Tankan Large All Indust Capex for Q2 -6.90% -6.60% 1:00 Vehicle Sales for June -19.4% y/y Europe 4:00 Euroland PMI Manufacturing for June 42.4 42.4 2:00 Germany Retail Sales for May +0.1% m/m -1.4% y/y +0.5% m/m -0.8% y/y 3:55 Germany PMI Manufacturing for June 40.50 40.5 3:50 France PMI Manufacturing for June 45.5 3:45 Italy PMI Manufacturing for June 42.50 41.1 12:00 Italy New Car Registrations for June -8.6% y/y 13:00 Italy Budget Balance for June -7.6B 13:00 Italy Budget Balance YTD for June -56.1B 2:30 Sweden Swedbank PMI Survey for June 45.00 43.7 3:30 Switzerland SVME-Purchasing Managers Index for June 41 39.8 UK 4:30 PMI Manufacturing for June 46.4 45.4 4:30 Index of Services for April -1.2% 3m/3m US and CAD Chicago Fed President Evans to speak in London 17:00 US ABC Consumer Confidence -47 -53 7:00 US MBA Mortgage Applications 6.60% 7:30 US Challenger Job Cuts for June +55.2% y/y +7.4% y/y 8:15 US ADP Employment Change for June -375K -532K 10:00 US ISM Manufacturing for June 44 42.8 10:00 US ISM Prices Paid for June 46.7 43.5 10:00 US Construction Spending for May -0.5% m/m +0.8% m/m 10:00 US Pending Home Sales for May +1.1% m/m +6.7% m/m 10:00 US Pending Home Sales for May +3.3% y/y 0:00 US Total Vehicle Sales for June 9.8M 9.9M 0:00 US Domestic Vehicle Sales for June 7.4M 7.4M No Canada Releases (by courtesy of my sales colleague Robert Savage and Richard Coppelson)
GOOD LUCK `

China: An Exit Strategy for the Renminbi

2009-06-29T08:52:00.000-07:00

China: An Exit Strategy for the Renminbi

The Renminbi exchange rate has entered a de facto new regime - featuring a quasi-hard peg to the USD - since July 2008, and we think this will remain unchanged through 2009 and most probably over the next 12 months. There are two likely exit strategies: 1) resumption of gradual appreciation against USD under a de facto crawling peg regime, and 2) a genuine and transparent peg to a currency basket. The latter is more likely to be adopted than the former, in our view.Hong Kong: Q&A on Monetary ConditionsThe stream of capital inflows into the Hong Kong dollar and the associated interbank liquidity has refueled discussions about the Hong Kong currency board and monetary system. In this report, we compile the commonly asked questions, and our answers to them, related to Hong Kong's currency board and monetary system, the latest developments with respect to liquidity conditions, and longer term fundamental considerations for monetary management in Hong Kong.India: Rising Significant of Rural DemandWhile we expect some of the cyclical factors to soften over the next 12 months, we are optimistic that the government will begin to address a few of the long- pending structural issues necessary to provide a sustainable improvement in farm incomes. Moreover, we believe that the non-farm rural income will maintain its healthy growth, implying that the rural economy will continue to be an important market destination for corporate India. Indonesia: Adding Another "I" to the B-R-I-C Story?Indonesia will still undergo cyclical pain in 2009. However, we expect the positive trigger in the form of strengthened political mandate in the recent general elections to help accelerate policy reforms, which together with the ongoing structural decline in cost of capital, is likely to help unleash Indonesia's growth potential of 6-7% by 2011 onwards.

US Outlook – GS Inc

2009-06-29T08:46:00.000-07:00

US Outlook – GS Inc With quarter (and half-year) end approaching, many are wondering whether market participants will use one of the summer's biggest liquidity events to add or reduce equity exposure. Clearly, simple asset allocation models will predict large equity notionals for sale (given 20% outperformance of equities over treasuries QTD), yet there are a number of other factors which could provide a worthy counterbalance to this potential selling -- and limit it's impact:
1. US Mutual Funds are beating the S&P 500 by the most in 26 years. According to Morningstar, Active U.S. Equity Funds were up 7% through the end of May (vs the S&P 500 +3%) - the biggest gap since 1983. A lower correlation and realized vol environment (more on this in point 3 below) has led to a far more attractive fundamental stock picking landscape. Anecdotal feedback from PM's is that they continue to see the environment as favorable, and will continue to deploy cash balances, even with a strong start to the year (and especially with the index in positive territory). TrimTabs also reports that hedge funds had record performance in May (+5.6% monthly return is the highest since the dataset began in 2000).
2. US Pensions are still broadly underweight equities. In a June 4 report, Michael Moran estimated that 80% of pensions were underweight equities as of the end of '08). In late May, TrimTabs estimated that if both Private and Public pension plans decided to fully rebalance, this would constitute approx US$450BN of equity buying. Even half this number would represent approx 2% of the mkt cap of all U.S. stocks. While it is clear to us through conversations, and our futures and PT flows, that pensions have done a lot of work correcting this underweight, there appears to be a lot more wood to chop. It is important to note that while asset allocation models may predict quarter end outflows - this assumes that pensions have been consistently rebalancing up until this point in time. Conversations with a broad array of pensions tell us that this has not been the case - hence our conviction that pensions are still underweight equities.
3. Equity markets are seeing a period of relative stability (a signpost institutions have looked for). In the last 3 weeks, the S&P 500 moved less than 1% on the day, 75% of the time (11 out of the last 15 days). This speaks to the magnitude of how much markets have calmed, and it is no surprise that realized volatility continues to bleed lower (Vix is now at pre-Lehman levels). While many people are talking about the pullback we have had - we have really been treading water for the last 2 months (on moderate volume) - holding an 880 - 950 range since the start of May. Remember that while we are -5% off the Jun 12 highs, we are still 36% off the March 9 lows!
4. Flow of funds continues to be very supportive for equities. AMG has reported 13 out of 15 weeks of net inflows (totaling approx US$11billion note: this week saw a small outflow) and Money Market Funds continue to see record outflows. Our flows clearly support this theme of money going into equities - since April 1st we have been net-to-buy through our program trading franchise approx 75% of the time (43 out of 58 days) - alongside a +15% rally in the S&P 500. The important thing to remember is that the amount of inflows still pales in comparison to the $100billion to US$180 billion of outflows in 2008. Key takeaway: while the trend is constructive, and there is money being put to work, there is clearly a lot more dry powder on the sidelines.
5. The trend is your friend. The mkt has moved in the same direction the day following quarter-end, 5 out of the last 6 times. The mkt has moved in the same direction the day following half-year end, 4 out of the last 5 times. The mkt has moved in the same direction the day following month end, 5 out of the last 6 times. One other trend worth noting - the market has traded higher on 5 of the last 6 quarter ends.
This is the most popular chart of Q2, money market assets/US equity market cap. having hit a 30 year high of 60%, it has come back to 42%, but still well above the long term average of 20%

GREED & fear - 25 June, 2009 - Gangreen

2009-06-25T09:13:00.000-07:00

The only interesting point about this week’s FOMC meeting is that Billyboy seems to be less worried about “deflation”. This is another contrarian reason to be constructive about government bonds. There is zero definitive evidence that housing is about to “bottom” in the US. While the American commercial real estate market continues to deteriorate.
· A stronger oil price continues to be a sign of rising risk tolerance and a falling oil price of rising risk aversion, with the US dollar trading inversely to that. As was the case this time last year, GREED & fear believes the oil price is now being pushed by financial players. While GREED & fear is as bullish as anyone on the structural story for emerging markets, the view here remains that the commodity complex is now vulnerable if there is renewed disappointment about Western growth prospects in coming months.
· “Global warming” maintains its status as the developed world’s new religion. This is why “climate change” seems almost as high on the list of the priorities of the Obama administration as “healthcare reform”.
· The arbitrary nature of “green” investment mandates is obviously irrational from an investment perspective. From a longer term perspective it is almost inevitable that the frenzy for green will attract to the area the usual mob of con men and spivs who jump on every bandwagon. There is also a more fundamental risk that government sponsorship of alternative energy leads to massive over investment in the area.
· Regardless of the fundamental merits or otherwise of the climate change story, alternative energy stocks will, for now, continue to trade as high beta proxies for the oil price. They, therefore, have no diversification merit.
· There is a very strong economic case for growing links between Malaysia and Singapore. Singapore needs land and space to grow into, in the sense that southern Johor could become the equivalent of what the Shenzhen special economic zone became for Hong Kong. Malaysia could also profit from Singapore’s skill sets and capital. Any such development would be a major positive for both stock markets.
· Lee Kuan Yew’s eight day visit to Malaysia is interesting since, in GREED & fear’s view, nothing significant is going to happen in terms of new bilateral agreements between Malaysia and Singapore unless it is approved by the “minister mentor”.
· Najib’s first three months in power since he took over from Badawi have at least seen some dilution of the New Economic Policy (NEP). Any dilution of the NEP should be viewed as a positive, even if investors should also remain fundamentally sceptical about whether UMNO is capable of wholesale reform of this outmoded policy.
· The Malaysia stock market has been relatively unexciting in the Asian equity context reflecting its by now well established low beta status. This means it underperforms the regional index in a rally and outperforms in a correction.
· The presidential election season is approaching in Indonesia with all the evidence suggesting a landslide victory for incumbent president Yudhoyono. The reasons why Yudhoyono looks an overwhelming favourite to win are his appealing acronym, his “clean” image and the relatively stable economy.
· The Indonesia economy has so far shown impressive resilience this year, because of its domestic demand orientation as well as its commodity gearing. This resilience also reflects the economy’s lack of corporate or consumer debt.
· Assuming a “SBY” victory, looking forward a critical issue from a macro economic perspective is domestic infrastructure where there has been a disappointing lack of progress in Yudhoyono’s first term despite an almost ridiculous amount of talk.
· Indonesia still offers a fundamentally exciting long term consumption story with a positive demographic. Another positive point is that Indonesia is now the marginal supplier of coal and palm oil to the resource deficient economies of China and India.
· Having fended off for now calls for the passage of a modern version of the Glass-Steagall Act, the vested interests behind securitisation are emerging from their caves to argue their case. But in GREED & fear’s view securitisation only makes sense in a “market” system where financial entities face the risk of going bust. America clearly does not have such a system.
· Agricultural machinery maker Kubota will be added to the Japanese thematic portfolio this week with an initial weighting of 3%. The investment will be paid for by removing Inpex. As for the Asia Pacific ex-Japan relative-return portfolio, the overweight in China will be increased by 1ppt will the money taken from Hong Kong.

korean equity

2007-10-12T11:05:00.001-07:00

korean equity

ASIA PACIFIC STRATEGY: MARKET SNAPSHOT: EARNINGS GROWTH REVISED DOWN - Corey Ng & GLOBAL ASSET ALLOCATION

2007-10-05T03:40:00.001-07:00

DOWNUNDER DAILY : DECOUPLED BUT IN SYNCH? - Gerard Minack

There are tentative signs of developed-economy slowdown outside the US. Those signs may not reflect the transmission of US weakness to the rest of the world; instead, growth may be slowing independently, due to tighter policy in other important economies. In other words, this may not be a matter of economic coupling, but the major developed economies may continue to be synchronized. A few thoughts:
First, I continue to believe that for investors (as distinct from economists), the coupling/decoupling debate is a sideshow: Regardless of the economic linkages, the recent correction has again demonstrated that markets remain highly coupled. As a result, if there is a US recession that leads to a bear market in US assets, then risk assets everywhere would suffer whether or not the economies prove to be coupled.
Second, while the evidence for now supports the view that the emerging economies have been able to decouple from slower US growth, the decoupling hurdle would be significantly higher if growth started to slow in Europe and Japan. In that scenario, the issue would be whether the emerging economies can decouple from a broad-based OECD slowdown.
Admittedly, the rest of the world has coped well so far with slower US growth. While overall OECD industrial production is growing at a moderate pace, production in the major emerging economies remains at cycle highs (Exhibit 1). More impressively, production has remained strong in the face of a material slowdown in US import demand (Exhibit 2). It's also notable that for the first time in 20 years, Asian exports have accelerated at a time when US manufacturing orders have slowed (Exhibit 3).

US ECONOMICS: CAPEX RECESSION AHEAD? - Richard Berner

What's New: Coming weakness in US capital spending, and thus at some US capital goods producers, likely will reflect slower growth and tighter financial conditions. Despite those headwinds, strong global demand and a weaker dollar will continue to support the top and bottom line for many high- and low-tech companies.
Conclusions: US capital spending discipline has limited the growth in and sustained "pent-up" demand for US business investment in this expansion. The resulting lack of excess will limit the near-term downside risks and help avert a capex recession. And that discipline should pay off in 2009, when we expect the housing recession to end and the economy to re-accelerate.
Market Implications: Weakness in capital spending will intensify recession fears. But it may also revive the debate over US productivity, potential output, and inflation risks, making a sluggish US economy appear more stagflationary. That may be a recipe for a bearishly steeper yield curve and a challenge to risky assets. Nonetheless, these developments continue to favor outperformance at capital goods producers with high global exposure.
Risks: Even a mild capex downturn could knock half a percentage point off an already-weak prognosis for US growth. Investors may also worry that capital discipline has swung too far towards corporate anorexia, making the domestic portion of US businesses less attractive than their global peers. Relative to our anemic baseline forecasts, however, strong gains in US exports create upside risks to the US outlook.

ASIA PACIFIC STRATEGY: MARKET SNAPSHOT: EARNINGS GROWTH REVISED DOWN - Corey Ng

Earnings growth estimates for 2007 have been reduced from last week's: Earnings growth estimates for 2007 for the MSCI Asia-Pacific Free ex-Japan index were at 14.9% YoY (vs. 15.3% last week), based on bottom-up IBES consensus estimates. Downward revisions were led by Taiwan (-1.8 ppts) and Korea (-1.1 ppts). By sector, Capital Goods and Consumer Durables & Apparel were cut by 4.4 ppts and 3.7 ppts, respectively. See pages 2-6 for details, Also see pages 11-20 for revision trends.
MSCI AC Asia Pacific ex Japan US$ Index increased by 25.3 index points (5.0%) last week. The leading movers are MSCI Australia and China, which contributed 8.4 and 6.7 index points, respectively. Over/Under Contributors: Based on the index weight, MSCI Australia should have contributed 7.2 index points and China, 4.2 index points out of the 25.3 regional index movements. They in fact contributed 8.4 and 6.7 index points, respectively, an over-contribution of 1.2 and 2.6, respectively, according to their index size. MSCI Korea, however, under-contributed by 1.9 index points. See page 8 for details.
Chart of the Week:MSCI China and India have the highest PBV in the region, at 4.2 and 4.1, respectively, for 2007E. At the industry group level, Household & Personal Products (9.2) and Commercial Services & Supplies (8.3) are the most expensive.

[GS] Subprime, 4 & loss severity: when bad news becomes good news

2007-10-05T03:35:00.001-07:00

From fear and uncertainty to calming policy moves, more
disclosures and the start of loss recognition
We believe reactions to Citigroup’s and UBS’ 3Q07 disclosures, earnings
warnings and MTM losses on MBS, CDOs, CLOs, leveraged loans suggest
markets are progressing from fear/uncertainty to damage assessment and
loss recognition, helped along by the Fed’s earlier moves to inject liquidity
and cut rates to prevent markets seizures and the economy from derailing.

Eye of the storm, or at the cusp of recovery? Some reset risks, too
Four factors make us uneasy to fully embrace “at the cusp of recovery”
views and an outright positive stance on the entire sector: (1) US
subprime/property markets as sizable, long-tailed, slow-motion underlying
problems; (2) risk of far higher-than-expected loss severity on subprime
NPLs; (3) knock-on macro impacts of these and rising levels of mortgage
loans in negative equity; (4) some risk of 2008 revenue/earnings resets.

Meaningful but manageable collateral damage for some in Asia
Two large US/Euro banks/capital mkts players have initially taken sizable
10%-15% haircuts on senior AAA-rated high-grade CDOs and MBS, with
the risk of higher haircuts for Asia financials if holding lower-tranche
paper, or if underlying loss severity proves high as feared. Assuming 40%
impairment losses on disclosed sub-prime CDO/ MBS/SIV exposures, we
estimate losses as % of 2007E PPOP at 82% for CIFH, 77% for Shin Kong,
42% for Cathay Fin, 31% for BOC, 27% for DBS.

Path of least resistance still the best
We prefer franchise names in solid-growth markets with minimal CDO
exposures, particularly in the China, HK, India, Indonesia banking sectors.

GEM EQUITY STRATEGY: TAKING SOME PROFIT - JONATHAN GARNER & US ECONOMICS: CAPEX RECESSION AHEAD? - RICHARD BERNER

2007-10-05T03:33:00.001-07:00

GEM EQUITY STRATEGY: TAKING SOME PROFIT - JONATHAN GARNER

In the global emerging markets strategy team we recommend taking some profits following exhilarating performance by MSCI EM over the last five weeks. We are reducing our equities overweight by 2% — going from 6% over benchmark to 4% over benchmark. We are raising our recommended cash weighting back to a level of 4% (just below our neutral level of 5%).
We think MSCI EM is starting to look technically overbought: It has risen by 23% since mid-August and is at a new all-time high. It is trading at an unusual distance of 19% above its 200-day moving average.
The fact that consensus has moved so quickly towards our core bull thesis of EM decoupling worries us. EM valuations are starting to become a concern, although earnings growth expectations remain firm. The MSCI EM trailing P/E (18.5 times) is now 12% above is 15-year average and at a 10% premium to MSCI World. Trailing price/book has also reached 3.0 times — it has been higher only three other times in the past 15 years. But the earnings cycle in EM remains strong, and some forward-looking valuation metrics are still below previous peaks.
Finally, we are also concerned that China A and H share valuations are at previous peak levels. Given that MSCI China is now the largest market in the MSCI EM index, we think any sharp sell-off in Chinese equities could cause investors to question growth momentum of the asset class as a whole, especially as China’s growth underpins our thesis of strong decoupling and commodity prices. But there are good reasons to think any impact would be temporary. We remind investors that not all equity bull markets end in bubbles and not all bubbles end in recessions. China’s bull market has deep underpinnings. Impact on economic growth in China from a fall in share prices could be less pronounced than anticipated.
Our core long-term bull thesis tells us to remain overweight EM equities. We have made two changes in our focus list: Adding Lonmin (£36.49) and MMK ($15.15) and removing Corporacion GEO (M$47.81) and Samsung (W573,000).

US ECONOMICS: CAPEX RECESSION AHEAD? - RICHARD BERNER
Coming weakness in US capital spending, and thus at some US capital goods producers, likely will reflect slower growth and tighter financial conditions. Despite those headwinds, strong global demand and a weaker dollar will continue to support the top and bottom line for many high- and low-tech companies.
Discipline should pay off in 2009. US capital spending discipline has limited the growth in and sustained “pent-up” demand for US business investment in this expansion. The resulting lack of excess will limit the near-term downside risks and help avert a capex recession. And that discipline should pay off in 2009, when we expect the housing recession to end and the economy to re-accelerate.

Weakness in capital spending will intensify recession fears. But it may also revive the debate over US productivity, potential output, and inflation risks, making a sluggish US economy appear more stagflationary. That may be a recipe for a bearishly steeper yield curve and a challenge to risky assets. Nonetheless, these developments continue to favor outperformance at capital goods producers with high global exposure.
Even a mild capex downturn could knock half a percentage point off an already-weak US growth prognosis. Investors may also worry that capital discipline has swung too far towards corporate anorexia, making the domestic portion of US businesses less attractive than their global peers. Relative to our anemic baseline forecasts, however, strong gains in US exports create upside risks to the US outlook.

ASIA-PACIFIC EQUITY STRATEGY: IMPLICATIONS OF A MORE AGGRESSIVE FED - MALCOLM WOOD
An aggressive US Fed has five implications for Asia-Pacific equities: 1) liquidity conditions will become more positive; 2) the PBoC becomes key in containing regional overheating pressures — so far, it appears to be succeeding; 3) downside risks to US growth are more moderate, but we only foresee a U-shaped recovery; 4) Asia-Pacific currency appreciation is likely to accelerate; and 5) risk appetite is likely to rise. We conclude: Stay invested; stay domestic; focus on financials, property and consumer; and avoid exporters.
US liquidity fuel on Asian liquidity bonfire: The Fed is likely to become moderately accommodative. This will add to Asian liquidity conditions, which are already very positive.

The PBoC will be key to containing overheating pressures: Excluding food, inflation appears contained in China. Five rate rises and seven reserve requirement increases should help contain inflation expectations.
US growth – less downside risk, but U-shaped recovery: A pre-emptive Fed should reduce recession risks. But monetary policy is unlikely to induce a powerful recovery. We see a U-shaped US recovery.
Asian currency appreciation to accelerate: Cost of carry for Asian currencies should fall. Together with strong fundamentals, we see a stronger, 7–10% upside.

Rising global risk appetite: Risk appetite is only back to average levels. We see more upside.

Battery Plant Fire -ve for LCD/Memory

2007-10-05T03:32:00.001-07:00

Investment Conclusion
The production stoppage at Matsushita Battery Industrial's Osaka plant will
likely have a negative impact on LCD IT panel prices and memory prices.
According to our analysis, MBI's Osaka plant makes up 14% of global lithium-
ion notebook battery demand, translating into about 4mn packs for the next
quarter. The production stoppage at the plant essentially will reduce global
notebook battery supply by at least 4mn units in 4Q07, or 14% of global
demand based on our calculations.

Summary
* On decreased notebook shipment expectations, we think that LCD makers will
transition some of their notebook capacity into monitor panel lines. While
the transition takes place, we expect LCD notebook panel prices to drop first.
The additional monitor panel capacity should accelerate monitor panel ASPs
drop during the upcoming price-fall season from November 2007 to February
2008. For memory, we believe that the already weak DRAM market will be even
more negatively affected in the short term as 4Q NB shipments are likely to
be lower than expected. Nonetheless, we maintain our view on industry
fundamentals and continue to expect that 1Q08 will be the bottom for the
industry.
* Essentially, the fire incident at Matsushita battery plant further
bolsters our pricing assumptions for the LCD industry. During the next price-
fall season, we expect monitor panel prices to drop by 25%, notebook panels
by 15% and TV panels by 5%.
* According to our channel checks, MBI's largest customers are Toshiba and
Acer. In terms of MBI's client breakdown, Toshiba (3-Underweight, covered
by Steven Myers) accounts for 27% of MBI's total notebook battery shipments,
Acer (1-Overweight, covered by Alex Yang) 20%, and Dell (2-Equal weight,
covered by Harry E. Blount) 13%. The lithium-ion battery market for
notebooks has been experiencing a serious shortage. Considering some
notebook makers' high dependency on MBI, notebook panel shipments could take
a big hit going forward.
* If we assume that NBPC production decreases by 13% as a result of the
battery plant fire, this would make up around 5% of total PC production in 4Q.
Under this scenario, this may impact 13% of DRAM used for NBPCs, or 5% of
DRAM for total PCs. Taken as a whole, this may impact 3% of total DRAM for
the quarter.
* The rechargeable battery industry has been experiencing a shortage
following a series of recalls due to safety issues. The MBI fire incident
will likely further tighten the shortage situation in the notebook battery
market. As a result, we expect ASPs of rechargeable notebook batteries to be
strong going forward.
* We once again recommend investors accumulate LCD names in December 2007,
when most of the seasonal price declines would have taken place. Our
expectation of very tight supply in 2008 remains intact.

Fire at Matsushita's battery plant, negative for IT panel prices
According to Bloomberg, Matsushita Battery Industrial (MBI) halted production
of lithium-ion batteries at a factory in Osaka after a fire broke out on
September 30. MBI has lithium-ion battery plants in Japan and China. MBI's
global production capacity is 23mn cells per month based on 3Q07 capacity,
and the Osaka plant's capacity is 18mn cells per month (11mn for cylindrical
battery cells and 7mn for prismatic batteries for handhelds). In terms of
notebook battery capacity, the Osaka plant accounts for 84% of MBI's total
battery production capacity. According to our analysis, MBI's Osaka plant
makes up 14% of global cylindrical lithium-ion notebook battery demand,
translating into about 4mn units for the next quarter. Our checks with
battery industry sources indicate that the line recovery will likely take at
least three months; it could take longer if the line test takes longer.

We believe that the production stoppage at MBI's Osaka plant will have a
somewhat negative impact on the overall IT sector, including the LCD industry
and memory chip industry for the rest of 2007. The rechargeable notebook
battery market has been suffering a shortage. As a result, we forecast this
fire accident could reduce global notebook supply by 14% or 4mn units,
assuming three months of line stoppage.

While the fire incident will likely have a negative impact on LCD panel and
DRAM prices, we expect ASPs of rechargeable notebook batteries to remain
strong going forward.

The notebook battery industry's supply has been very tight. As a result,
notebook makers who depend on MBI for batteries will likely face further
difficulties in securing battery supply. This should decrease overall
notebook unit shipments. According to our industry checks, MBI's top clients
are Toshiba and Acer.

With decreased notebook shipments, LCD panel makers should experience more
aggravated slow seasonality, further bolstering our aggressive assumption of
25% monitor panel ASP drop during the upcoming price-fall season (from
November 07 to February 08). LCD makers will likely reallocate some of their
notebook production capacity to monitor panels, as they expect notebook
shipments to decline on battery shortage. This should aggravate monitor panel
oversupply during the upcoming price falling season, and accelerate ASP
declines.

On the flip side, we expect ASPs for cylindrical lithium-ion batteries to be
stable and strong. As the battery industry was already experiencing a
distinct shortage on quality issues, we think that there is no direct
beneficiary as a result of the fire. However, tighter supply in the market
should increase or maintain overall notebook battery ASPs.

Impact to DRAM Further Short-Term Negative
If we assume that NBPC production decreases by 13% as a result of the battery
plant fire, this would make up around 5% of total PC production in 4Q. Under
this scenario, this may impact 13% of DRAM used for NBPCs, or 5% of DRAM for
total PCs. Taken as a whole, this may impact 3% of total DRAM for the quarter.

According to our Taiwanese analyst, Alex Yang, he expects NB ODMs to record
shipment growth of 5-10% QoQ in 4Q07, below the historical 15-25% growth due
to component makers' capacity limitations.

We note that the DRAM market hit a peak in end-06, showing a downward trend
until the three-month rebound from May 07. After the short rebound, the DRAM
market began to show another decline from August. In light of the battery
plant fire, we believe that the already weak DRAM market will be even more
negatively affected in the short term as 4Q NB shipments are likely to be
lower-than-expected. Nonetheless, we maintain our view on industry
fundamentals and continue to expect that 1Q08 will be the bottom for the
industry.

Notebook supply decline to accelerate seasonal LCD price fall from November
According to our analysis, the fire incident will reduce global notebook
battery supply by 4mn units in 4Q07, or 14% of global demand. Currently, LCD
makers are enjoying very high margins in the notebook panel business. However,
we conclude that the decreased battery supply will likely negatively impact
notebook panel prices first, as panel makers reallocate their notebook
capacity to monitor production. The time it takes for panel makers to
transition a notebook line into a monitor line is about a month. During the
transition time, we expect notebook panel prices to decline. The next impact
will be on LCD monitor panels. We expect the additional monitor panel
production capacity should accelerate monitor panel ASP drop during the
price-fall season from November 2007 to February 2008.

Essentially, our ASP drop assumption during the upcoming price-fall season is
intact; a 25% drop for monitor panels, a 15% drop for notebook panels, and a
5% fall for TV panels. The fire incident at Matsushita battery plant further
supports our assumptions considering: 1) the plant caught fire on September
30, and 2) LCD makers would need to spend about one month transitioning some
of their notebook lines into monitor lines, early November is when the
additional monitor panel capacity would come into effect. Early November is
when we originally expected the seasonal price fall to begin. Overall, the
14% notebook supply decrease on the fire incident should translate into a 7-
8% monitor panel supply increase in 4Q07, as the average monitor panel size
is bigger than that of notebook panels.

We forecast the additional monitor panel capacity to drag monitor panel
prices by about 3%. If the fire broke out during a high demand season, there
would have been no material impact on overall panel prices. Unfortunately, we
think the monitor supply increase on the fire incident is taking place when
the LCD industry is on the verge of entering a price-fall season. We have not
modified our panel price estimates. We simply have become more confident on
our price cut assumptions.

We recommend investors accumulate LCD names in December 2007, when most of
the seasonal price declines would have taken place. Our expectation of 2008
exhibiting very tight supply is still intact.

We expect some notebook makers to face difficulties in securing batteries
According to our channel checks, MBI's customer base includes major global
notebook makers, such as Toshiba and Acer. In terms of MBI's client breakdown,
Toshiba accounts for 27% of MBI's total notebook battery shipments, Acer 20%,
and Dell 13%. The lithium-ion battery market for notebooks has been
experiencing a serious shortage. Considering some notebook makers' high
dependency on MBI, notebook panel shipments could take a big hit going
forward.

Acer, in particular, sources about 40% of its panel needs from Samsung
Electronics, 40% from LG.Philips LCD and 20% from AU Optronics (2-Equal
weight, covered by Naiwen Kerr). We think these panel suppliers should also
experience material notebook panel shipment declines as well.

Figure: MBI's Client Breakdown

Source: Lehman Brothers estimates

Strong notebook battery prices
The rechargeable battery industry has been experiencing a shortage following
a series of recalls due to safety issues. The MBI fire incident will likely
further tighten the shortage situation in the notebook battery market. As a
result, we expect ASPs of rechargeable notebook batteries to be strong going
forward.

[GS] Powertech Technology (6239.TW): Record high Sept. sales at NT$2.17bn, despite DRAM weakness

2007-10-05T03:31:00.003-07:00

What's changed

Powertech (PTI) reported record high September sales of NT$2.17bn, up 4.3%
mom and up 39.1% yoy. 3Q2007 sales of NT$6.2bn, up 12% qoq, came in 2.6%
higher than GS estimate of NT$6.1bn. We believe the main reason PTI
continues to outperform despite DRAM industry weakness is mainly a result of:
(1) testing time extension for 70nm technology products; (2) CAPEX
discipline leading to industry capacity shortage.

Implications

PTI's capacity is currently running at 100% utilization due to incremental
demand resulting from 70nm technology migration from PTI's major customers,
such as Elpida, ProMOS and Rexchip. As a result of memory back-end
discipline on capacity expansion, PTI was able to enjoy a slight ASP hike in
3Q and also to negotiate with customers for a flattish ASP settlement qoq in
4Q. In addition, according to Bloomberg (Oct. 04, 2007), Elpida management
has publicly announced that it will reduce the numbers of chips sold into the
spot market. This will also remove investors' concerns of a repetition of
2Q2007 earnings softness, when most of PTI's customers were dumping Ett/Utt
DRAM chips into the spot market resulting in a sharp reduction in testing
times. On the back of strong demand, we would expect PTI revenues to grow in
4Q2007E by another 10% qoq. We expect PTI to deliver its guidance of gross
margins of around 30%-32% for both 3Q and 4Q.

Valuation

We maintain our Neutral rating, but raise our 12-month target price to NT$157
(3.9x 2008E P/B), from NT$139.2, to reflect better earnings growth momentum,
and have raised our 2007E EPS by 17.7%, 2008E by 5.4% and 2009 by 8.7%.

Key risks

Faster than expected DRAM pricing decline with more customers shifting to
Ett/Utt chips in the spot market.

Empas - Met with the CEO of Empas

2007-10-05T03:31:00.001-07:00

We sat down with the new CEO of SK Communications, Mr. Shin Cho the other night. This was actually during SK Telecom's Analyst Day and we were lucky enough to be seated on the same table during dinner (we requested it obviously). Mr. Cho, is currently heading SK Telecom's Internet & Media Group but once the merger is consummated between Empas and SK Coms on November 1, 2007, Mr. Cho will become the co-CEO of SK Coms along with Mr.
Park Sang Joon originally from SK Coms. The current CEO of SK Coms, Mr Yu Hyun Oh, will re-join SK Telecom and head the US operations, both Helio and Cyworld of the US.

Main takeaways:

1) Mr. Cho will be in charge of strategy while Mr. Park will mostly oversee operations.
2) SK Coms decided to completely merge with Empas sooner than later because once the synergy is realized, Empas' value would have been too high for SK Coms to buy later.
3) Mr. Cho was very optimistic about Empas synergy with SK Coms (Cyworld and NateOn) and was confident that search ad market share would increase going forward. Right now, users are led directly to Empas from Cyworld homepage, but once the merger completes, NateOn will also carry Empas'
search box along with all the minihompys.
4) Mr. Cho believed that SK Coms now has all the parts to succeed and grow.
Future acquisitions will only be targeted on key start-ups with break-through technologies. Nothing major in acquisitions.
5) The CEO also confirmed that Etoos sales have hit an inflection point but he still believes there is much work left to do.
6) On Cyworld, Mr. Cho was a bit conservative and said that HappyClick is in still in early trial. (However, our channel check confirmed that roughly 1.5m active users have signed up already.) Cyworld overseas is taking a bit more time than expected.
7) On mobile search market, Mr. Cho agreed with our view that there is tremendous opportunity for both Empas and Nate.com, considering SK Telecom presence in Korean wireless market.
8) Mr Cho also pointed out that there are many ways SK Telecom can support SK Coms... Did not get into much details here.

Our Two Cents:

We had no prior interaction with SK Coms management team before we met Mr.
Cho, so the meeting was actually a relief since we were done with the initiation report (sent to editing) and most of what Mr. Cho said more or less confirmed our views. Here is the full PDF report. Sorry for the delay.

UBS Semiconductor Research: H1 Oct PC DRAM ASPs to fall 20%

2007-10-05T03:30:00.003-07:00

Memory Semis Update H1 Oct PC DRAM ASPs to fall 20%

* DRAM oversupply to continue to push down ASPs:
* We expect H1 Oct DRAM ASPs to fall roughly 20% to US$32/1GB module.
PC OEMs will likely take DRAM delivery in a 20%/80% split in H1 vs. H2
Oct leaving more downside for H2 Oct ASPs. MU indicated that MB/PC
growth has been slowing and that it intends to regain market share.

* Waiting for marginal DRAM players to push back capex:
* We expect ASPs to reach marginal player’s leading edge fab cash
cost in Q408 at around US$1.30/512Mb. DRAM makers are coming off 4
strong years of profit and may resist capex cuts at early stages of
cash cost resulting in more ASP downside. We believe Elpida and Hynix
planned reduced supply to the spot market alone may not have a
meaningful impact on ASP trend in Q4.

* H2 Sept NAND SLC/MLC ASPs fell 5/15% from H1 Sept:
* More successful ramp of 50nm and card maker reluctance to build
inventory has helped push NAND contract ASPs down. We continue to
expect seasonal demand slowdown towards the end of Q4 as Hynix and SEC
ramp new capacity and improve yields.

* Maintain caution on memory semiconductor sector:
* We rate more diversified NAND makers SEC and Hynix Neutral and more
pure DRAM makers Powerchip, ProMOS, NTC, and Inotera Sell. We believe
SEC and Hynix should benefit from relatively better NAND profitability
and lower cost structure from more successful sub 70nm DRAM migration.

NCsoft (036570.KS) Sell: Take profit on full valuation; Downgrading to Sell

2007-10-05T03:30:00.001-07:00

Downside risk #1: Mixed outlook for Tabula Rasa
Previews to date for Tabula Rasa have been mixed, with a recent preview from
MMORPG.com citing lack of “addictive” game play as a potential weakness for the game.
We believe the recently announced two-week delay in commercialization of TR is largely
attributable to the company attempting to better address the game-play issue prior to
game launch. We believe addictive game-play is a critical success factor for any MMOs
and see the recent development as a potential risk to the game’s success.
We currently forecast W57bn in 2008 revenues, compared to W53bn for Guild Wars in 2006.
We believe Guild Wars is a good reference point for Tabula Rasa due to similarities in
“instanced MMO game play” and thus cater to a similar gaming audience; we believe the
difference in profit model (subscription base for TR, box sale for GW) should be irrelevant
in the first year of TR’s launch.

Downside risk #2: L1 and L2 revenues may disappoint
As we’ve highlighted in our recent comment on September 18 (“3Q07 likely difficult for L1
& L2 revenue; PC café regulation marginal”), recent discussion with company suggests
that L1 revenues are likely to be slightly down qoq despite stronger seasonality as
management indicates that account base has stabilized but not recovered.
While L2 may have seen an increase in accounts following the launch of its expansion
Kamael, we believe 3Q is unlikely to see a boost in revenues as we suspect the increase in
accounts has largely drawn a pool of users attracted to the 100 hrs of free play.
We regard L1 and L2 as cash cow games that offers some anchor and stability in earnings
that justifies NCsoft’s higher valuation multiple than more volatile and faddish casual
game stocks. Worse-than-expected declining revenues in L1 and L2 could, over time, be a
factor for investors to start ascribing NCsoft with a lower multiple.

Downside risk #3: knock-on delays to other smaller titles
Recent delays in delivery of Aion and TR have arisen from development issues with game
play rather than bugs. While we acknowledge delays in game production is common, we
believe there is an increased risk factor that we should attribute to game development
management, since the success-critical game play issues are arising so close to
commercialization. Thus, we believe there is possibility that the problems with game
development management could bleed into production of smaller/later game titles. We
have also trialed the company’s smaller titles such as Dungeon Runner and believe
monetization may be less robust than previously expected. We have thus taken down our
casual and other game revenues from a combined W44bn to W18bn for 2008, a 5.6%
reduction in total 2008 revenue forecast.

Valuations
NCsoft is trading at 22X forward EPS, which we believe fully values the business outlook
for 2008. We see the potential for either multiple contraction and/or downward revision in
earnings estimates around 3Q earnings should 1) L1/L2 revenues disappoint and/or 2) TR appears to be less successful than expected. We note global online game peers are trading
at an average of 20.2X forward earnings.

We believe there is also liquidity driven risk for NCsoft, should a disappointment in growth
outlook lead to a sharp and rapid decline in share price as investors scramble to exit the
stock. We recall that poor 1Q06 results and downward revisions to full year guidance led to
a 36% share price correction over one month in May of 2006, which we believe was fueled
by an initial share price correction that prompted more selling as investors tried to exit
hurriedly.

China Life - Stil the one

2007-10-05T03:28:00.001-07:00

Event
Following our recent decision to upgrade our valuation assumptions for Ping
An (2318 HK, HK$103.10, Neutral, TP: HK$95), we have applied consistent
inputs into our China Life valuation, lifting our target price to HK$50, from our
previous HK$41.50 price target.

Impact
Sector due to consolidate: Share prices in the China insurance sector have
increased by between 70% and 90% since 1H07 results were reported in mid-
August and have doubled since our China report, The Rising Tide, was
published at the start of June. With valuations at especially-stretched levels,
we believe the insurers are due to consolidate and we have downgraded the
sector weighting to Neutral (from Overweight).
China Life offers best value: Within a Neutral sector weight, China Life
offers the best exposure, in our opinion. Using actuarial valuations, we believe
China Life is 15–20% cheaper than Ping An while its exposure to a reversal of
equity markets (the key risk for the sector) is estimated to be equal or lower
than its peers, in terms of earnings and value.
Catalysts for relative performance: We believe confirmation that VNB
growth trends remain strong and deployment of surplus capital will be the key
drivers of relative performance for China Life. In particular, we believe fears
about weakening premium growth in monthly disclosures are overdone. The
softer premium trends reflect a one-off period of adjustment where renewal
premiums are weak due to a maturing product and Hongxin premium payment
plans. New business volume remains solid, and business mix continues to
improve, paving the way for VNB growth above 20% for 2007, in our opinion.

Earnings revision
No change.

Price catalyst
12-month price target: HK$50.00 based on an Appraisal value methodology.
Catalyst: Near term, QDII and QDRI reforms. Long-term, higher investment
returns, strong earnings and value growth and deployment of surplus capital.

Action and recommendation
Given the run-up in sector share prices, we recommend a pragmatic
approach: retain weightings, but look to take some risk off the table. While we
worry about valuations, the growth credentials of the sector remain extremely
strong in terms of both organic expansion and M&A.
We retain an Outperform recommendation with 10% upside to our HK$50
target price. China Life remains our top pick in the China insurance sector.

JPMorgan - Bank of China; Korea Investment Holdings; Mirae Asset Securities; Banking Sector; Macquarie Bank

2007-10-05T03:26:00.001-07:00

China: Bank of China
Operating improvement in mainland may offset subprime loss; we upgrade the H-share to Neutral
We upgrade BOC-H to Neutral, in light of the widened valuation gap with its peers and potential narrower A-H valuation gap going forward. We believe market concerns on subprime woes have retreated, although have not been entirely dismissed.

South Korea: Korea Investment Holdings (Overweight)
Negatives are priced in; we reiterate OW—SOTP valuation included
We view recent share price weakness as a good buying opportunity: Since June-07 KIH’s share price has underperformed the KOSPI and Korea securities index by 21% and 28% respectively. We believe the underperformance is largely due to: (1) KIH’s weakening mutual fund sales growth; and (2) lack of share price catalysts from non-operational drivers such as M&A of regional banks and life insurers. We believe the above negatives are fully priced into the stock and the recent weakness provides a good buying opportunity.

South Korea: Mirae Asset Securities (Overweight)
We remove the stock from AFL, but remain Overweight
We remove Mirae Asset Securities (MAS) from our Asia Analysts’ Focus List (AFL): As MAS’s share price has soared to our previous price target, we remove the stock from our AFL. The stock has outperformed KOSPI by 25% over the past month.

Australia: Banking Sector
Labour Unlikely To Budge Four Pillars
In recent times BOQ CEO David Liddy (refer First To Market March 20), WBC CEO David Morgan (refer Reuters September 12) and ANZ CEO John McFarlane (refer Dow Jones September 11) have all called for an end to the existing “4 Pillars” prohibition on mergers between Australia’s 4 major banks. We believe any expectation of accelerating M&A activity is overdone and continually speculated upon by banks given their respective interests.

Australia: Macquarie Bank (Overweight)
MBL Model Holding Up
Perceptions that prevailing credit market conditions provide a fundamental challenge to the MBL business model are being addressed by some recent transactions. Specifically: 1. While MBL acknowledge that velocity of capital has slowed, deals are still being done. MBL have recently been announced as the highest bidder for a S$2bn (A$1.5bn) land parcel at Marina View in Singapore, and have lodged a Summary Of Proposed Investment for a US$1bn Macquarie India Infrastructure Opportunities Fund. Media reports also indicate that MBL are currently assessing a KRW20tr (A$24bn) project to develop a business district in central Seoul, South Korea (Reuters 21 Sept), and are sounding out interest for a A$20bn takeover of BXB in conjunction with AIO (AFR 26 Sept).

Australia: National Australia Bank (Underweight)
Senior Executive Changes Open Path For Succession
Yesterday, NAB announced several changes to key management positions: (i) Michael Ullmer, current CFO, has been appointed Deputy CEO, (ii) Mark Joiner, current General Manager Development and New Business, has been appointed CFO, (iii) George Frazis, current General Manager Business and Private Banking, will replace Mark Joiner as General Manager Development and New Business.

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

2007-10-05T03:24:00.001-07:00

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.

Absolute Intelligence: Mooncake Madness

2007-10-01T01:57:00.001-07:00

MOONCAKE MADNESS

* STOP PRESS: Today was CLSA’s best-ever volume day by a country mile. Granted, part of it may be ‘forum effect’ but a lot of funds are also being reallocated from US/Europe to Asia. Also, today is the first day since this rally really started on August 17th that we saw real sector country rotation from leaders to laggards. Up to now, HK/China/India had been a very concentrated bull market – a bit too concentrated for some appetites. Small and mid-caps remain out of favour, but we are seeing big buy flow into the likes of Sony, Samsung Electronics, TSMC, FIH, Shinhan Financial, Infosys, and Nintendo. We think this diversification into other sectors and countries is a very healthy technical development for Asian markets. Despite all our positive anecdotal stories below on HK property, the reality is the HSP index is sitting on an RSI of 68, is +38% since Aug 17, and we still have over a month until the next FOMC (86% chance of 25bp cut and 14% chance of none). An HSP back-and-fill consolidation at 30-32,000 would be timely and healthy – already been hitting resistance at 32k for the past few days.

* Meanwhile, more worldly concerns were on the minds of local HK property realtors yesterday. Having dim sum with my wife & son yesterday late morning (gotta beat the rush), my wife received a call on her mobile. Then another. Then another. And another. We turned her phone off after that. Overall 50 calls and messages were left on her phone from HK property realtors and end-users/buyers/sellers. My wife & I have been active in the HK soho flat market, buying / fixing up / and then selling or letting to newly arrived bankers / lawyers / accountants / teachers. It appears that the 50bp Fed cut and subsequent 25bp cut by HK banks have stimulated animal spirits. WE THINK THIS STORY HAS ONLY JUST STARTED. * WHY THE HIBOR MARKET IS STILL TIGHT: Since mid-August, the Libor-US Treasury spread has been easing (as commented by Chris Wood), when markets took off and Fed Fund Futures started pricing in a 50bp cut on 18-Sep. However, Hibor rates have not moved down in line with Libor and US treasuries. Meanwhile, the HKD has been strengthening on robust economic growth and cutting prime and deposit rates only 25bps, less than the Fed's 50bps. AI has two theories regarding this: 1) since HK only cut 25bps, it should have attracted global funds for higher HKD yields. This explains the stronger HKD, but not the tight money market conditions, 2) Large Hedge Funds have been borrowing heavily in the HKD money markets as a HKD CARRY TRADE.

* HK HOTELS AS AN INTERESTING SECONDARY ASSET PLAY: Looking into this as these have in past cycles been good inflation plays (see our technical analyst Laurence Balanco’s views on hotel plays attached). Mandarin & Shangri-La lead in performance.

* DULL H-SHARE PERFORMANCE POST-A-SHARE IPOS: With PetroChina gaining approval to list A-shares and CCB (939 HK) listing on Shanghai today, we’ve taken another look at the potential impact on the listed H-shares in the run-up and after a mainland public offer. We first wrote about this in the 21 June edition of AI and observed that while the H-shares do outperform pre- the A-listing they underperform post the IPO. Next up for mainland listing is COSL (expected date 28 Sept) and then Shenhua Energy (9 Oct). We would suggest taking profits on these H-shares just before or on the A-share IPO date.

* BUY THE OLD LADY: On Wednesday, we heard our Alan Chen calling on HFs to buy SEC (005930 KS). There were few responses until today. Alan cited cheap valuations, potential for DRAM bottoming, strength in NAND and 4Q tech seasonality. Of course, today, in one of the biggest turnover day for CLSA, SEC was one of the top net buys on our pad. SEC was up 4.5% and fellow tech laggard Hynix (000660 KS) was up 6%. Further, Hynix today reported that it has stopped selling DRAM through the spot market and is planning to sell only to long-term customers. Hynix pointed out that there is demand from personal computer makers.

* RISK LOVE RETURNS: No matter how one measures the degree of risk appetite present in the financial markets, the appetite appears to have come back to the financial markets in most of the major asset classes. The exhibit below shows the typical “carry trade” cross (AUDJPY, inverted), along with the VIX index, and the European Crossover credit spreads, all showing very similar optimistic dynamics.

* FAST-MONEY BULLETS: regional property, plantations, rubber, SET hidden breakout, FIH

UBS Semiconductor Research: Early DRAM ASP peak raises concern for 2008 (downgrade SEC, Hynix, ProMOs, Powerchip, Inotera, and Nanya Tech)

2007-10-01T01:56:00.001-07:00

* Tough DRAM market to continue: ASPs at cash cost; consensus EPS risk:

* DRAM ASPs could be near bottoming (again), but we do not expect
profitable ASPs for most DRAM makers until 2008. We think consensus
EPS estimates are still too high. We now forecast 45%/32% 2007/08 YoY
DRAM ASP declines. We expect strong Q4 NAND demand, but remain
concerned over accelerating supply.

* NAND market strong but approaching seasonal demand peak:
* Despite a slew of positive high-density, NAND-based product
announcements from Apple, Sandisk, Nokia and others, we continue to
expect NAND supply growth to overwhelm demand growth in late Q407,
pushing ASPs down 25% in Q407 and a further 27% in Q108. NAND card
makers have begun adjusting inventory.

* Proprietary supply demand models point to more near-term risk:
* Using proprietary UBS models, we lower our 2008 DRAM/NAND ASP
estimates 2.1%/15% and now expect 7%/2% 2008 DRAM/NAND YoY revenue
growth. We forecast DRAM makers to expand capacity into H107, despite
likely increasing losses due, in part, to several years of
profitability and rising capex.

* NAND makers still likely to fare better than DRAM makers in H207:
* NAND makers are enjoying improved profits on stable ASPs and
declining costs, but DRAM makers’ profits could continue to suffer
into H108. We downgrade our ratings for Hynix and Samsung Electronics
from Buy to Neutral, and downgrade DRAM makers Powerchip and ProMOS
Technologies from Buy to Sell, and Nanya Tech and Inotera Memories
from Neutral to Sell.

JPMorgan Morning Bird's Eye View

2007-10-01T01:55:00.001-07:00

Stocks were little changed Thursday as investors weighed mixed economic data and prepared to close out the third quarter. Stocks spent most of the day in positive territory, despite a report of another slump in housing sales. Sales of single-family homes decreased by 8.3% last month to a seasonally adjusted annual rate of 795,000, the Commerce Department said. That was below expectations and was the lowest level since June 2000. Data released on Tuesday showed existing-home sales fell 4.3% to a seasonally adjusted annual rate of 5.50 million in August, the lowest level in five years.
GM -3.1% after its sharp rise the previous day.
Palm Inc +6.3% after the company released a smart phone.
And More...

Europe

European shares advanced Thursday, paced by gains in construction companies & airlines, though BMW weakened after revealing a new strategy. FTSE +0.83%, CAC +0.75%, DAX +0.64%, IBEX +0.47%, MIB -0.03%, DJ€50 +0.56%
Saint-Gobain +5.2% after French investment company Wendel said late Wednesday that it has built a 6% stake in the company. Lafarge +1.8% ACS +4.1%
BMW -1.1% benefited early in the session from a broker upgrade to buy, which said it expects to see significant change as BMW's management take action on costs. In the afternoon, however it revealed a new strategy for the next decade. BMW said its strategy to 2020 will focus on improving profitability and the brand's reputation for premium products, as well as safeguarding its independence.
And More...

Resources

Crude oil futures extended prior session gains, surging over 3% on renewed concerns that tropical storms might spell damage for oil installations in the Gulf of Mexico and geopolitical fears linked to the heightened tensions between the U.S. and Iran. The ability of crude oil futures to rally in the face of an unexpected build in U.S. inventories is an important indicator that crude could be poised to make new records.
Gold futures closed higher Thursday, getting a boost from a rally in crude-oil prices, as traders digested a mixed bag of economic reports, including a seven year plunge in new home sales.
On the LME, prices were broadly higher with lead and nickel the only exceptions. Lead equalled its record $3,520 a tonne amid concerns over tight supplies approaching winter when demand from battery manufacturers rises. Profit-taking subsequently dragged lead 1% lower to $3,420 a tonne.
And More...

Malaysia Essentials - Macquarie Research Equities

2007-10-01T01:54:00.001-07:00

[GS] Pan-Asia Strategy: Stance-at-a-Glance (Oct Issue) -- Climbing the wall of worry: Gearing up for a strong 4Q

2007-10-01T01:53:00.001-07:00

Climbing the wall of worry: Gearing up for a strong 4Q. The start of a Fed easing cycle, coupled with cautious investor positioning, points to further strength for Asian equity markets in 4Q. Within Asia ex-Japan, we prefer China, India, Singapore and Hong Kong, and we remain more cautious on Taiwan and Korea. Interim earnings results may provide a catalyst for Japan to catch up. Across the region, we emphasize growth stocks.

Pan-Asia outlook: Further gains ahead. Despite the risk of a near-term pullback in Asia ex-Japan markets given the swift rebound from their August lows, our strategic case remains positive given conservative investor positioning and benefits from a more accommodative Fed. Japan continues to lag the region, but forthcoming earnings results may support a rebound in 4Q. Within Asia ex-Japan, we are overweight industrials, energy, mining, telcos and steel. For Japan, we highlight areas exposed to Asian growth and stocks with potential for positive earnings surprises.
Things to watch: earnings, Chinese policies and US macro. Catalysts include 3Q earnings results, China’s 17th National Party Congress, US and EU macro data.
Performance: Strong gains. In September, our buy list advanced 9.5% and our funding list rose 2.4% resulting in a positive spread of 708 bp in local currency terms. Ytd, our buy basket has outperformed our funding basket by 27.8 pp.
Our Oct buy list: Matsushita Electric Industrial (6752 JP, B), Suruga Bank (8358 JP, B), Hitachi Construction Machinery (6305 JP, B), Murata Mfg. (6981 JP, B*), China Resources Power (836 HK, B*), Angang Steel (H) (347 HK, B*), New Oriental Education & Technology Group Inc. (ADS) (EDU US, B*), Sun Hung Kai Properties (16 HK, B*), U-Ming Marine (2606 TT, B*), Keppel Corp (KEP SP, B), Reliance Industries (RIL IN, B*), LG Chem (051910 KS, B*)
Our Oct funding list: Casio Computer (6952 JP, N), Advantest (6857 JP, N), Japan Airlines (9205 JP, N), Sumitomo Bakelite (4203 JP, S), Bank of China (H) (3988 HK, N), iShares FTSE/Xinhua 25 (FXI UN, NC), Netease (NTES US, N), Henderson Land (12 HK, N), Mega Financial Holdings (2886 TT, N), Singapore Press Holdings (SPH SP, S), Honam Petrochemical (011170 KS, S)

Oct STAAG picks (new additions bolded)

Buy list                        Funding list
6752 JP Matsushita Electric Industrial vs      6952 JP Casio Computer
8358 JP Suruga Bank             6857 JP Advantest
6305 JP Hitachi Construction Machinery          9205 JP Japan Airlines
6981 JP Murata Mfg.     4203 JP Sumitomo Bakelite
836 HK China Resources Power   3988 HK Bank of China (H)
347 HK Angang Steel (H)        vs      FXI UN iShares FTSE/Xinhua 25
EDU US New Oriental Education & Technology     vs      NTES US Netease
16 HK   Sun Hung Kai Properties vs      12 HK   Henderson Land
2606 TT U-Ming Marine   vs      2886 TT Mega Financial Holdings
KEP SP Keppel Corp             SPH SP Singapore Press Holdings
RIL IN Reliance Industries
051910 KS       LG Chem vs      011170 KS       Honam Petrochemical

Singapore Exchange — Reining in the bull

2007-10-01T01:52:00.001-07:00

(SGX SP, S$13.20, Underperform, TP: S$11.10)

Event

We downgrade Singapore Exchange (SGX) from Outperform to Underperform, with a revised target price of S$11.10 (previously S$10.90). We believe that the sharp run-up in the share price has surpassed our fundamental view of earnings.

Impact

Revised average daily turnover value by 2% to S$2.1bn. In the wake of the recent cut of 50bp in the US Fed funds rate, turnover value has surged to S$2.6bn per day, which we do not think is sustainable. Moreover, we think that market uncertainty could prevail, and we estimate that trading activity could remain pretty flat for the rest of the financial year. Nonetheless, we have raised our turnover value assumption by 3% to S$2.1bn for FY6/08 and reduced it by 7% to S$2.0bn for FY6/09.

Positive view of derivatives is unchanged. We maintain our positive view that the derivatives market is ramping up existing products and launching new ones (Mini Asian Index futures contracts, single stock derivatives, Japan ETF based on TOPIX and a product suite from the revamped Straits Times Indices). Therefore, we have raised our daily volume assumption from 0.161m contracts per day to 0.164m for FY6/08.

M&A event priced-in. We believe that the recent run-up in the share price reflects a potential M&A event. Although we cannot rule out such a possibility, we believe that any potential suitor will need to bring synergies to enhance SGX and Singapore as a financial service centre. However, at this moment, there does not appear to be one.

China Macro Strategy - Mortgage policies tightened

2007-10-01T01:51:00.001-07:00

PBOC and CBRC jointly announced overnight a set of regulations tightening lending policies for home buyers and developers. The highlights are: (1) min mortgage down payment ratio will be raised to 40% from 30% for second homes; (2) min mortgage rates will be increased by 10% from benchmark lending rates (e.g., for 5-10yr mortgage rates, it's raised by 78bps to 8.61% from 7.83%) for second homes; (3) down payment ratios and mortgage rates should be raised further for borrowers buying more than two homes; (4) borrower's monthly mortgage payment should not exceed 50% of the monthly income;
(5) for commercial properties, min down payment ratio is raised to 50% from 40%, and min lending rates are also raised by 10% from benchmark rates; (6) banks are not allowed to offer mortgage loans to buy units in projects that have not yet completed superstructure (e.g., ceilings of the buildings); (7) technical arrangements (database/information sharing etc) are made to ensure second home buyers can be effectively identified by banks (even if a family has borrowed from other banks before); (8) banks are not allowed to issue loans to developers that stock up land bank.

Among these, items (1), (2), (3), (5), (7) are broadly in line with our expectations. Item (6) should be a surprise to the market; it will likely delay sales and increase working capital costs of many developers especially those in second-tier cities. Items (4) and (8) also suggest that the government is more determined to address property inflation and associated credit risks than what the market has expected. We think overall the policy package is a bit more aggressive than market expectations. This policy set, together with possible further measures such as pilot program of a property tax and tighter mortgage quotas, should continue to pose short-term downside risks to share prices of developers.

Deutsche Bank - Equity Research

Best of Asean - Spoilt for choice

2007-10-01T01:50:00.003-07:00

Asean insights – Country weighting changes

Today we issue the first edition of The Best of Asean - a new product that looks at where to find value in some of Asia's highest growth countries.

Our regional strategy team changed its country weightings last week. Country allocations are harder as we are spoilt for choice. Our internal debates have been around whether we should be positioned in countries that are genuinely booming already but where valuations are rising (Malaysia, Singapore, Hong Kong, China, Philippines) or those that are just starting to join the party and where valuations remain compelling (Taiwan, Korea, Indonesia). We favour the second group and also stick with Singapore because of the opportunities in the banking sector. Hence we have Indonesia and Singapore within Asean as overweights in our regional model portfolio.

ASEAN focus – Malaysia, Thailand and Phil banks

In Malaysia, we believe the changes in the recent 2008 Budget to the tax and savings policies are highly positive for the economy. Stocks that could raise dividends include Digi, Public Bank, B Toto, BAT and Gamuda.

History suggests that the Thai market usually rallies ahead of a general election, with positive returns over three months for the SET prior to seven of the past eight general elections. Financials (banks, fincos and property) and the traditional high beta sectors are best placed we believe.

Our recent work on the Philippine banking sector examines what impact higher NPLs and lower coverage ratios could theoretically have on book values. We essentially derive an adjusted book value for the Philippine banks. On adjusted book value alone, the cheapest banks are CHIB, Security Bank, and BDO.

Asean ideas of the week – Switch out of IOI Corp (IOI MK, RM$5.90, Neutral, target price RM 6.00) into London Sumatra (LSIP IJ, Rp6,900, O/P, target price Rp8,500). We also like the soft commodity theme and revised our target prices for Olam (OLAM SP, S$3.14, O/P, target price S$3.57).

Asean top ideas – Our top two country picks in ASEAN are given below. The rest of our country picks are on pages 2 and 3.

Source: Bloomberg, Macquarie Research, September 2007

NCsoft (Neutral) - Hoping to start from a clean slate

2007-10-01T01:50:00.001-07:00

Hoping to start from a clean slate

Event

We paid a company visit to NCsoft.

Impact

Short-term focus will be on Tabula Rasa. NCsoft plans to launch Tabula Rasa on 17 October in the US and Europe. So far, reviews were mixed. Positive reviews were focused on the differentiated experience the game offers, while the main negative indicated was the game was less addictive. The level of success of this highly-anticipated MMORPG will likely determine the strength of NCsoft shares ahead of 3Q07 results in early November.

Korean operations recovering. Lineage I is recovering from piracy server issues and Lineage II remains stable with a new update. However, our checks indicate that the financial impact may be limited as Lineage I user metrics remain below previous highs and Lineage II promotional activity was high.

Overseas operations mixed. The success of Guild Wars and the stable City of Heroes/City of Villans (CoH/CoV) franchise suggest that operations in the US and Europe are in line with expectations. However, operations in Taiwan and China remain disappointing due to extreme competition.

Downside risk to 3Q07 estimates. We expect 3Q07 results to be better QoQ, due to seasonality and the launch of the Guild Wars expansion pack in August. However, we believe the improvements may not be as significant as the market expects, as the piracy server issue still seems to be weighing down on results, while the free-trial promotion event of Lineage II following the recent update is not expected to have a huge benefit to the top line.

Earnings revision

No change.

Price catalyst

12-month price target: Won80,000 based on a PER methodology.

Catalyst: Shares may stay range-bound for the time being until more concrete data points from new titles emerge.

Action and recommendation

NCsoft shares have gone up 51% year to date, outperforming the KOSPI by 15%. The shares have also rebounded from a recent correction ahead of Tabula Rasa’s launch on 17 October and the short-term direction of shares will likely be determined by the launch’s level of success. Therefore even though the longer-term growth outlook remains in question (2009E adjusted EPS may decline 4% YoY), and 3Q07 results are at risk of falling below expectations, taking profit at this time may be premature, in our view.

[MORGAN STANLEY] ASIA/PACIFIC MORNING MEETING SUMMARY & AP STRATEGY & DOWN UNDER DAILY

2007-10-01T01:48:00.001-07:00

AP STRATEGY: KEY EVENTS: ASIA CPI & US PAYROLLS - Malcolm Wood

Asia Events - CPI (Korea, Taiwan & Indonesia), Trade (Korea, Indonesia & Malaysia) & RBA Rate Decision: With rising food and oil prices, we expect the September CPI to have edged up in Korea (2.5%Y), Taiwan (2.0%Y) and Thailand (1.6%Y), while Indonesia's CPI is forecast to have remained steady. Korea's export & IP growth are expected to have moderated from high levels. The central Banks in Australia & the Philippines are expected to keep rates unchanged. See page 2 for details
Asia Earnings - A Quiet Week: Consensus EPS growth expectations for AP ex-Japan in 2007 and 2008 are 15.3%Y (vs. 15.2% last week) and 11.0%Y (vs.11.3% last week), respectively. Asia was trading on 17.7x 07 and 15.9x 08 consensus earnings estimates. See page 2 for details.
International Economic Events: US ISM, Non-Farm Payrolls, ECB Rate Decision & Tankan Survey: US non-farm payrolls are forecast to have rebounded by 125k, while we expect a dip in the ISM to 52.5. The ECB is expected to leave rates unchanged. See page 3 for details.
International Earnings - A Quiet Week: Consensus EPS growth expectations for the S&P 500 are 8.3%Y in 2007 and 11.8%Y in 2008. The S&P 500 was trading on 16.0x 07 and 14.4x 08 consensus estimates. See page 3 for details.
Market Performance - Asia Outperforms: Global equity markets rallied last week, with Japan up 3.1% and the US & Europe both up 0.8%. AP ex-Japan rose a sharp 3.7%, led by China (7.3%) and Taiwan (+4.9%). US 10-year bond yields declined by 14 bps. Most Asian currencies extended the rally against the US dollar, led by the Aussie dollar (+1.9%). Among commodities, the WTI oil price dipped (-0.5%) from a record high, while copper (+3.7%) and aluminum (+1.2%) rallied. See pages 4-8 for details

DOWNUNDER DAILY : THE PHONY WAR - Gerard Minack

Take your pick: equity markets are either behaving as if the worst is over for credit and housing problems or they remain convinced that the Fed can offset whatever bad news may unfold. The end result is the same: the consensus remains solid that the US will soft-land and that rates will head lower - which is seen as a marvelous combination for equity assets, not just in the US but globally.
This phony war can last a little longer, in my view. Until there are casualties - and, in an economic sense, that means sustained job losses - investors will remain confident in a Fed-engineered soft-landing. While ever that remains the case, equity markets are likely to continue to follow the recent pattern: 'soft growth = Fed cuts = equities rally'.
However, the view that the worst is over is dead wrong in my opinion. Certainly, the residential construction recession has been evident for some time, but even so it seems set to run well into next year, based on our US team's forecast. But the bigger issue - the important issue for investors - has always been the extent of the knock-on to consumer spending, and then the labour market. I expect the knock-on to come through several routes:
First, the household sector continues to draw substantial equity from its dwelling wealth - equivalent to 3⅓% of household income over the year to the June quarter. There is a close relationship between home equity extraction and the change in housing wealth, so it seem likely that extraction will fall in coming quarters (Exhibit 1).
Second, as is well known, the mortgage reset wave is yet to crest. Exhibit 2 is from colleague Janaki Rao, showing estimated resets.
Third, potential borrowers have to cope with a material tightening in financial conditions. One gauge of that tightening is the rise in mortgage rates. Despite the Fed’s rate cut, mortgage rates are now at or near cycle highs (Exhibit 3).

[MORGAN STANLEY] HANDSET SUPPLY CHAIN & REFINING&MARKETING & UTILITIES & OIL&GAS

2007-09-27T06:47:00.003-07:00

HANDSET SUPPLY CHAIN: RAISING HANDSET FORECAST POST ASIA TRIP; BUY SWKS, OVTI, AND NOKIA - AARON D HUSOCK

Conclusion: We are raising our 3Q07 global handset forecast by 7% to 300 million units driven by upside at Nokia and Samsung over the course of the quarter that
also appears to be driving strong order momentum into 4Q07.
What's New: We met with industry contacts at 52 companies in Asia over the past two weeks, spanning semiconductors, handset components, EMS, and component distribution.
Component Implications: We reiterate our Overweight ratings on Skyworks and OmniVision and are raising our above-consensus estimates for both companies as our
checks indicate fundamentals are accelerating faster than we expected. We are also incrementally more positive on RFMD (upgraded to Equal-weight on 8/24/2007) as Nokia demand appears to be driving near-term upside to estimates and the company appears to be preparing for a much larger Nokia transceiver ramp than we were modeling.
Handset Vendor Implications: Our colleagues are upgrading Nokia to Overweight from Underweight as they see 15% upside to 2H07 consensus EPS driven by higher than expected volumes led by a ramp at the mid-to-high-end, increased market share and new product introductions continuing to stabilize ASPs resulting in margin and revenue outperformance. Our colleagues who cover Motorola are reducing 3Q07 and 4Q07 unit estimates as they see a slower than expected recovery.

REFINING & MARKETING: LOWERING ESTIMATES, STRAW HATS IN WINTER AHEAD? - DOUGLAS T. TERRESON

Estimates Appear High for Q3 2007:

Our earnings forecast for Independent R&M companies’ declines by 10% with today’s revision. Our estimates were 15% but are now 20% below consensus for Q3 2007. We are maintaining financial projections for 2008-2009 and under normal conditions.
Straw Hats in Winter Seasonal Trade Ahead?
Margins in refining, financial projections in R&M and investor sentiment typically declines during the 2nd half of each year, setting up the seasonal trade. With performance of R&M stocks superior during December to May in 15 of 18 years, we prepare for “Straw Hats in Winter”.
Constructive Outlook Remains For 2008-2010:
Margins are likely to remain near record levels during 2008-2010. Global growth in supply of “light-products” will modestly outpace that of demand, but global utilization rates and margins will remain unusually high, in our view.
Maintain In-Line on R&M Sector:
While earnings estimates appear high for 2007, financial conditions in refining will remain positive thorough the end of the decade. Valuation appears attractive on
normalized conditions, with select equities representing attractive value over the longer-term.
Overweight Stocks: VLO, SUN, TSO, COP, MRO, and XOM: Our price objectives are VLO - $90/sh., TSO - $66, SUN - $95/sh. COP - $105/sh., MRO - $75/sh., and
XOM - $96/sh.,

UTILITIES: KEY TAKEAWAYS FROM OUR 5TH POWER & UTILITY SUMMIT - BOBBY CHADA

Positive power price trend to continue: CEZ, EDF, IPR and SSE all explained that investment needs and sustainable high costs for power plant technology, fuel and CO2 emission certificates should continue to support higher power prices. We forecast that prices in Europe will increase by around 10%, to around EUR 60/MWh, over the next few years. This should continue to benefit European generators, especially the nuclear and hydro based generators like EDF, British Energy and Fortum.
Growth strategies: Many companies mentioned organic growth opportunities in the construction of new power plants and regional expansion not only in Europe
but also in the US, South America, Asia and South Africa. IPR’s growth pipeline offers one of the most clear-cut growth opportunities in our view. Regulated
utilities like Severn Trent, Terna and Snam Rete Gas see scope for growth in the expansion of their asset base and cost savings. The reinvestment of cash and
value that this can create will be an increasing focus over the next year in our view.
Renewable energies gaining attention: Utilities like IPR, SSE, EDP and CEZ all stressed their renewable plans. Some are more advanced than others — and
after major acquisitions in the last year we believe that IPR and EDP will move to a more organic development focus from now on. The major challenges to the
execution of a renewables strategy are finding the appropriate project and location, securing the relevant government approvals and sourcing the equipment in a
tight market. Nevertheless, an increased focus on renewable energy is a clear trend.
Our Key Overweight ratings are AEM, EDF, Centrica, International Power and Veolia.
Our Key Underweight ratings are PPC, United Utilities and Union Fenosa.

OIL & GAS : WHO GROWS THERE? - NEIL W PERRY

Volumes matter. After four years of declining volumes for the integrated oils, we see a resumption of growth between 2007 and 2009. It will be very unevenly dispersed between companies, and should act as a catalyst for performance.
It’s the declines that matter most. New projects are important, but the key is in the underlying declines. We separate out growth from decline and analyse our numbers and company targets in the context of realistic decline scenarios.

StatoilHydro, BG and Total stand out. The Norwegians look set for an outstanding year in 2008; BG is slowing down, but only slips to number two in the sector. Total has the highest growth rate of the larger companies, albeit it more risky than StatoilHydro and BG, and should show the greatest contrast with the last three years.
BP set to beat expectations by the most. BP has humble targets of just 1%. Our forecasts suggest 2% CAGR to 2009. We believe that the company has built in
aggressive underlying decline, and see up to 3% CAGR as viable.
Resuming coverage of StatoilHydro at Overweight. StatoilHydro replaces BG as our top pick in the sector, with 9% volume growth in 2008, the benefits of the merger and leverage to crude prices from a reasonable valuation base.
Integrated oils are 20-30% undervalued. We believe that the integrated oil sector is fundamentally undervalued. We expect a combination of continued earnings upgrades to both 2008 and longer term numbers, as well as a resumption of growth, to act as a catalyst for performance.

Citi: Food 4 Thoughts: China Wind Power Industry - Sexy Growth but Not Risk Free

2007-09-27T06:47:00.001-07:00

Citigroup Asian Utility Research
China Wind Power Industry - Sexy Growth but Not Risk Free

New news:

* A Food-for-Thought Investor Luncheon Event — We hosted the event on 25 Sep 2007 with more than 70 investors discussing China Wind Energy with speakers: 1) Alex Tancock, general manager of a wind power consultant firm Wind Prospect (HK) with experience in the UK, Australia and China; and 2) Yuchuan Tian, managing director of Hong Kong Energy (Holdings) Ltd, the renewable energy arm of Hong Kong Construction (190 HK, NR).

* High growth potential — China is the fifth-largest global wind market with 1,700MW by end-2006. Wind Prospect forecasts this capacity will rise to 30,000MW by 2020, implying a CAGR of 23% pa. Most of the increment would be in Northeast China with high wind speed and large load.

* Tariffs setting to be a key — Based on Wind Prospect, plants larger than 50MW are of limited profitability as they are granted on competitive biddings; but, projects smaller than 50MW each are determined at the local level, offering 5-12% project return, though PPAs are unlikely in place until after commissioning. Big projects are often broken up into 49.5MW each to avoid bidding.

* Risks — Key risks are (i) wind mast and data collection are rarely to global standards, (ii) data in feasibility report could be questionable, (iii) local entity may choose non-IEC compliant local turbines, (iv) delayed completion, (v) problems in grid connection and (vi) uncertain tariffs before completion.

* Rewards — Key rewards are (i) projects could be built quickly, (ii) less uncertainty after getting local government support, (iii) huge market in China, (iv) possible equipment cost cut once domestic manufacturers are familiar with them, and (iv) extra profit from CDM and carbon credits.

* Hong Kong Energy (Holdings) Ltd — It is an early bird in PRC wind power with one operational wind farm in Heilongjiang, with two more (in Hebei and Inner Mongolia) planned. They also invest in waste-to-energy and biofuel projects.

* Stock implications — PRC IPPs should invest more in wind power plants as the government requires those with over 5,000MW to have 8% of capacity from renewable energy. Among the five HK listed PRC IPPs, Huadian and CR Power have operational wind power plants and Datang has a farm under construction.

[MORGAN STANLEY] GLOBAL STRATEGY BULLETIN

2007-09-27T06:46:00.001-07:00

Global Economics : Priced for Perfection - Joachim Fels

Our latest estimate of fundamental fair value for 10-year US Treasury yields stands at 5.0%, based on our MSFAYRE model, still some 35 basis points above current 10-year yield levels. The model also tells us that the current 10-year yield of 4.65% is consistent with a fed funds rate of 4% and actual core inflation and inflation expectations a touch lower than they are now — in other words, bonds look to be currently priced for perfection.
We believe inflation expectations will respond to global pressures and dollar depreciation, pushing bond yields up. The Fed rate cut and a fall in actual and expected inflation have pulled our fair value estimate down by some 30 bp. Bond yields have risen some but should continue to rise further to their fair value of 5%. Why? Current economic conditions resemble a midcycle slowdown rather than a recession.
Our fair-value estimate suggests that Treasuries still look expensive, and we expect yields to rise towards their fair value in the next several quarters. Already, 10-year yields have priced in a fed funds rate of 4%, which would take the Fed to neutral according to estimates from our natural rate model. Being bullish on bonds at current levels then implies a hard landing for the US economy, with the Fed being forced to slash rates below neutral.

GEMS Equity Strategy : Multiple Expansion — Where Next? - Jonathan Garner
The next leg of the EM bull market will be driven largely by an expansion in multiples, we believe, in line with a rerating in global equities. For the most part in the rally since 2003, earnings growth has been a key driver of performance: On average, EPS growth has contributed 84% of the yearly price returns for the MSCI EM. We expect P/E expansion to assume a greater role in driving performance from here.
MSCI EM has already started to benefit from multiple expansion. China’s substantial re-rating has been a prime driver of the multiple expansion for the overall asset class. In the last 18 months, MSCI China’s trailing P/E increased by 125%. Russia, in contrast, has had the largest multiple contraction of the top eight markets. The multiple expansion of the MSCI EM as a whole in this period has been 16%. Countries that have the greatest potential for multiple expansion and that are overweighted in our country allocation model include Russia, Turkey, Hungary, Israel and Malaysia.
At the sector level, consumer discretionary, industrials and financials have re-rated the most this year. In contrast, EPS growth has been the primary driver of
performance in materials, energy and utilities. Those sectors which should benefit most from multiple expansion and which we continue to favour on a fundamental basis are energy and materials.
Historically, P/E expansion has been an important driver at this stage of the cycle. It should be all the more so in light of the recent reflationary actions by central banks. These are intended to boost credit availability, but the short-term effect will also be to raise the price of real assets. The liquidity increase should quickly be intermediated into financial assets perceived to offer defensive growth, such as Asian and EM equities and oil, mining and industrial stocks. These measures add fuel to an EM bull market that was structurally intact, in our view.

Currencies : Demographic Trends and the Financial Markets - Stephen L. Jen
Demographic trends have important economic and financial implications. Without remedial action, global ageing in the developed world tends to raise the level of real interest rates, flatten the yield curves, benefit equities at the expense of bonds, and lower the value of the dollar.
Declining fertility and mortality rates. These two trends have been the primary factors behind the demographic trends (slow population growth and ageing structure) in much of the developed world. With the exception of China, much of the developing world is still enjoying a ‘demographic dividend,’ as their youth populations continue to grow rapidly.
Ageing exerts fiscal burdens that could lead to higher borrowing costs. The levels of real interest rates could be distorted by the lower potential growth rates, lower tax intake, and higher fiscal outlays associated with an ageing population.
Population ageing could also twist the shape of the yield curve. Notwithstanding the point above, decelerating potential growth rates imply higher short-term interest rates and lower long-term interest rates. Conversely, young and growing populations tend to bias the slope of the yield curve upward.
Ageing in the developed world may favour equities over bonds. While the popular notion among academics is that retirees prefer safe assets (i.e., bonds over equities), longevity risk could force retirees to take on more investment risk, as it already has in Japan. While pension funds still hold more bonds than equities, the share of the latter has been rising rapidly.
The US demographic trend is not friendly to the dollar.
Unless the US raises its savings rate at a faster pace than that of dis-saving by the rest of the world, a resurgence in its current-account deficit would not be good for the dollar.

US Economics - How Much More Work Does the Fed Have to Do? - Richard Berner

Fed officials left the door wide open to further easing last week but gave little guidance either on the economic outlook or on the path of monetary policy. Yet their intentions are clear: They will respond as needed to forestall downside risks to economic activity.
We expect another 50 bps of easing by early next year, with the Fed having “front-loaded” stimulus so far. Risks seem balanced around that baseline: The uncertain collateral damage from the housing downturn implies downside risks to rates. But the Fed could also do less, partly reflecting healing markets.
Expect weaker growth in earnings. Investors should continue to expect steeper yield curves, elevated volatility, a weak dollar, and weakening earnings growth. That backdrop may challenge equities. In my view, the jump in breakeven inflation so far signals the reflationary impact of policy on commodity prices, rather than a near-term inflation pickup.
Markets face three risks: Rising defaults may upset the benign outlook for both credit and equities. Inflation might fall faster than expected. Conversely, although the chance seems small, investors should consider that the economy could pick up sooner than expected.

Global DRAMs - Stay away until rationality returns

2007-09-18T21:22:00.001-07:00

* Reduce exposure to DRAM stocks over the next 2-3 quarters

Given that the DRAM market is already rolling over in what should be a seasonally strong quarter, we believe the market environment will deteriorate further sequentially into 4Q07 and a seasonally weak 1H08.
That said, we advise investors to reduce exposure to DRAM stocks over the next 2-3 quarters. We downgraded Powerchip to Hold and ProMOS to Sell. We maintain Hold on SEC and Hynix.

* DRAM market has already peaked; capex discipline needed

As the DRAM market is unraveling again after a brief recovery during early 3Q07, we now expect CY07 DRAM ASPs to be down 46% YoY, exiting the year with new lows in terms of ASPs. We now forecast 4Q07 to be no longer in short supply with an excess of 0.2% vs. a 1.1% shortage previously. The poor DRAM market in CY07 is attributable to substantial capex-induced 91% YoY bit supply growth. In order to prevent another oversupply situation in CY08, the industry must reduce capex significantly. While we expect CY08F global DRAM capex to decline 12% YoY, capital intensity should remain high at 46%, not sufficient enough a cut to stave off the potential oversupply.

* CY08 likely to be another poor year for DRAMs

Therefore, we expect CY08 to be another weak year for DRAMs and forecast a DRAM ASP drop of 38% YoY with market oversupply of 4.4% compared to 6.3% in CY07. Also, we now forecast DRAM contract ASPs of US$1.80 (4Q07F), -13% QoQ, US$1.60 (1Q08F), -11% QoQ, and US$1.45 (2Q08F), and -9%QoQ before a slight recovery into 2H08F.

* A positive scenario is possible in CY08 though after severe pain early on

However, we believe that not everything is doom and gloom for CY08.
There is one potentially positive (or first pain then gain) scenario.
A drastic DRAM ASP collapse to below or near cash costs in early CY08 coule induce significant cutbacks in CY08 capex and accelerate the de-commissioning of "8" capacities, leading to a powerful supply-constraint-driven structural recovery into 2H08. In this scenario, a large capex cut/delay announcements should catalyze potential entry points into DRAM stocks.

* More competitive/diversified players should outperform weaker rivals

While we are cautious on all DRAM-related stocks, we believe some interesting pair trades are possible within the group. For example, we believe those with a competitive edge such as SEC and Hynix can outperform weaker rivals such as ProMOS (Sell; TWD 9.44) and Micron (NR; $11.00). SEC and Hynix's more diversified business mix should also provide a bit more cushioning during downturns. Risks to the upside/downside include memory chip capex, 8"de-commissioning, and global economic strength.

[MORGAN STANLEY] ASIA/PACIFIC MORNING MEETING SUMMARY & DOWNUNDER DAILY & HYUNDAI MARINE&FIRE & KOOKMIN BANK & SAMSUNG SDI

2007-09-18T21:20:00.001-07:00

DOWNUNDER DAILY : A GET-OUT-OF-JAIL-FREE CARD - GERARD MINACK

This time is not different - at least not in terms of the initial investor response to an unexpectedly aggressive Fed rate cut. But I'm not convinced that the Fed's move makes a material difference to the risk of recession, which is the decisive issue for medium-term investors. A few thoughts:
First, rate cuts are like tequila shots: You rarely have just one. Morgan Stanley US economist Richard Berner expects the FOMC to ease by a cumulative 100 basis points. The prospect is underlined by the second-round collapse in housing indicators. For example, Reality Trac reported overnight a substantial jump in housing foreclosures in August (Exhibit 1).
Second, equities usually perform well in the initial stages of a Fed easing cycle. Morgan Stanley European strategist Teun Draaisma has provided a nice summary of past equity performance around the first Fed cut (see Striking Statistics, 17 September). Teun notes that historically the first rate cut may only stabilize markets, while better returns follow the second easing. Rightly, however, Teun notes that it's not a stretch to argue that the discount rate cut was the first easing in this cycle.
Third, equities are a sell in extended Fed easing cycles. That's because extended easing cycles usually occur in recessions, and recessions are always bad for equities. But even within recession-driven bear markets, Fed rate cuts can provide a short-term boost for the market, particularly if they are unexpected. Amidst the TMT rout of 2000-03, the NASDAQ jumped 14% on the day of the first (surprise) Fed cut in 2001. Of course, in a bear market, it pays to sell such bounces.
With the daily run of economic data soft, but not providing compelling evidence of recession, my base case assumption is that the Fed easing will provide support for equities in the next quarter or so. For medium-term investors, however, the key issue remains simple: Is the US heading into recession?

HYUNDAI MARINE & FIRE: W25BN CAPITAL INJECTION; IN-LINE WITH EXPECTATION - JENNIFER HAN

Quick Comment: Hyundai M&F (HM&F) announced that it will inject an additional W25bn into its online auto insurance subsidiary, Hi-Car Direct. This is in-line with our expectation, and we expect an additional capital injection in the future if Hi-Car Direct continues to increase its market share.
What's New: Due to the nature of auto insurance business, it is inevitable that online auto insurers would require additional capital in their initial stages to maintain adequate capital levels and to help increase market share. Hi-Car Direct was established with initial capital of W20bn in Dec 2005 and since it began operations in Apr 2006, HM&F have injected additional W35bn in Sep 2006. Following today's announcement of W25bn, Hi-Car Direct's paid in capital will increase to W80bn and its solvency ratio will rise from 140% to 200% level.
Implications: Hi-Car Direct's market share is about 2% in total auto insurance market and 13.6% among online auto insurers closely catching up to no.2 player Daum Direct with about 15% market share. If Hi-Car Direct continues to increase it market share, we expect HM&F to inject an additional W20-30bn into Hi-Car Direct in the future.
Reiterate Overweight Rating: We believe recent share price weakness provides a good buying opportunity as we expect the company to continue to benefit from sector turnaround in auto insurance business and from its maturing high-yield guaranteed policies.

KOOKMIN BANK: 5.1% STAKE SALE (ING KOREA) TO INCREASE 07E EPS BY 4% - CHAN HWANG

Quick Comment: Kookmin Bank has decided to sell a 5.1% stake in ING Life Korea (20/80 JV with ING Group) to ING Group sometime next week, which will lower Kookmin Bank's ownership to 14.9%. This transaction between KB and the ING Group had long been scheduled to occur this year.
Transaction Details: Out of 1,400,000 shares held, Kookmin Bank will sell 357,000 shares for W193.9bn (or W543,000 per share). These were bought at W11.6bn (or W32,417 per share) back in 1999. Currently, 5.1% of ING Life is booked at W31.8bn, suggesting the potential gain from the stake sale could amount to W162.1bn.
Impacts on Kookmin Bank: Even though this is a one-off event, we believe that the impact on Kookmin Bank will be big enough to attract attention, increasing the bank's 3Q07E earnings by 15.5%. In addition, 07E EPS and 07E BV could be raised by 3.7% and 0.7%, respectively, based on our analysis.
Kookmin's Book Value Understated by 2%: Kookmin will not mark-to-market its remaining 14.9% stake in ING Life Korea, as it has been classified as equity-method applied stocks. If we use W543,000 per share value for remaining shares, Kookmin's 07E BV could increase by 2.2%.

SAMSUNG SDI: MID-3Q07 UPDATE - NO FUNDAMENTAL IMPROVEMENT - HENRY KIM
Another Disappointing Quarter Likely: Our channel checks indicate that, unlike other technology companies, Samsung SDI (SDI) is likely to report another weak result, even in seasonally strong 3Q07, on weaker volume growth and a higher start-up cost burden.
Maintain Underweight Rating: We expect the magnitude of the seasonal earnings recovery to be very disappointing due to competition with other display devices, such as TFT-LCD, the start-up cost burden from new production lines in PDP and AM OLED, and restructuring charges in CRT. We view anticipation of Samsung group's rescue plans for SDI, including possible business portfolio changes, as highly speculative in the near term. We maintain our Underweight rating on the stock.
·PDP (Better volume but no improvement in profitability): We now expect SDI's 3Q shipment volume to grow around 40% QoQ, higher than guidance for 30% sequential growth and our prior estimate of 30%. Our full-year shipment forecast of 3.2 million units is unchanged considering softer 4Q07 volume guidance. The company is guiding for mid-10% ASP erosion in 3Q07, on continuing pricing pressure from TV customers. We expect SDI to record a similar operating loss in 3Q on the initial ramp-up cost burden from the new P4 line and pricing pressure despite stronger volume growth.
·Mobile Display (Worse Mix): We expect overall volume shipment to meet the guidance of mid-10% sequential growth but actual revenue growth to remain flattish on a worse product mix (less TFT-LCD) and continuing pricing pressure. We expect the operating margin to remain at the mid-single-digit level in 3Q07.

4Q07 Eye on Asian Economies

2007-09-18T21:17:00.001-07:00

We have just published our 4Q07 Eye on Asian Economies. As may be
guessed from the title: Apocalypse begins, changes in this quarter, are
typically downgrades. We have cut our projections for 2008 growth in all
but four countries. Across the ten Asia ex-Japan countries we forecast our
2008 growth forecasts are down 0.5ppts from the third quarter EoAE (our
Japan forecast has been cut 0.8ppts). For the same ten countries our 2008
GDP growth projections are 2.4ppts below consensus (we are 2% below
consensus for Japan in CY2008).

We have reinstated aggressive US rate cuts in our forecast, a decision
vindicated by the Fed’s 50bp cut on Tuesday. This creates the potential for
Asian rates to come down. However in a number of countries rates are
already so low, thanks to the liquidity inflows in the last two years, that it
is unrealistic to expect Asian central banks to match US cuts one for one.
On the contrary the reversal of these flows means that rate cuts in many
places will be limited (and we expect a small increase in T-Bill rates in the
Philippines). We see the greatest prospects for interest rate cuts in
Singapore and Hong Kong.
Last week’s Triple-A introduced the changes to our forecasts for the US, EU
Japan and China. Though there are few changes to our numbers for 2007 – a
sharp US slowdown has been in our forecast since the start of this year – the
scale of the credit unwind in the last quarter has caused us to move back the
point at which we expect the US economy to recover from 2H08 to 2H09. We
have made a similar change to our EU forecast, greatly moderated the upturn
we expect for 2008. Economic data have been softer than we expected in the
last quarter and the EU financial system is likely to be no less affected by the
credit and risk unwind than that of the US. Following the revision to 2Q GDP
Japan’s economy is already in reverse. Japanese cycles are short and we expect
a recovery to begin in 2H08. But this will be modest while other developed
markets are weak and, from an Asian perspective, Japan is not large enough to
act as an offset to weakness in the EU and US.

The absence so far of any meaningful slowdown in China has caused us to
increase our 2007 growth forecast to 11.5%; this implies no deceleration
compared with the second half of the year. For 2008 we have maintained our
expectation of 9% growth, with most of this front loaded into the first half
thanks to aggressive government infrastructure spending and the inevitable, but
temporary, boost to consumer spending that that will result from the Beijing Olympics. For the second half of the year we remain pessimistic about Chinese
growth. Its massive current account surplus (we estimate that the surplus will
be 12.1% of GDP this year) points to productive capacity having grown far
beyond domestic demand. This makes China vulnerable to a slowdown in its
external markets. And 23.5% of China’s exports go to the US with a further
22% to the EU. The 9% full year 2008 forecast implies a quite rapid
deceleration in the second half.

The Indian exception
The combination of weak US and EU demand throughout 2008, an anaemic
Japan and China slowing in the second half is a difficult one for most Asian
countries. The exception to the rule is India. Its economy is driven by domestic
forces. Growth in the second (calendar) quarter was stronger than we expected
thanks to robust performances from manufacturing, financial services and
community, social and personal services. The last of these is a category unique
to India and includes retailing and wholesaling. It accounts for 15% of GDP.
With finance and manufacturing also motoring ahead despite tighter monetary
conditions it is now difficult to see India recording less than 9% real growth in
2007/08.

We expect next year to be slower but India has a key advantage over China. Its
interest rates are much more appropriate relative to its trend rate of growth than
are those in the PRC. There has not, therefore, been the rapid overexpansion of
capacity that has ballooned out the Chinese current account surplus. While
global growth, liquidity and risk appetite has been abundant this difference has
been seen as an advantage for China allowing faster rates of investment, GDP
and asset price growth. But these have been achieved through an inadequate
discipline on investment. Indian businessmen have been kept on a much tighter
leash – the dependency on external demand to absorb incremental production
has not been developed and bad investments have been heavily discouraged.
India is an outperformer in our forecast; we expect GDP growth of 8.4% in
2008/09. By the end of 2008 this will make it the fastest growing economy in
Asia.

Don’t rely on OPEC
Outside of India however conditions will be difficult. The slowdown we expect
in the EU and US will directly affect the order books of Asian manufacturers.
The electronics industry is likely to be especially badly hit. China at this point
will still be acting as an offset but a rather smaller one than the share it takes in
each country’s exports implies. Intra-industry trade, whereby materials and
parts are shipped to China, assembled and shipped to their final destination, has
muddied the issue. In some countries, most conspicuously Taiwan and Korea,
parts (as best we can judge) have been the largest source of export growth to
China. Slowing US demand will hit these countries via their Chinese order
books.

Chinese growth in the first half is, however, likely to maintain demand for
commodities. In turn this suggests that demand for Asian goods from
commodity producers will remain firm. We see a more acute risk of falling
commodity prices in the second half of 2008 than the first. However, even
while Chinese demand remains strong, EU and US demand will be weakening
and rising risk aversion and contracting liquidity also suggests softer
commodity prices. In short we think that the peak has now passed for oil and
commodity prices and consequently for the export revenues of commodity
exporting countries. In Asia this has direct implications for Indonesia and,
especially, Malaysia but it also means that it is unwise to rely on current robust
exports to OPEC, Latin America and the CIS. Certainly such reliance flies in
the face of experience.
It is almost embarrassing putting Figure 1 into Triple-A again as it is a chart
that we have used repeatedly this year (most recently two weeks ago). It shows
which regions have driven extra-Asian export growth. We have included it
again because the high correlation of Asian export growth to all four trading
blocs – USA, EU, commodity producing countries and the rest of the world is
the clearest indication we know of why robust Asian exports to commodity
producers now is no indication that they will continue to act as an offset when
world growth slows.

A number of Pacific Rim countries showed robust domestic demand growth in
1H07. But we do not feel confident projecting that to continue in light of the
broad export slowdown implied by Figure 1. In some cases domestic spending
is weakening already. We believe that Korea’s consumer spending indicators
are looking tired and, though capital spending is stronger, we judge that it too
has passed its peak. Others will soften when the second round effects of a US
and EU slowdown develop. In the first half of this year Malaysia combined
decent consumer spending growth with lacklustre exports of goods. But this
says nothing about whether consumer spending can stay robust faced with falling exports of goods if commodity prices are also weakening (reversing
rural outperformance) and, thanks to falling oil prices, shrinking export receipts
are weakening Islamic banking’s primary market.

Soft domestic demand is the rule
But in truth more countries display fragile domestic demand stories than robust
ones meaning that a net export slowdown will bite directly. Taiwan is probably
the archetype here. Its domestic economy is weak and if electronics exports
slow growth will fall rapidly. Thailand is in the same position. Consumption
and investment are both presently soft and we are sceptical that a general
election will deliver the decisive result needed to support a rebound in
confidence and spending. Philippines consumption growth has been good. But
there is little capex and consumption is fragile, supported by a single – cyclical
– revenue source: overseas workers remittances. The downgrades to our extra-
Asian demand assumptions therefore imply cuts in our 2008 Asian growth
projections. Figure 2 shows the forecasts in the fourth quarter EoAE with the
3Q report for comparison.

Excluding India we have increased our 2008 growth projections in only one
country, Korea. This reflects the competitiveness gains that allowed it to live
with an appreciating won between 2003 and 2006. Our numbers for China and
Hong Kong remain unchanged. In all other countries we are less optimistic
about 2008 growth than we were three months ago.
The extent of the downgrade is broadly speaking a function of the openness of
the economy and the anticipated resilience of domestic demand. Hence
Malaysia and Singapore have received the biggest cuts in our forecasts because
these countries are most geared into world trade. Thailand and Indonesia
because weaknesses in their economies leave domestic demand vulnerable.

[GS] Commodities: Super spike framework remains intact. Raising WTC forecasts

2007-09-18T21:13:00.001-07:00

GS GLOBAL OIL CALL => Raising WTI forecasts to $80 and $90 in 08/09; no signs of demand destruction
The core drivers of our "super spike" framework remain intact: spare capacity throughout the oil value chain remains limited, supply is struggling to grow, and demand growth continues. (Note below conf call details with GS global commodities team)

What’s changed:
1) Higher WTI assumptions
- $67, $80, $90 per barrel in 07/08/09 (vs $65, $68, $68 before)
- $80, $75 per barrel in 2010/11 (vs $45 normalized before)
2) Higher normalized oil price assumptions
- Normalized oil price (in 2012 and beyond) pushed up to $50 (was $45) reflecting cost escalation

Reasons for the upgrade
1) Accelerating demand growth in 2007
- After two years of deceleration, demand growth has accelerated in 2007 despite oil prices at $60-70/bbl
- GS expects ~1.5m b/day per annum demand growth for the remainder of this decade
- Demand growth has been the strongest since 2004 in part because the y/y price inflation has been at the lowest level in three years. Stable oil price ($60-$80 / bbl range) has stimulated demand growth, particularly in the US and China, despite a sluggish US economy in 2007.

- Demand at the current price is likely more inelastic (The massive rise in energy prices from late 2004 to the summer of 2006 killed off excess discretionary demand and a large price increase is likely required to slow demand growth similar to the experience of 2005 and 2006).

2) Non OPEC supply growth remains challenged
- Non OPEC supply growth has continued to fall short of consensus expectations
- GS expects not more than 700k b/day non-OPEC supply growth per annum in the coming years
3) OPEC spare capacity at minimal levels
- As demand growth continues and non-OPEC supply falls short, expect rising dependence on OPEC to grow its production
- GS base-case assumes Saudi Arabia meets its 3% per annum production capacity growth targets
- Note all the super majors have been falling short of their own production growth targets
4) No signs of demand destruction – subsidies suppress demand elasticity
- Key Reason: 2/3 of demand growth comes from emerging economies (China, India, Mideast) where prices are heavily subsidized

- Estimate tipping point for demand destruction is >US$130 (At that level, gasoline spend as % of income will be 7% - the level in early 80s when demand growth turned negative. Today gasoline spend as % of income is 4.5%)

5) Note slower US demand growth is already built into assumptions
- GS has already assumed incremental demand from the US falls from 370k bbl/day in 07, to 270k bbl/day in 08
- Even assuming the entire 270k bbl/day disappears (ie, ZERO demand growth), global oil demand growth is 1.1m bbl/day (instead of 1.4m bbl/day)

- Still significantly outstrips non-OPEC supply growth of only 700k bbl/day

Risks: Lower US demand if US goes into recession plus potential near-term Energy equities sell-off. GS thinks oil prices will remain firm because of tight global supply and strong demand from emerging markets.

Traders' perspective Energy and gold remain the focal points of the commodity complex leading into todays FOMC - both creeping higher in a subdued trading environment yesterday.

Oil Early yesterday oil dropped on diminishing storm fears (Ingrid was downgraded) and flow on effects of jitters in other financial market but the dip was short lived ... option expiry explained much of the late rally and the 60 cent burst after the close (beyond $81, currently $81.14)) was also seen to be gamma scramble.

We're getting plenty of questions about the best way to play the crude market to the long side in the current environment - its actually a very easy question to answer and its well illustrated in the chart below. The crude forward curve is discounted (light blue line), implied vols are historically low (red line), lagging other asset classes and there is very little Call skew that you need to pay. Six and twelve month 105 and 110 Calls make good sense and price up attractively - ie. 6 month $85 (105% of spot) WTI Call is $2.25 per barrel or (2.75% of spot (spot WTI $81)).

Gold

Gold traded up to $718.75 from $711.00 (in Asia) on a spot basis yesterday and has held most of those gains in pre-FOMC trading. The positioning issue is slowly gaining a focus as the CFTC reports from Friday showed a 4m oz build which is 78% of its maximum positioning; up from 40% 2 months ago. The Northern Rock issue which was seen to contribute to a $10 spike in prices on Friday, lingers in the background. ETF demand is likely to continue and one senses that money market fears are not yet easing. The vol market was mostly unchanged yesterday, with some FOMC related upside Call interest. Theres been some good sized selling around in gold this morning that seemed to be triggered by a little-dip in the EUR (USD strength) - Tocom related profit taking also going through but the market is absorbing it well - down $1.50 from the New York close.

[MORGAN STANLEY] AP STRATEGY & US ECONOMICS & SEMICONDUCTORS & DOWNUNDER DAILY & ASIA/PACIFIC WEEKLY PREVIEW

2007-09-18T04:44:00.001-07:00

AP STRATEGY: KEY EVENTS: FOMC DECISION; IBK RESULTS - MALCOLM WOOD

Asia Events - Singapore Trade, Taiwan Export Orders & RBA Governor Speech: We forecast Singapore's NODX growth to pick up further to 8.3% YoY, though downside risks to external demand could undermine export growth in late 2007 or early 2008. RBA Governor Stephens' comments are expected to reveal a hard-line attitude toward the market turmoil. See page 2 for details.
Asia Earnings - Agile Property, Fosun, China Coal, Henderson Land, Sino Land & Coles Group Results: Consensus EPS growth expectations for AP ex-Japan in 2007 and 2008 are 15.5%Y (vs. 15.1% last week) and 10.9%Y (the same as last week), respectively. Asia is trading on 16.4x 07 and 14.8x 08 consensus earnings estimates.
International Economic Events: FOMC & BOJ Rate Decisions, US CPI & Housing Data: We expect the Fed to cut rates by 25 bps, while the BOJ is likely to leave rates unchanged. US Housing Starts are expected to fall another 2.2% MoM to 1.35k. See page 3 for details.
International Earnings - US Investment Banks, Best Buy, Oracle, FedEx & General Mills Results: Consensus EPS growth expectations for the S&P 500 are 8.5%Y in 2007 and 11.7%Y in 2008. The S&P 500 is trading on 15.5x 07 and 13.9x 08 consensus estimates. See page 3 for details.
Market Performance - Equities Flat: Global equity markets were mixed last week, with the US up 0.4%, Europe down 0.4% and Japan down 2.9%. Asia-Pac ex-Japan was flat, with Hong Kong (+4.8%) outperforming, while Korea (-2.1%) and the Philippines (-1.9%) lagged. The US 10-year bond yields declined by 5 bps. Most Asian currencies strengthened against the US dollar, with the NZ dollar rising 3.8%. WTI oil price rose a further 5% to a record US$80.1/bbl. Base metal prices gained, with copper up by 2.5% See pages 4-8 for details

US ECONOMICS: BUSINESS CONDITIONS: HEADLINE IMPROVEMENT MASKS UNDERLYING DETERIORATION - SHITAL PATEL

What's New: The MSBCI gained eight points in early September to 38%, retracing half of August's stunning 17-point plunge. But deterioration in survey details augurs weakness. Among them: Advance bookings edged down by two points to 48%, while the business conditions expectation index plunged nine points to 40%.
Conclusions: The overseas-domestic results dichotomy extends to the bottom line. Earnings at those S&P 500 companies for which international sales account for more than 25% of total sales (roughly half of the S&P 500) are expected to grow 6.8% in 3Q07 versus 1.3% for the domestically-focused companies, based on consensus estimates.
Market Implications: Ongoing weakness in business indicators continues to spur expectations of aggressive Fed ease, steepening of the yield curve.
Risks: Although pricing conditions didn't change much from last month and commodity prices have risen 3.6% from a month ago according to the GSCI (3.5% ex-energy), prices charged have risen faster than unit costs for 34% of the companies, up from 26% last month. Similarly, 59% of analysts expect margins to expand in 2007, up from 51% last month. Analysts may be overly optimistic given these trends.

SEMICONDUCTORS: GLOBAL SEMICONDUCTOR WEEKLY - LOUIS P. GERHARDY

Last Week-Top and Bottom Performers Globally: SiRF +16% (GPS chip maker), Solomon Systech +8% (handset display driver IC supplier in Hong Kong), and Motech +7% (Taiwan solar manufacturer) were the best performers in our global semiconductor universe in the last week. Richtek 13% (Taiwan power management IC supplier faced concerns on double ordering), Sandisk -10% (NAND-flash memory maker), and International Rectifier -10% (power discrete and IC supplier with accounting problems) were the worst performers in our global semiconductor universe in the last week.
YTD-Top and Bottom YTD Performers Globally: JA Solar +122% (solar cell manufacturer in China), LDK Solar +102% (solar cell manufacturer in China), and Mediatek +84% (Handset and advanced TV IC maker in Taiwan) are the best YTD performers in our global universe. ViMicro -56% (vendor of handset media processor ICs based in China), Core Logic -53% (handset camera ICs based in Korea), and Mtekvision -44% (Korean camera control processors for camera phones) are the worst YTD performers.
Technology Sector Performance (Exhbiit 5): We expect a strong Q3 earnings season will serve as a catalyst for strength in semiconductor shares, but our confidence in the 2008 industry outlook has diminished somewhat and will also likely cap a short term rally. The semiconductor stocks in our N. American universe advanced 0.2% last week versus a 2.1% increase in the S&P500 and a 1.4% increase in the NASDAQ.
Industry Observation: Channel inventory appears low and the rise in semiconductor company inventory appears to represent a structural shift not a cyclical problem. Investors appear to have discounted much of the positive 2H seasonality but the global credit crunch has increased the uncertainty into the 2008 semiconductor industry outlook.

DOWNUNDER DAILY : IT'S SLOW, BUT IT'S HAPPENING...- GERARD MINACK

It's happening slowly, but it does seem that the US consumer is weakening. The monthly data are noisy, but Friday's retail sales data show that real sales increased by just 0.75% at annual pace over the three months to August (I've assumed no retail-level price increase for the August month). The broader personal consumption expenditure series increased by 1.4% over the three months to July, down from 3.7% in the March quarter.
Detecting a change in trend, even when looking at growth over three months, is not straightforward. In particular, swings in real consumer spending are clearly affected by the swing in energy prices. Exhibit 1 shows the rolling three-month growth in real sales and a rolling three-month change in energy costs (inverted, so the line goes down when energy costs go up).
But not all the slowdown in real spending reflects an energy-inspired price squeeze. Nominal spending is also slowing at the margin: the dollar value of sales was up only 2.4% saar in the three months to April, while PCE was up 5.3%% in the three months to July, down from a recent peak of 7.3% in the March quarter. (This can be erratic: this series fell to 2.1% in the three months to last November.)
Moreover, energy prices were not a factor in the softer-than-expected July sales report. Despite the recent increase in oil prices, petrol (gasoline) prices were sharply lower in August compared to July (Exhibit 2).
The most immediate implication of this is that it builds the case for the Fed to ease policy on macro-management grounds. A softer consumer almost always leads to a broader slowdown, for example amongst goods-producers (Exhibit 3). Our US team expects the Fed to ease by 25 points at this week's FOMC.

ASIA/PACIFIC WEEKLY PREVIEW: TUMBLING EXTERNAL DEMAND? - DENISE YAM

Singapore-August Trade (Sep 17): August trade data are likely to continue to register strong momentum. We believe the next few months' data are likely to remain healthy as well. However, downside risks to external demand could pose a threat to export strength in late 2007/ early 2008, in our view.
Australia -RBA comments will be the obvious focus. So far other central bankers - notably in Europe and the UK - have taken a hard-line attitude on market turmoil. We expect Glenn Stephens to have the same attitude.

A Fed cut could help regional equity markets but effect on economies less impressive. Based on option pricing, the market is assigned a 50% chance of a 25bp cut, a 42% chance of a 50bp cut and an 8% chance of a 75bp cut – there is absolutely no probability of the Fed keeping rates on hold. One month ago, the probability of a 50bp cut was only 5%. If the Fed does cut, will that help Asia? The answer depends on why they are cutting.

If the Fed cuts rates to ease money market problems that were not spilling over to the US economy, Asian economies and currencies could pick up strength. Lower US rates would boost US demand for Asian exports and also improve rate differentials (typically helping boost currencies). In some cases, possibly with a lag, lower US policy rates would also translate into lower domestic rates, and help boost activity.
However, in our view, the Fed is not responding solely (or even mainly) to the money market problems. Rather, they are likely to cut rates in response to clear signs of a deteriorating economy. In this case, the net impact on Asian activity is unlikely to be positive – the boost from lower US rates is unlikely to outweigh the impact from activity.

Last month, when we estimated the hit to Asian growth from a US slowdown, we already incorporated the average US rate response in the calculations. As a result, even if the Fed cuts rates on Tuesday, we still estimate that a 1ppt further slowdown in US consumption (beyond our baseline) would nudge down Pan-Asian growth by 0.3ppts to 6.9% in 2008, from 7.2% in our baseline, and 7.6% in 2007. For more details, please see the original piece:

Asia Views – Fed Cuts Coming While Asia Hikes

2007-09-18T04:43:00.001-07:00

Last week saw a slight easing in global money markets; the largest borrowing from the Fed’s discount window since September 2001; and the emergency bail-out of the largest mortgage lender in the UK. The extreme dislocations in USD, EUR and GBP money markets eased slightly last week, with most short-dated rates rallying and overnight LIBOR actually falling below the effective Fed Funds rate. Further out, 3-month LIBOR rates fell around 8bps over the week. Even the Asset-Backed Commercial Paper spreads edged down a touch. During the week, banks borrowed $7.2bn from the Fed’s discount window, the most since the immediate aftermath of September 11, 2001. On Friday, the Bank of England (until now the “toughest” of the major central banks in its response to money market dislocations) announced it had provided Lender of Last Resort facilities to Northern Rock, secured on its own mortgage book. Despite the draw-downs on the US discount window and some dramatic stories of UK depositors queuing outside branches to withdraw money, the overall mood in global money markets seems to be slightly better now than a week ago.

In Asia, some key rates have continued higher despite the global normalization. In China, 1-month SHIBOR rates climbed another 117bps (and are now up 165bps since end July), 7-day repo rates continued their dramatic spike higher, rising to 21.5% from 11% last Friday and a low of 1.4% on August 20. Unquoted onshore inter-bank rates also increased (albeit far less dramatically), jumping higher a few hours before China announced yet another modest 27bp rate hike (which brought the deposit rate to 3.87% and the lending rate to 7.29%). As we noted last week, Chinese rates are highly immune from global fluctuations – actually falling during the worst of the turbulence in the US and now rising even as things seem to be improving a touch globally. Chinese money markets are protected by capital controls, and have been partly driven by the authorities’ efforts to reign in domestic liquidity (via special T-bill issuance; the September 6 increase in required reserves by another 50bp to 12.5%, and last Friday’s rate hike). A number of important pending IPOs have added to the tightness by taking money out of the banking system, and this impact should fade. In Hong Kong, overnight HIBOR is now 80bps higher than on Tuesday, and 55bps higher than last week, while 3-month yields have edged down in line with global markets. Singapore rates were better behaved, with 3-month SIBOR edging down around 6bps more in line with global conditions.

Despite the PBOC rate hike, Chinese and HK equities outperformed the region, yet implied vols remain high. Chinese and Hong Kong equities rose by 3% and 6% respectively last week, clearly outperforming the 1.8% rise in the regional index MXAPJ, confirming that while the exact timing of hikes is a bit of a lottery, the move was much as expected. Since the recent trough, regional equities have bounced more impressively than their global peers (the regional index is now only 4.5% below its peak after being down 19% at one point). However, implied volatility remains higher in Asia than in the majors (implied vols in AEJ are mostly in the high 20s-low 30s, while the implied vols on the majors in generally in the low 20s). This higher implied vol seems more a direct result of the actual volatility rather than a measure of real fear, as Asian equity markets show less skew than the majors (investors don’t seem to be as one-sided in their desire to get protection from price falls).

DRAM/NAND update (Sep 15): Risks still appear high - more cautious on Tier 2 pure plays

2007-09-18T04:42:00.001-07:00

Risks still appear high
We are impressed that chipmakers' guidance has not changed much over the past 2-3 weeks (eg, healthy chip orders, low inventories, no plan to cut back capex, etc) even as investors are getting more worried about a potential US recession. However, DRAM and NAND prices have declined by 15-20% over the past two weeks. We believe chipmakers' current guidance cannot warrant upside if actual sell-through of end products were to be hit by a US-led global slowdown. Our concerns are still (1) chipmakers' record high spending, (2) channel inventories and (3) sell-through of end products. The recent chip price erosions may suggest higher bit growth (sales volume increase) or spot market stabilization (or technical rebound led by speculators) as usual (price elasticity), but we are still worried about record high capex and low margin profiles on top of the US economy.

Key takeaways from our Japan conference
Three major memory companies - Toshiba, Hynix and Elpida - attended our Japan conference this week, which hosted about 1,700 investors and over 200 corporates. All the three companies denied reports that they were cutting back capex and facing order cancellations from their respective customers. Furthermore, they presented a positive outlook for the business by highlighting that: (1) DRAM price should recover or stabilize soon thanks to seasonality and lower supply growth, (2) NAND orders from OEMs remained healthy and that rumors about order cancellations were groundless, (3) price elasticity will continuously function well, particularly with the recent spot price weakness. They also expect a better pricing environment if supply growth turns weak, thanks to acceleration of 200mm fab retirement and companies facing more difficulties in using new nano technologies.

More cautious on Tier 2 pure plays
Spot prices have recently been weaker than expected (DRAM spot: US$1.5 currently vs our estimate of around US$1.8; NAND spot: US$6.8 currently vs US$7.5) with higher volatilities, whereas most memory chipmakers seem to be willing to maintain their target spending - as indicated by the three memory companies at our conference. This will drag industry upturn unless demand can absorb all capacity. We saw short-lived chip price strength this summer, indicating that short-term driven demand recovery (including speculative trading) can easily be counterbalanced by excess capacity. Our global supply-demand model still shows oversupply, particularly in DRAM, not only in 2H07 but also in 2008, if the chipmakers meet their target spending and capacity expansion. This may result in more severe price competition and acceleration of industry consolidation, coupled with Tier 2 players' poor cash flow and the difficulties they are facing in raising new capital. We believe this supports our Sell recommendation on Tier 2 plays, such as Taiwan DRAM stocks - Nanya (NNYAF; NT$22.55; C-3-8), ProMOS (PTGSF; NT$9.82; C-3-9) and Inotera (INMFF; NT$32.35; C-3-8).

Cautious investor positioning + Fed ease = better chance for Q4 strength

2007-09-18T04:41:00.001-07:00

Following a large number of meetings in Asia and the US, we find a great deal of
uncertainty among equity investors regarding the prospects for Asian equity markets
and therefore what actions to take in the wake of sharp August declines and
subsequent swift rebounds. We continue to think markets remain vulnerable to
retracing some of their recent gains if 2008 EPS growth estimates are revised down
due to US consumer weakness. However, the chances for a 4Q rally, potentially off a
lower base, are stronger now given evidence of conservative investor positioning and
the likelihood that the Fed will move into easing mode.

We organize our thinking about Asian regional equity market prospects around five main
considerations:
(1) The strategic case for Asia remains in place;
(2) There will likely be downward revisions to 2008 EPS growth for parts of Asia given
downside risks to US consumption;
(3) Markets have rebounded swiftly from mid-August lows, raising the risk of a reset if
earnings estimates start to be cut; however
(4) Investor positioning appears quite conservative now, following the August market
turbulence, so the ‘pain trade’ is again to the upside; and
(5) The Fed is likely to commence an easing cycle that may cushion the downside risks to
US growth and result in Asia being the unintended beneficiary of more accommodative
monetary policy.

Combining these various leit motifs, the prospects for a 4Q rally, potentially off a lower
base, appear better now than they did several weeks ago. We continue to think that the
key investment criteria will be the level and visibility of earnings growth: stocks that offer
good growth potential with low probability of disappointment are likely to be in demand,
particularly if EPS growth globally is in scarcer supply in 2008. This leads us to emphasize
secular and domestic demand themes and to be cautious on US-sensitive areas, such as
technology and autos. Our market preferences are China, India, Indonesia, Singapore and
Hong Kong, and we remain more cautious on Taiwan and Korea.

UK Strategy Outlook - Still cautious

2007-09-18T04:39:00.001-07:00

The UK market has out-performed the rest of Europe during the past month. UK equities continue to gain support from the commodity-related sectors, and the latter have also supported the large cap segment relative to the FTSE 250 and the FTSE Smallcap. Looking ahead, we believe that the the market upside is likely to be capped in the short term.

Yet, we stress that the UK market looks cheap and we stick with our year-end target of 6900 for the FTSE 100. The market has de-rated in the recent sell-off and valuation multiples are now back to levels not seen since a year ago. Indeed, the UK market's low valuation is the chief factor making it attractive relative to other markets (a suggested Overweight) according to our models. Earnings momentum, for instance, is inferior to that of the rest of the pan-European market.
We maintain our Overweight on UK equities in a pan-European context, although we have trimmed our active weight this month as we believe the UK economy is among the most vulnerable given the higher cost of credit.

In terms of positioning, we continue to prefer large caps to small caps. This is in line with our preference for exposure towards economic growth in emerging markets, notably Asia. The FTSE 100 is likely to benefit from this given its large exposure to the Oil & Gas and Basic Resources sectors. In addition, as long as uncertainty prevails in the market, investors are likely to prefer large caps which are often perceived as being safer assets than small and mid caps. Hence, we think that the valuation premuim of the small and mid caps is unjustified.

Sectorwise, this month we are reducing exposure to Banks (to Underweight). In our view, Banks are likely to face the risk of earnings downgrades going forward. Our analysts are also negative towards UK banks, many of which could be vulnerable to the tight money market. We are halving our Underweight in Utilities and are also adding some weight to Personal & Household Goods, focusing on names with relatively less exposure to the UK. Utilities and Consumer Goods have improved on our models during the past month.

GS Asia banks Sept 18: Taiwan financials/CDOs (-ve); China banks/rate hikes (=); India financials/loan pricing (=); US debt/MEW metrics (-ve)

2007-09-18T04:38:00.001-07:00

Taiwan financials: CDP exposures may be understated; remain defensive/selective
Domestic "bond fund" issue in 2004-06 may have lead to some high-risk CDO purchases

Since mid-2004, some of Taiwan's local ITCs have been going through a "bond fund" crisis...
...as inverse-floating notes suffered losses in the rate-hike environment which then triggered redemption risk
The FSC asked ITCs/key shareholders at that time to step up and bear the loss for bond fund investors.
In order to mitigate the loss, some FHCs chose to arrange CBOs...
...mixing those money-losing inverse floating notes with high-yield CDOs, and selling them to other financial institutions (FIs).
To ensure they could price these CBOs at attractive terms, CBO arrangers would include some equity/junior tranche CDOs
In some cases, arrangers also provided principal guarantees to the FI buyers
For instance, Mega Bank disclosed it had arranged two CDOs (NT$18bn in total) under such circumstances in 2005-06.

Banks/FHCs might be understating their CDO exposures as a result of the bundled currency swap

The CBO arrangers would sometimes bundle a currency swap with the CBOs to hedge the currency risk and increase their appeal to potential buyers
These buyers may then put these currency-risk-free securities within their less-investor-scrutinized NT$ investment portfolio...
...despite the underlying (and now sharply rising) credit risk that resided with such overseas CDO exposures
When evaluating/disclosing the extent of their US sub-prime exposure, some FHCs would only look at their FX investment portfolios
This could potentially lead to an under-stated CDO exposure figure.

Implications: go defensive; avoid those with huge bond fund balance in the past

We are currently checking with each FHC/bank under our coverage to see if they have such exposure in their NT$ investment portfolio.
Meanwhile, we suggest investors avoid those FHCs that had huge bond fund balance on their ITC subsidiaries back then (e.g., Fubon FHC).
We identify SinoPac FHC (2890.TW, Neutral) as a more defensive play, given its modest CDO exposure, and below ex-growth valuation.
Key risks are unexpected proprietary trading loss and asset quality deterioration

China banks: Latest rate hike modestly positive for 2008E NIMs; still key to watch CPI trend
Backdrop
PBOC raised loan and time deposits rates by 27 bps, effective September 15th, while leaving demand deposit rates unchanged.

We see two positives

It shows a more decisive PBO move to curb accelerating CPI inflation
We estimate it could be modestly (+2bp to +9bp) positive for banks’ 2008 NIM (especially for smaller banks with high L/D ratio and demand deposits)
…in turn an earnings buffer for any subsequent tightening measures, e.g. more data-dependent rate hikes, loan growth curbs
We believe by allowing for better NIMs, PBOC is hoping for banks to be more cooperative in curbing excessive loan growth (17% YoY in August)
However, it remains to be seen if inflation/overheating risks are now under control, before we could turn outright positive on China banks

Key questions in our mind:

1. Whether inflation may continue to accelerate, as we believe:
Note this rate hike was largely expected and therefore may not be effective in reducing CPI/asset inflation expectations
1-year real deposit rates after interest tax of 3.7% still far lower than 6.5% CPI in August
Overall monetary condition (e.g. loan growth at 17% yoy in August) still far from neutral
2. Whether A-shares/property markets continue to surge before/during the 17th National Congress of the Chinese Communist Party in mid-October
This rate hike left demand deposits rates unchanged and did not raise long-term deposit rates more than short-term deposits rates
This may therefore not attract much liquidity from A-shares markets back to the banking system
We do not rule out the possibility of more heavy-handed tightening after the party meeting in October if potential A-share/asset “bubble” continues to build up

Source of opportunity

We retain a neutral stance on China banks at present, and would be more positive if CPI/PPI inflation materially slows.
Given the valuation gap and potential QDII expansion, we are more positive on H-share banks than A-shares.
We prefer CMB (3968.HK, Buy; one of the highest beneficiary of this rate hike) and ICBC (1398.HK, Buy).
CCB (939.HK, Neutral) is our next-best pick, given its high profitability and A-share floating as a near-term catalyst, and as this rate hike slightly benefits CCB’s 08E NIM 1bp to 2bp more than ICBC’s.
We keep Neutral rating for CCB on valuation reasons, as its market cap (including 9bn new Ashares) is just 4% below ICBC’s (vs. 1H07 assets 36% below ICBC’s)

India financials: Loan pricing - will it remain stable?
What’s new?

Several company/ press releases since start of September noting that banks and finance companies have cut or are considering a cut in mortgage lending rates as well as other retail loan products.

What do we think of the reduction in lending rates?

The decision (or talks) by lenders to cut lending rates comes as a bit of an against-the-grind surprise
... as liquidity elsewhere in the world dries up, market rates rise, bank pricing power improves
We believe that the motive to cut lending rates on a selective basis is
1) to deploy excess liquidity in the better-yielding assets; or
2) to gain market share in a chosen segment (especially mortgage).
This potential action may however, in our view, result in
1) asset liability mismatches if excess short-term liquidity is deployed into L/T assets, e.g., mortgages
2) lower sector profitability, with deposit rates now showing any corresponding signs of decline.
The trade-off of growth over profitability would be unfavorable for banks, particularly public sector banks given their low profitability.

Does it change our positive stance on the Indian financial sector?

Stable loan pricing environment is one of the key driver to our positive stance on the sector.
Despite the announced rate cuts, we continue to maintain our positive stance as.....
.....we expect continued benign macro environment, strong demand for loans, and restoration of a stable pricing environment.
We attribute low probability to the prospect of further cuts in lending spreads to:
1) our expectation of system pick-up in credit growth in 2HFY2008;
2) its adverse implications on the profitability of the banks.

Our top picks

Our top pick are Axis Bank (AXBK.BO, Buy) and HDFC (HDFC.BO, Buy)
We also maintain our Buy ratings on ICICIB (ICBK.BO) and IOB (IOB.BO)

Key risk to our positive sector stance

A slowdown in economic activity
Further tightening of monetary policy (in our view, current macro conditions do not warrant further action in 2007)
Significant deterioration in asset quality (we assume a benign environment for credit quality base-case)
Deterioration in loan pricing environment.

US macro (-ve) and MEW: Was Q2 the last hurrah for debt?
Backdrop: excerpts from our US economics research team reading on the latest US debt metrics
Asia banks read-across: still focused on impact of falling US mortgage equity withdrawal, combined with subprime/credit markets unwinds, on the US economy and its pass-through impacts to various parts of Asia and its banking sectors.

The Fed’s flow of funds report for the second quarter provides evidence of a substantial shift underway in borrowing patterns even before the latest blow-up in credit markets
Corporate sector borrowing continues to pick up, with borrowing requirements now at 1.7% of GDP
The profligate household sector maintained a steady pace of debt accumulation
...while the federal government actually paid down debt in the second quarter
Third-quarter data are likely to show sharp deceleration in borrowing as tighter credit standards took hold
Mortgage borrowing looks poised for an especially heavy hit, and as a result we have revised down our forecasts for mortgage equity withdrawal (MEW)
We now expect total MEW to fall to just over $200 billion in 2008, from our previous forecast of roughly $300 billion and a 2006 level of $830 billion

Citi Regional Strategy: The Asia Investigator - Fed Cuts: What You Pay Determines What You Get

2007-09-12T01:54:00.001-07:00

Fed Cuts: What You Pay Determines What You Get (by Markus Rosgen)

Since 1980 we’ve had 7 Fed cuts, 2 at current valuations; both times markets fell — During the five periods of Fed easing when markets rose, the P/BV averaged 1.2 times. The two periods when markets fell, P/BV averaged 2.3x. P/BV is currently 2.6x. We are at a 116% premium valuations to periods when markets rose and a 13% premium to levels when markets historically fell by 1/3.
Interest sensitives and consumers outperform — Even though these sectors do well, they are amongst the least well owned by Asian investors. The biggest underweights are still banks, the utilities and the telecoms sectors. Ditto Korea, Taiwan and Thailand, which are relative outperformers. Only Thailand is an overweight. Korea and Taiwan remain investor underweights.
A falling OECD indicator is bullish, not a rising one — Whenever the OECD leading indicator has been falling and the Fed has cut, Asian markets have risen. The indicator is currently rising on a year-on-year basis. Historically this has been negative for returns. Composite valuations and earnings yield gap models are still elevated and witnessed Fed rate cuts only once at these levels.
Peak valuations since 1975 are 19% away — US markets and European markets peaked in 2000 when valuations reached 3 stdev above mean on either P/BV or P/E. Asia ex is 19% away from reaching 3 stdev above mean.

China: Delay in individual QDII – short-term consolidation expected (by Lan Xue)

According to one of China's most influential financial magazines, Cai Jing, the Chinese government is undertaking a more detailed study of the individual QDII scheme before letting domestic retail investors rush into the HK stock market.

India: Fed cuts generally good for Indian markets as well (by Ratnesh Kumar)

Bar the period when the tech bubble burst and earnings collapsed, the Indian market has done very well for 12-24 months after Fed rate cuts. As we do not see an earnings collapse in India even in our worst-case scenario, due to its broad-based economic growth (current forecast 17% ex-oil earnings growth for FY08 and FY09), Fed cuts will likely be supportive of our positive view on India equities.

Thailand: Fundamental analysis meets Quants (by Nithi Wanikpun)

Stars (cheap with strong momentum) are RATCH, ATC and TTA. Note that ATC has been a Star since April 2007. Sell-rated EGCO is in our Stars list due to continued earnings upgrade momentum.

Fun With Flows: Global funds underweight Asia for first time in six years (by Elaine Chu)

Global funds have been well positioned to cope with the current market turmoil. Besides, fund managers trimmed regional weights in Europe and the U.S. by a total 220bps in end-July. Cash weights were raised from 2% to an above-avg 3.8%.

[MORGAN STANLEY] ASIA/PACIFIC MORNING MEETING SUMMARY & KOREA EXCHANGE BANK & S.KOREA FIN. SERVICES & ASIA/PACIFIC STRATEGY

2007-09-12T01:52:00.003-07:00

KOREA EXCHANGE BANK: HSBC IN BID TO ACQUIRE 51% OF KEB: VERY POSITIVE - CHAN HWANG

Conclusion: HSBC has agreed with Lone Star to buy a 51% stake of KEB at W18,045 per share, which is at the low end of our calculated M&A value for KEB (see Oversold, In Our View - Stick with Fundamentals, June 29, 2007). The proposed deal is still subject to receiving the necessary regulatory approvals. However, we believe that the announcement itself is very positive for KEB's minority shareholders and KEB's share price.
Minorities to benefit from buyout or deployment of KEB's excess capital: HSBC has said that KEB would remain a listed entity even after the completion of the proposed transaction. However, we think that HSBC may be very tempted to acquire 100% of KEB given: 1) KEB's strong fundamentals, 2) its excess capital, and 3) additional accretion to HSBC's earnings. Even if HSBC kept KEB listed on the KOSPI, minorities could benefit from the potential deployment of excess capital.
What if HSBC fails to get regulatory approvals?If HSBC fails to receive FSS approval, any potential bidders in any subsequent auction may have to pay more than W18,045. Investors should also bear in mind that Korean banks are expected to decide on their 07 dividend payments in February 08, which makes it possible that Lone Star could pay a large dividend for 2007 if the situation remained unclear.
1.4-2.5% accretive to HSBC's 2008E earnings: Anil Agarwal, MS's HK banks analyst, has run a pro-forma analysis for the transaction. Based on our estimates for KEB and assuming funding at 5.5%, we estimate that the transaction as constituted would be accretive to 2008 earnings for HSBC by about 1.4% without any positive synergies (HSBC Holdings: Acquisition of KEB - Impact Analysis, September 3, 2007). According to Anil's analysis, however, the accretion to HSBC's earnings could increase to about 2.5% if KEB increased non-interest income to assets to 1.9% (avg. for HSBC in Asia) from the current 1.3%.

S. KOREA FIN. SERVICES: HSBC'S PURCHASE OF KEB - POSITIVE FOR KEB, HFG, & IBK - CHAN HWANG
Conclusion: HSBC has agreed to buy KEB at W18,045 (based on KRW939.9 = US$1.0), which is the low end of our calculated M&A value for KEB (See "Oversold, In Our View - Stick with Fundamentals", June 29, 2007). We believe HSBC may face difficulties in winning FSS approval for the acquisition due to complications with Lone Star and KEB. Nevertheless, in our view, the announcement of the deal should be very positive for KEB, positive for Hana FG and IBK, and neutral for KB.
Very Positive for KEB: First, if the FSS approves the transaction, we think HSBC will be very tempted to acquire 100% of KEB (even though HSBC says it intends to keep KEB listed on the KOSPI). Second, even if HSBC dose not buy out minority shares, it may have to release excess capital of KEB, and minority shareholders will benefit. Third, if HSBC failed to receive FSS approval, any subsequent bidders were there to be any) might have to offer more than W18,045 considering fierce competition for KEB. Fourth, Lone Star may pay a large dividend for 2007 (decision to be made in Feb 08) if the situation remains unclear.
Positive for Hana FG and Industrial Bank of Korea: Given limited excess capital, Hana's intention to buy KEB has been a dilution risk to existing shareholders. Hence, HSBC's announcement will likely be positive for Hana's share price as its overhang issue has been removed. In addition, as we think that IBK could be the next target for any further industry consolidation (based on the government's intention to privatize the bank), any deal is also positive for IBK, in our view.
Disappointing, but Neutral to Kookmin Bank: Initially, it should be a disappointing for Kookmin's shareholders. However, we think downside risks on KB should be limited because 1) any positives from KEB have never been reflected in KB's current valuations, 2) there is still a possibility that KB could eventually acquire KEB, and 3) the anticipation of high dividends will provide its share price with downside protection.

ASIA/PACIFIC STRATEGY: MONTHLY UPDATE: A V-SHAPED REBOUND - MALCOLM WOOD

While Asia-Pac ex-Japan equities fell just 1.9% (in US$-terms) in August, they tumbled 15% until August 17, followed by a V-shaped 15.1% rebound. The China A- (+17.3%) and H-shares (+7.6%) significantly outperformed, while Malaysia and Thailand lagged. At a sector level, the defensive Telecoms (+5.1%) led, while the cyclical Consumer Discretionary and Tech lagged.
Asia-Pac market fundamentals: Consensus bottom-up MSCI AP ex-Japan 2007 earnings forecasts increased by 2.5 ppts to 15.1% YoY. Asia's forward P/E moderated to 14.9x from 15.7x in mid-July, but remained at a premium (4.5%) to the US. Liquidity conditions remained positive, with strong money growth. Sentiment soured, with foreigners record equity sellers.
Global equities were largely unchanged (-0.2%) in August, with the US rising 1.3%. Emerging markets fell 2.3%, with most market declining, expect China. Sector performance was mixed, with the defensive Consumer Staples and Utilities sectors relatively resilient.
Asia-Pac and Global macro update: Our global lead indicators point to a moderating outlook. However, our Asian lead indicators, led by China, remain strong.
Global bonds rallied: 10-year bond yields declined in the US (-21 bps) and Euro zone (-11 bps). In Asia, bond yields declined in Hong Kong, Taiwan and Australia, but rose in Indonesia, the Philippines, and Korea. The Central Banks in India, Australia, Korea, and China raised reserve requirements or their policy rates.
Currencies and commodities: The Thai Baht (-8.1%) and the high-yielding Kiwi (-7.4%) and Aussie (-3.7%) dollars fell sharply against the US dollar. Among commodities, WTI oil prices declined a sharp 5.3%, as did Zinc (-14.6%) and Copper (-7.1%).

China: Infrastructure investment hits mid-cycle slowdown

2007-09-12T01:52:00.001-07:00

The PMI index, up mildly to 54 in August, still points in the direction of a moderation in economic activity in the coming months. This is consistent with our call that GDP growth will soften towards 10.5% in H207, synchronizing to a global slowdown led by the US. Executives complained more about rising food prices and wage rates than commodity prices lately.
The most important message from the survey is the continued weakness in machinery orders. New orders for general machinery, electric machinery and transportation equipment remained subdued. We think a mid-cyclical slowdown in infrastructure investment is happening now, possibly affecting domestic and international machinery producers.
We think the moderation in new loan issuance is probably responsible for the slide. The pace of infrastructure investments in railway, airport and power stations has slowed anecdotally, but this is unlikely to be the end of China's infrastructure boom.
We argue that the real economy is not as overheated as others suggested, and Beijing probably would only launch selective and measured tightening to the real economy. However, inflation remains out of control and interest rates need to rise substantially, in our view. Rate hikes will likely keep up with inflation and maintain a neutral monetary policy stance.

[MORGAN STANLEY] CHINA TECHNOLOGY & CONSUMER ELECTRONICS & A/P CONTAINER SHIPPING & STEEL, NONFERROUS METALS&MINING, WIRE&CABLE

2007-09-12T01:51:00.001-07:00

CHINA TECHNOLOGY: CHINA HANDSET MARKET, UPDTAE: FROM BLACK TO WHITE - BILL LU
Conclusion: Recent checks with IDHs, local brands, chipmakers, and other food chain suppliers indicate that: 1) China handset demand remains very robust in 2H07 with new emerging local brands gaining the most share; 2) local handset makers are starting to make inroads internationally (e.g. South Asia, Russia and India), but 3) the roll-out of TD-SCDMA seems to be delayed slightly; and 4) the pricing environment remains tough given the lack of new killer applications and rising competition.

Raising our China handset shipment forecasts: We are revising up our 07 shipment estimate to 206 mn units (up 25% YoY) from 176 mn units –with the combination of grey market and emerging local brands outgrowing with 55% YoY growth, far ahead of global brands’ 18% rise and Tier 1 local brand names’ 25% YoY decline. We expect 08 YoY unit growth to decelerate to 16%. Our cross-checks with chipset vendors suggest “export” shipments could reach 52 mn and 78 mn units in 07 and 08, up a sharp 60% and 50% YoY.
Implications for IC design: We see robust handset unit demand as a positive for Mediatek and Spreadtrum, both IC suppliers to the domestic handset makers. We note that while TD appears to be pushed out slightly, it is not unexpected, and actual units are still likely to exceed our current forecasts; we are more comfortable with Spreadtrum’s competitive position after recent checks. On the other hand, the continuation of share loss by Moto is likely to be a negative for Solomon Systech, although our view is that most of this is well understood by the Street and thus in the stock price.
Implications for handset food chain: We read this as overall neutral for China IDHs (SIM Tech, Longcheer) as robust volume growth was offset by pricing and margin erosion, although fundamentals seemed to trough in 1H07. The next catalysts are when overseas expansion starts to bear fruit and TD takes off. Among IDHs, we think SIM Tech is still ahead of peers in NRE collection from brand names despite a delay in TD rollout.

CONSUMER ELECTRONICS: CORRECTION: EFFECT ON JAPAN BRANDS OF US COMSUMPTION - MASAHIRO ONO

Risk of FPD TV price fall: Risk of slower consumption in N. America is showing up as a rising share of cheaper models in LCD and other FPD TVs. Momentum in Taiwanese/Chinese brands (eg, VIZIO) also needs to be watched for risk of price falls for Japanese brands too.
High risk for Funai, Pioneer: All of our forecasts factor for annual falls of 25-30% for average prices in all sizes, and weighted average falls of 5-10%. However one question we ask concerns the effect on operating profit in a risk scenario of firms pushing through added price cuts of 10%. Funai and Pioneer could be hardest hit, and Sony and Sharp would be affected relatively mildly.
Still bullish on Sony, Sharp: Distances to fair value in our bear case are greatest for Sanyo, followed in order by Sharp, MEI and Pioneer. Sharp’s high valuation multiples relative to industry averages make downside look substantial assuming the valuation gap adjusts. Yet we think the premium is warranted by the high certainty of growth in the LCD business especially, and its cost competitiveness in LCD TVs. Sony currently trades close to our bear case fair value and even with gains on the former HQ land sale is unlikely to turn in strong 2Q numbers. Further PS3 price cuts may also loom from late September. But we are hopeful that momentum will pick up from 3Q and we remain Overweight.
Our industry view is In-Line: We believe the lines of success have already been drawn. Competition is heating up noticeably in the FPD field but we expect the
competitiveness of Japanese brands to shine through again from F/309, as screens become ever larger.

A/P CONTAINER SHIPPING: US SUB-PRIME NOT ENOUGH TO CHANGE OUR POSITIVE VIEW; PREFER TAIWANESE TO HK/CHINESE CARRIERS - SOPHIE LOH

Conclusion: We reiterate our positive view on the global container shipping industry despite the market’s lingering concerns over the sub-prime issues in the US.
That said, as select stocks in the sector, most noticeably CSCL and OOIL, are now trading either near or above our fair value estimates, we would recommend investors to focus on the Taiwanese long-haul carriers, YMM in particular, for exposure to the anticipated sharp earnings recovery of the sector beginning 2H07.
What's New: Given current low/no profitability of the transpacific trade, slower US import volume should have a minimal impact on liner profitability, in our view. Moreover, as capacity is being continually removed from the trade, the loss-making inter-modal services in particular, we believe this will provide solid support to
freight rates even assuming continued anemic demand growth. On the other hand, we continue to expect carriers’ earnings will improve markedly from 2H07 onwards, underscored mainly by the extremely robust freight rates and volume growth of the Asia-Europe trade since the beginning of this year.
Stock Recommendations: We are downgrading our long-held Overweight rating on CSCL to Equal-weight. We retain our HK$5.35 price target on the stock, but consider the expected strong earnings momentum, proposed A-share issue and possible corporate restructuring activities to have been fully discounted by the 330% share price appreciation YTD. In contrast, we believe the market has continued to underestimate the value of the Taiwanese long-haul carriers, YMM in
particular. The stock is currently trading at 1.0x P/BV, 0.7x P/NAV and 8.5x 2008 P/E, suggesting a 25-55% discount to its HK/China peers.
Risks: Major global economic slowdown.

STEEL, NONFERROUS METALS & MINING, WIRE & CABLE: WATCH FOR VALUATION DISCOUNT FACTORS TO LOSE FORCE - HARUNOBU GOROH

Monthly, Vol. 138 (August 2007)
Watch for discount factors to ease: Steel stocks may be discounted due to (1) US-originated financial market instability and recession concerns since late July and (2) alarm over volatile steel prices in China. From Oct-Dec, however, we may be able to confirm a turnaround in North American steel prices and stabilization of Chinese steel prices. As reasons to apply a discount recede, hare price levels should be pushed up.
Domestic steel sheet supply/demand in a phase of inventory buildup: Japan’s steel sheet cycle remains in the inventories rising/shipments rising quadrant. This marks the bumper period for earnings, reflecting aggressive production in response to brisk orders currently being booked by the large steel makers. We
expect earnings in 1H F3/08 to track ahead of full-year company forecasts. There is room for robust fundamentals to be valued more fully in stock prices.
Steel view Attractive, In-Line for nonferrous metals, wire & cable: For steel, high-grade product prices are firming, and we expect mid-term growth in Asian high-grade steel demand. For wire/cable, telecom demand growth is easing but we are watching electronic materials growth strategies. In nonferrous, despite concern about high LME prices, we watch individual strategies in electronic materials, etc.
Picks: JFE, Kobe, Hitachi Metals, DOWA and SEI. Hitachi Metals is lifting core business profits and entering growth areas. JFE faces better fundamentals and has an investor-centric FCF strategy. Kobe Steel has high exposure to special steel and rising medium-term input from machinery, construction machinery and electronic materials. Electronic materials are driving better asset returns at DOWA. SEI has new growth areas (electronic materials, etc.) and automotive business margins should recover in F3/08.

[MORGAN STANLEY] S.KOREA SHIPBUILDING & CHINA A-SHARE STRATEGY & CHINA TFT LCD & MOTOROLA

2007-09-12T01:43:00.001-07:00

S. KOREA SHIPBUILDING: KOREA SHIPBUILDING MONTHLY - JASON KANG

New record for ship price: The Clarkson ship price index gained another point in August and reached 175. We are seeing even higher ship prices in September, as early September prices suggest a ship price index level of 176. Bulk carrier new building pricing led the rise in overall ship prices, up by 27.8% YoY and 3.3% MoM. It is not just tight berth space pushing up prices as building costs are also rising. Korean shipyards and JFE steel agreed to raise heavy plate prices to US$645/ton from US$625/ton (+3.2%), starting this October to March 08.
Robust bulk carrier and containership order: Global new orders were 6.8 mn CGT in August, up 72% YoY.On the back of strong freight rates, bulk carrier and containership new orders soared, up 562% and 93%, respectively. Tanker new orders slowed down by 72% YoY.
Freight rates surge based on shipping demand from China:BDI went up to US$8,270 on September 6, vs. US$6,993 on August 1. Despite recent turmoil in the credit market, demand from China has not shown any sign of weakening yet. While the container freight rate also recovered, tanker rates stayed low. The VLCC Worldscale index for Mid-East to Japan was down 43.2% YoY on August.
Korean yardsplan to add more docks: Major yards came up with new dock plans to leverage the containership new building up-cycle. DSME revealed its plan to purchase a 438m x 84m floating dock and HHI confirmed that it will build a 475m x 175 m new dry dock.
Super Cycle Continues: We expect strong shipping market fundamentals and new orders to continue to drive up ship prices, which should positively contribute to shipbuilders' profitability in 2009E through 2011E. The macro outlook remains as a key risk. We have Overweight rating on three shipbuilders, Hyundai Heavy Industries (TP W480,000), Samsung Heavy Industries (TP W67,000), and Daewoo Shipbuilding Marine Engineering (TP W79,000). Our top pick is Hyundai Heavy Industries.

CHINA A-SHARE STRATEGY: SPECIAL TB FLOATING: UNCONVENTIONAL TIGHTENING - JERRY LOU

Impact on Our Views: Although a Rmb200 bn special treasury bond (TB) issuance to the open market is only roughly equal to China's trade surplus in one month, the MoF's decision to directly float a portion of its Rmb1.55 trillion special TBs is exactly what we expected as part of China's "unconventional tightening" efforts (see our note dated May 2, 2007, "What are the Policy Options to Control Market Mania?"). The domestic A-share market should suffer upon this, and we reiterate our Cautious view, given its demanding valuation, inflated growth by securities investment income and overly speculative nature (see our note dated Sep 3, "1H07 Result:Super Growth or Super Bubble?").
What's New: The Ministry of Finance (MoF) just announced that it will issue Rmb200 bn special TBs to the inter-bank market directly. Rmb100 bn of that amount will be sold within this month starting from Sep 17, and the other half will be issued before the end of this year. The bond sale is part of the MoF's planned special bond issuance of Rmb1.55 trn. The ministry will use the proceeds to buy foreign exchange reserves from the People's Bank of China (PBoC) and fund China's sovereign investment agency. Last month, the ministry issued Rmb600 bn special bonds to the PBoC via the Agricultural Bank of China. PBoC has floated Rmb10 bn of that portion in the market already.
Investment Thesis: The market's myth that China will see no aggressive tightening before the 17th CPC Conference in October is now broke. We believe regulators are now turning more hawkish in fear of inflation and onshore asset speculation.
Impact on Offshore Equities: We also believe this new tightening effort will be a moderate negative to offshore-listed China equities in Hong Kong. However, the major risk for Hong Kong market is a US-centric de-risking, not China's tightening. But we do expect asset price-driven sectors such as financials and prope rties to underperform.

CHINA TFT LCD: TAIWAN PANELS, CHINESE RETAILERS BEST POSITIONED FOR 2008E SUPER-CYCLE - FRANK A. Y. WANG
Conclusion: We reiterate our Attractive view of the Taiwan TFT LCD industry and our Overweight-V ratings on AUO (NT$50.50) and CMO (NT$33.70). Taiwan panel companies are best positioned for the 2008E super-cycle, in our view, on largest share in Gen 3.5 to 7.5 fab capacities for sweet spot demand growth (42”/32” LCD TV, wide format monitor/notebook, emerging small/medium size applications). Chinese TFT makers’ global share will stay marginal at ~5% in 2008, on our estimates, as most growth will come from existing fab expansion, supporting global capital discipline trend. Like in the US two years ago, Chinese retailers are best positioned in China LCD TV foodchain on good margin, high turnover, and long payment terms for the rapid growth.
What's New: We visited China TFT LCD foodchain across components, panels, TV assembly, TV brand, and retailer last week. Given China accounts for over 70% of global TV, monitor, and notebook assembly production, like in semiconductors, China will build TFT fabs on government supports (only 5% global share
today). Chinese TFT fabs are debt heavy with the highest debt/equity ratio globally (for banks, companies are allowed to have debt to equity mix of 2 to 1 on average debt cost of ~7% per annum). For the long term, we view the announced merger between BOE OT, SVA-NEC, IVO as the best outcome for China TFT on scale and global TFT sector on consolidated supply.

The merger will likely be delayed again from the extended September deadline as: 1) participants need to agree on the swap ratio (not easy in upcycle); 2) the new merged entity needs new state capital injection for expansion that is likely only after 17th Party Commission in October. Given 12 months equipment lead time to production, on weak balance sheet, any new fab production will be in 2009 even if the newly merged SMIC equivalent TFT maker starts to operate by end-2007, which would help supply discipline in 2008.

MOTOROLA: QUICK COMMENT: ANALYST DAY PROVIDES NEEDED DETAILS ON IMPROVING RETURNS - SCOTT COLEMAN
Impact on Our Views: We have increased confidence that Q2 marked the bottom for handset operating margin and that sequentially improving profitability results should push MOT shares towards our sum-of-the-parts valuation of around $21.
What's New: Motorola hosted an analyst day in NY on Friday where management provided sufficient detail on (1) how it will improve profitability and instill operational discipline in the handset division; (2) increase overall capital efficiency and returns; and (3) the healthy growth and profitability in the Home & Networks and Enterprise Mobility divisions. Among the areas lacking in detail were how Motorola would gain profitable traction in the 3G/WCDMA and GSM markets where it has lost share over the past few quarters. Motorola did not introduce new handsets but indicated launches would occur within the next 30 days.
Investment Thesis: In a crowded market for telecom equipment restructuring stories, MOT may have the best chance to quickly improve results and drive estimates higher. Longer term, we remain concerned about the lack of 3G presence and the drag on growth and earnings coming from iDEN and wireless infrastructure.
Valuation: Shares trade on 0.9x EV/Sales, an attractive multiple assuming that the company is able to grow the top line at least 6+% that we estimate in 2008. Our updated sum-of-the-parts model implies a $21 per share value (higher on sales multiples; lower on EBIT multiples), and each 100 bps of margin improvement in handset over our 5.4% estimate for 2008 adds around 60¢ in value. We estimate normalized earnings power of $1.25 assuming MOT can consistently deliver 30+¢ quarters on average, which implies a price around $21 using a three-year average P/E of 17x.

[MORGAN STANLEY] US ECONOMICS & US ECONOMIC AND INTEREST RATE FORECAST & COMMODITY MARKET REPORT & ASIA ENERGY

2007-09-12T01:41:00.001-07:00

US ECONOMICS: DOWNSIDE GROWTH RISKS BECOME REALITY - RICHARD BERNER

What's New: Courtesy of the shock from abruptly tighter financial conditions, the downside risks to US growth have morphed into reality. Paced by a deeper and longer housing recession, we now expect that US growth will average just 2% over the next six quarters, or 0.6% below our forecast of a month ago.
Conclusions: Spillovers from tighter lending standards and higher borrowing costs likely will also hobble consumer and business capital spending. In contrast, still-solid global growth seems likely to help thwart a recession. But, increased slack in the domestic economy likely will hasten a moderation in core inflation to below 2%.
Market Implications: Against that backdrop, the Fed will have ample latitude to respond to softening growth, easing monetary policy twice this year and twice early in 2008. However, the market already appears fully priced for such an outcome. Thus, we expect little movement in longer-term Treasury yields.
Risks: As much of the impact of tighter financial conditions has yet to be seen, near-term downside risks to growth - and especially to earnings - predominate. But a first look at 2009 suggests a more cyclical profile, with growth rebounding from well below trend to slightly above it. Over the near term, however, fixed income investors may be disappointed in the Fed's easing pace, while equity investors may be too sanguine about earnings.

COMMODITY MARKET REPORT: HUSSEIN ALLIDINA
Energy prices continued to rally last week with WTI and Brent front-month prices up by 3.6% and 3.3%, respectively. Prices found support from another constructive Department of Energy Weekly Petroleum Status Report, which showed larger-than-expected draws in both crude and gasoline inventories. The likelihood that OPEC will leave production unchanged at its next meeting on September 11 is also lending support. Natural gas prices rebounded by 0.6% last week as rising temperatures increased demand and Chesapeake Energy Corporation announced that it would cut production owing to currently depressed prices.
Base Metals prices sold off across the board, with losses ranging from 9.7% in nickel to 2.9% in copper. Copper and lead prices weakened despite tighter inventories, suggesting the declines may have been driven by sentiment stemming from weaker-than-expected US economic data support, which increased fears of a US slowdown.
Precious Metals prices continued to rebound, with gold and silver prices increasing by 4.1% and 3.6%, respectively. Rising ETF demand and general return-tosafe-haven buying help lift gold to $701/oz — the highest level since May 2006. The potential for increased Swiss central bank selling through the remainder of the current
CBGA year (ending September 26) may mitigate nearterm upside in gold prices; however, the front-loading of Swiss selling is, in our view, bullish long-term.
Agriculture prices increased across the board with a 9.5% increase in wheat prices lending support to both corn and soybeans. Despite record high wheat prices, export demand remained robust with reports of dry weather lowering expectations for southern hemisphere harvests.
Technical Outlook: Gold’s surge to new yearly highs should result in further gains on an intermediate-term basis, with daily closes above $723/oz leading to $750/oz and potentially $800/oz. However, near-term consolidation is possible to alleviate overbought conditions between $718-$723/oz.

India July industrial production: Weaker due to base effects - GS

2007-09-12T01:30:00.001-07:00

Industrial production (IP) growth slowed to 7.1% year on year (yoy) in July, in part due to base effects from July 2006 when IP had grown by 13.2% yoy (see Exhibit 2). The IP numbers for June were also revised downwards to 9.0% yoy from 9.8% yoy. On a month-on-month basis, the IP Index (IPI) fell by 0.9% in July compared to a fall of 1.3% in June. In 1QFY2008, the IPI had grown by 10.8% yoy and in FY2007 by 11.5% yoy.

A fall in consumer durables growth causing IP slowdown. Consumer durables fell by 3.2% yoy in July 2007 compared to a 16.1% yoy rise in July 2006 due to rising interest rates. Capital goods grew by 12.9% yoy compared to 18.3% yoy in July 2006, higher than headline IP suggesting continued capacity expansion. Growth is still being driven by investment demand with capital goods having grown at an average of 18% in the past 24 months (see Exhibit 3).

We think the July IP numbers exaggerate the moderation in activity due to base effects. Although significant monetary tightening by the central bank and the sharp rupee appreciation earlier this year is having an impact on activity, the underlying momentum is still strong. Co-incident indicators, such as growth in cement production, cellular subscribers, and motor vehicle sales have moderated only a notch in recent months (see Exhibit 4). Indeed, the PMI actually accelerated in August to 57.9 from 52.9 in July and 53.2 in June. We believe activity will continue to moderate from the higher-than-expected 9.3% yoy growth in 1QFY2008 to 8.2% yoy by 4QFY2008.

Growth story on track. We have recently increased our GDP growth forecasts for FY2008 to 8.7% from 8% on the back of continued strength in investment demand, higher-than-expected 1QFY2008 GDP and a better-than-expected monsoon which bodes well for the agriculture sector employing 60% of India’s work-force. A good crop will be a positive supply shock, boosting incomes and depressing primary commodity prices. Therefore we expect inflation to remain under 5%, although there are upside risks from higher oil prices. We do not expect any further change to benchmark interest rates in 2007, as capacity expansion is in train, inflation has come off its peak and money growth is declining on a sequential basis.

China CPI inflation was up 6.5% yoy in August - CS

2007-09-12T01:12:00.001-07:00

China CPI inflation was up 6.5% yoy in August, prompting further rate hikes and more imports of food from the rest of the world

China reported CPI inflation of 6.5% year on year in August, compared to 5.6% yoy in the previous month. The market expectation was for 5.9%, and the actual data was an upside surprise. The last time CPI inflation reached over 6.5% was back in December 1996. China’s inflation has hit our target set for mid-2008 nine months ahead of time. We expect inflation to continue rising in the coming months, but probably at a slower pace due to a higher statistical base. Nevertheless, we think the pressure on inflation is still pointing to the upside. Over the next 12 months, we believe rising inflationary expectations will replace food inflation as the main driver of price hikes, and that wages and service prices will go up, driving non-food inflation higher.

With the inflationary situation continuing to deteriorate, we expect local interest rates to go up more aggressively. Higher interest rates, however, was are intended to keep up with rising inflation in order to maintain a neutral monetary policy stance. We therefore do not view the current rate hikes as tightening, but rather a normalization of monetary policy. We recognize that rate hikes will not ease the strain in food supply, but not raising will likely to lead to grave consequences, as negative real interest rates will continue to erode the value of bank deposits and prompt capital to flow into the property and stock markets, causing asset price inflation. The real interest rate has now fallen to -2.9% yoy.

While the monetary stance of the economy is deteriorating (i.e., there is rising consumer and asset price inflation), we maintain our view that the situation in the real economy continues to improve. July’s industrial production and fixed investment growth data have shown a moderation from their peak in Q2, for the first time in three months. New loan issuance also slowed during May to July when compared to its level in the previous three months. Moreover, the forward looking PMI index in August has also suggested a moderation in the pace of growth and a mid-cycle slowdown in infrastructure investment. We expect August’s macro economic data, to be released this week and next week, to show a moderation in growth momentum as well.

In view of the moderation in the real economy, we expect the government to refrain from initiating drastic austerity measures similar to those in 2004, despite the continuing rise in interest rates. Measured tightening policies in specific areas of the economy, such the property sector, are possible, however. In the event of a clear sign of a slowdown in the real economy, along with a slowdown in global growth led by the US economy, however, we would not rule out the possibility that the government will make corresponding adjustments to its administrative controls over loan and credit growth.

We now expect two more rate hikes in 2007. We expect the PBoC to tighten again over the next two weeks, followed by another rate hike after the Communist Party’s Congress in October. We now expect the one-year deposit rate to be raised by 81bps (to 4.41%) and the one-year lending rate to be raised by 54bps (to 7.56%) by the end of 2007. We also expect one more 50 bps reserve requirement ratio hike (to 13%) in 2007. Further government actions aimed at stabilizing the surging prices are also expected to be launched. In 2008, we expect the normalization to be followed by a 108bps hike in the deposit rate (to 5.49%) and a 81bps hike in the lending rate (to 8.37%), together with three more reserve requirement ratio hikes (to 14.5%) and the complete removal of interest income tax, currently at 5%.

We expect the government to increase imports of food from the international market to ease the domestic supply bottleneck. In August, food prices continued to surge, rising by 18.2% yoy. Meat and poultry prices jumped 49% yoy, while growth in grain prices remained rapid at 6.4% yoy. We expect the government to increase its imports of meat and grain in the global market in order to ease the supply bottleneck. The Ministry of Commerce has make known its intention to raise imports of pork to 100,000 metric tons this year, more than quadruple the level of last year. This is likely to be followed by increased imports of grain, such as wheat, from the rest of the world. We think this would tilt the balance of supply of demand in the global market and have major implications for international prices of agricultural products.

[MORGAN STANLEY] GLOBAL STRATGY BULLETIN

2007-09-12T01:07:00.001-07:00

GLOBAL ECONOMIS: A MID-CYCLE SLOWDOWN, NOT A RECESSION - JOACHIM FELS
We are witnessing the first financial crisis of the securitization age. It has now lasted long enough to meaningfully affect banks' and investors' ability and willingness to extend credit to the economy. As a consequence, Morgan Stanley's global economics team is cutting its global growth forecast. We expect global GDP growth will slow significantly, especially in 4Q07 and 1Q08, taking full-year 2008 GDP growth down by about half a percentage point, to 4.5% — and the risks to this number are on the downside.

However, we are forecasting a global midcycle slowdown, not a recession. We expect growth to reaccelerate in the second half of 2008 and more so in 2009. We bank on three factors to contain the collateral damage from the US housing slump and consumption slowdown: (1) robust consumer spending in Europe; (2) strong capital spending by corporates and governments worldwide, especially in the emerging markets; and (3) global monetary easing led by the Fed, which we expect to lower short rates by 100 bp over the next six months. Other major central banks could follow, the Bank of England likely before year-end, and the ECB possibly early next year. Note also that with many emerging countries on a dollar standard, Fed cuts imply an easier monetary policy stance in these countries as well.
Market implications: (1) In my view, easier global monetary policies over the next year imply higher inflation in future years. Central banks are refocusing on stabilizing financial markets and containing the economic fallout, at the risk of creating higher inflation in the later stages of this cycle. Global yield curves are likely to steepen further as a consequence. (2) Some argue that there is no asset market left to inflate, and monetary easing therefore won't help. This may be true for housing and credit markets. But there is one important asset class where valuations look reasonable and which would benefit from a midcycle slowdown and monetary easing — equities.

GEM EQUITY STRATEGY: CLIENT CAUTIOUSLY OPTIMISTIC AS WE ENTER A SEASONALLY FAVOURABLE PERIOD FOR EM RETURNS - JONATHAN GARNER
This week we provide feedback from our meetings with long-only and hedge fund clients in the US and Asia. There was considerably more agreement amongst long-only GEM managers in the US with our thesis of EM medium-term growth leadership than was the case amongst global PMs. About one-third of the GEM managers we met with were on the same page as us on the heightened likelihood of a very strong market (or even a bubble) developing within EM assets over the next two years. We saw all but unanimous agreement that China’s growth and financial markets are key to the asset class over the next two years (much more so than the US).
Global hedge-fund managers as well as some long-only global PMs were more bearish generally, in particular on the topic of the risks to the global financial system going forward. The most optimistic PMs we met were based in Hong Kong running Asian mandates.
Looking at specific countries, there was plenty of optimism on Brazil, although the pace of credit extension growth worried a few. Taiwan was perceived as having the deepest value characteristics in the asset class. Business cycle downside risks expected by most to be highest in Mexico (due to sensitivity to US), South Africa and India. Sentiment on Russian political and corporate governance risk was still very negative.
Last, we are entering a seasonally favourable period for EM equities, with 4Q returns traditionally the highest of any period. However, we expect more volatility than in previous years and will monitor various events that we think could affect market sentiment in the weeks to come.

CURRENCIES: TRACKING THE CURRENCY SEASONS - STEPHEN L. JEN
Obviously, a soft landing in the US will have consequences for the rest of the world. But the economic impact will likely not be overly severe. We look for a soft landing in the US and soft de-coupling in the rest of the world. I have looked at what I think the actual FX relationships will be this time around, using a model of the “seasons” of the economic and financial life cycle that I used after the 2001 recession (see the Sept. 6 FX Pulse for details on this model).
There are several special factors we need to consider.
(1) Valuation is a problem, as the USD is already quite cheap relative to many other currencies. (2) There is also the risk of repatriation, not just for Japanese investors, given how much they have invested in non-JPY assets since last summer, but also USD-based investors. If things really get ugly, I can see the USD getting a safe-haven bid. (3) Given the strength of the economies outside the US, a soft landing in the US could still permit other central banks to tighten interest rates. (4) Equities are not that richly priced. It will be hard for global equities to sell off, in my view, even if the US slows.
Putting currencies into seasonal quadrants: We created a chart with global growth on the x axis and equity markets on the y axis. The upper right quadrant is when growth is strong and markets buoyant, which we call summer, while the lower left is winter, when everything has turned down. Typical “summer” currencies are those in Asia and other emerging markets, plus Australia, while the Swiss franc is a typical winter currency. I would characterise EUR and GBP as “fall” currencies. I also now view the JPY as a “winter” currency, given how much capital outflows have taken place since summer 2006. For the time being, I believe we are transitioning from summer to fall. Unless the US slips into recession (winter), I would not expect the summer currencies to do all that badly, while the EUR and GBP should benefit.
I am turning a bit more cautious — an incremental change in my view, not a U-turn. I still think that the global economy is healthy and that this US slowdown, while more evident and a bit more severe than I had thought, will be a cyclical slowdown, manageable by the Fed.
Inflation is a multiyear risk. The sharper deterioration than I expected in the US economy's outlook will obviously affect the financial markets. But I still think the global economy looks great and should withstand a mid-cycle slowdown in the US. Potential aggressive rate cuts by the Fed and other central banks, if necessary, will sow the seeds for a robust economic recovery in 2009, and a potentially powerful rally in global equities after this 6-9-month soft patch. I still view the real risk, from a multiyear perspective, as inflation.

US ECONOMIS: DOWNSIDE GROWTH RISKS BECOME REALITY - RICHARD BERNER
The downside risks to US growth have morphed into reality, courtesy of the shock from abruptly tighter financial conditions. Paced by a deeper and longer housing recession, real GDP in the US will expand at just a 2% pace over the next six quarters, we now expect, or 0.6% below the forecast we published a month ago. The evidence of tighter credit conditions is fairly widespread — affecting both bank lending and securitization — the two main avenues of financial intermediation. Bank funding costs have spiked, and the commercial-paper market has started to shrink. Problems in important segments of the mortgage
market are likely to lead to a prolonged decline in residential construction activity.
Statistical quirks in employment number. Last Friday’s employment report was much weaker than anticipated, but several statistical quirks may help explain some of the softness. A relatively late August survey period appeared to help trigger a very sharp drop in the labor force participation rate for teenagers. If students left their summer jobs before the August survey there could obviously be a significant negative impact on the payroll employment tally as well.
Spillovers from tighter lending standards and higher borrowing costs also likely will hobble consumer and business capital spending. For the consumer, a deeper decline in home prices is expected to trigger a negative wealth effect that will shave about one-half point from consumption over the next year or so. In contrast, still-solid global growth seems likely to help thwart a recession. The increased slack in the domestic economy could hasten a moderation in core inflation to below 2%.
The Fed will have ample latitude to respond to softening growth, likely easing monetary policy twice this year and twice early in 2008. However, the market is already fully priced for such an outcome. Thus, we expect little movement in longer-term Treasury yields.
Our first look at 2009 suggests a more cyclical profile, with growth rebounding from well below trend to slightly above
it as the housing market stabilizes and easier financial conditions provide stimulus. The Fed is expected to respond
by recalibrating monetary policy with the funds rate moving back up to 5% or so.

ASIA/PACIFIC EQUITY STRATEGY: BEWARE SELECT EARNINGS RISK - MALCOLM WOOD
Our G7-developed economy leading indicators appear to be rolling over. In addition, the fallout from the US-led credit squeeze is tracking worse than we expected. The sharp contraction in the commercial-paper market may also lead to some inventory liquidation. In our view, this adds up to earnings risk in sectors and markets particularly exposed to the G7 economies, such as the technology, materials and industrials sectors, and Taiwan and Korea. We are underweight these sectors and markets.
A peak in G7-developed economy indicators. Our G6 leading indicator has moved materially lower since peaking in June. The slowdown appears broad-based, as reflected in our Momentum Index falling sharply in July.

Fallout from the US credit squeeze is tracking worse than expected. Housing and employment indicators have been worse than expected. The gasoline price tailwind appears to be over. The sharp contraction in the commercial-paper market may lead to some inventory liquidation.
Asia-Pacific is not exempt from earnings risk. We see earnings risk in the technology, materials and parts of the industrials sector, whilst Taiwan and Korea also appear exposed to weaker G7 growth.

CHINA EQUITY STRATEGY: CHINA'S RESISTANCE TO DE-RISKING - IT DEPENDS - JERRY LOU
We remain constructive on Hong Kong listed China equities, despite worrying employment data in the US and rising concerns of a US-centric recession and global derisking in financial markets. The Hong Kong listed China equities have a unique liquidity booster thanks to China’s coming deregulation of retail capital to invest in Hong Kong. However, if the US economy confirms a recession, in which case panic de-risking in EMs would likely materialize, our view
would turn more bearish because de-leveraging investors in panic would likely take profits from Hong Kong listed China equities to plug holes in their home balance sheets. While another rally in global financial markets seems quite unlikely, with the US slowdown clouds gathering again, we still believe offshore-listed China equities in Hong Kong should outperform in a moderate EM de-risking scenario.
Risks to our Call: China’s investors should realize their risks are US-centric. If the US reports more negative economic data to confirm its slippage into recession, a panic de-risking in global financial markets seems unavoidable. If that picture materializes, offshore-listed China equities in Hong Kong, thanks to strong performance recently, would underperform as a major target of profit-taking to fund leveraged investors’ liquidity.

How vulnerable is Japan?

2007-09-07T00:41:00.001-07:00

The Japanese stock market has underperformed other world markets in the recent global
correction largely because of: 1) the perception that the Japanese economy and corporate
sector remain more vulnerable to a US slowdown than other economies, and 2) the
overwhelming influence of foreign investors, which account for nearly 60% of average
daily turnover in the stock market.

In our report titled Stress-testing Japan to slower US growth, dated August 29, 2007, we
said that a 1% decline in US consumption growth in 2008 (from our US economists’
current baseline forecast of 2.1% to 1.1%) could reduce Japanese GDP growth by 0.4 pp,
but still above the 2% level in 2008E. However, the risk scenario is if US consumption
slows by 2%, Japanese GDP growth could fall to a below-trend level of 1.5%.

In terms of profit exposure, similar to Taiwan and Korea, Japan is also vulnerable to
weaker US demand. However, our sensitivity analysis suggests that if total overseas sales
of TSE1 non-financial firms (which accounted for 27% of total sales as of March 2007)
declined by 10% yoy, the negative impact to operating profit growth would be -3.9-5.0 pp.
Given our current top-down operating profit growth estimates of 10% in FY2007E and 8%
in FY2008E, profits could still grow, albeit at a more modest pace. The stock market’s 12%
decline from its July 9 peak seems to be discounting a scenario of declining profits ahead;
however, given our expectations of steady Asian/European demand as well as stable
domestic demand, we believe reality is likely to prove more benign.

Foreign selling diminishes, domestic investors testing the waters
For September, we expect a tug-of-war between concerns over US housing and credit on
the one hand and anticipation of Fed easing on the other to cause market volatility to
persist in the near term. Other near-term factors to watch for will be the central bank
actions (FOMC on September 18, BOJ MPM on September 18-19) as well as 3Q results of
overseas financial institutions.

In terms of recent flows, foreign selling appears to have run its course for now. Following
four consecutive weeks of net selling since late July (totaling over Y1 trn), foreigners
returned as modest net buyers during the week ending August 24 (Y11 bn). Market
momentum in September will depend heavily on the risk appetite of foreigners, in our
view.

Meanwhile, domestic investors (including individuals, investment trusts and corporates)
have been net buyers during the recent correction. The yen’s recent surge appears to have
dampened enthusiasm among Japanese retail investors for foreign currency-denominated
assets. According to Ministry of Finance data, net sales of foreign currency-denominated
bonds reached Y1.5 trn in August (from the week of July 29 to the week of August 24),
marking the highest level of liquidations since February 2007.

Although we doubt that Japanese retail demand for offshore assets will disappear, at the
margin, continued yen strength could suppress appetite for such instruments and possibly
lead to more purchases of domestic equity products, especially those offering high
dividend yields.

Watch for inflation surprises in some countries

2007-09-07T00:40:00.001-07:00

A risk on the horizon for some Asian economies is inflation. These are China, Hong
Kong, India, and Singapore. Our weighted average 2008 CPI inflation forecast for Asia
ex-Japan is 5.4% yoy versus consensus 3.9% (Exhibit 3). However, inflation dynamics are
varied in the region. There are two distinct group of countries which we believe face
different inflationary pressures. The economies where inflation may surprise the market on
the upside in 2008 are China, Hong Kong, India, and Singapore. In Korea, Malaysia,
Philippines, Taiwan, and Thailand we believe inflationary pressures are moderate. Our
forecasts for China and Hong Kong are very high, so the risk is likely not to our forecast,
but consensus. In India, our inflation forecasts for 2008 are below consensus, hence we
feel that both we and consensus could be surprised on the upside. In Singapore, our 2008
inflation forecast is in line with consensus. Hence the risks to our and consensus forecasts
for 2008 inflation may be tilted to the upside, in our view.

In China, Hong Kong, India, and Singapore the common ultimate drivers of inflation
are the output gap and lagged inflation. These are the economies where demand side
pressures resulting from a positive output gap are probably the strongest, labor market
have tightened rapidly, and core inflation is rising. In addition, monetary indicators in China
and India are flashing red and may induce further inflationary pressure in the next 12
months. In economies where GDP growth is at or below trend, monetary indicators are
well behaved and inflation inertia is moderate - such as in Korea, Malaysia, Philippines,
Taiwan, and Thailand - we believe the pressures on inflation are likely to be moderate,
absent any significant global shocks from food and oil prices.

What should investors focus on to gauge the momentum of inflation in the region
over the next 12 months? It may be worthwhile monitoring:

• The further narrowing of the domestic output gap, which may induce demand side
pressures on inflation, and the impact of lagged inflation on future inflation. These may
be prevalent in China, Hong Kong, India, and Singapore.
• How the volatility of money growth and the real effective exchange rate impacts the
volatility of inflation in the region. China and India stand out on the M3 growth front,
while Indonesia is susceptible to the impact of high volatility in the exchange rate on
inflation.
• Regional central banks need to continue to implement prudent monetary policies to
contain inflationary expectations.
• Rising transport costs, and unanticipated commodity price shocks from oil and food
prices may push regional inflation higher.
• Should Asian currencies weaken against the USD on the back of a continuation of global
financial market jitters, upside risks to regional inflation may ensue. In countries where
the degree of pass-through from exchange rates to inflation is visible, the risks to our
CPI inflation forecast may be tilted to the upside. These are India, Indonesia, and
Singapore. The evidence is mixed for the Philippines and Thailand.
• Asia’s impact on global dis-inflation may be moderating since the region is an important
supplier of manufactured goods to the world and costs are rising.

Global equity strategy

2007-09-07T00:37:00.001-07:00

Four key observations/ Investment implications
(1) Emerging market credit spreads have held up very well relative to corporate
credit spreads. In part this is because the market has not sold off aggressively the
‘growth’-sensitive regions (GEM, Japan) and cyclicals, but to a larger extent it reflects
that emerging markets are now much ‘safer’ as a group. This is because both NJA and
LatAm have near-record current account surpluses and record foreign exchange
reserve accumulation. Investment conclusions: (a) Stay overweight more resilient
GEM (i.e. LatAm, NJA—albeit we reduced our overweight on 30 July). After all, NJA
has a 0.7% higher equity risk premium than the US with much less macro risk. We are
now also overweight Hong Kong: (b) Still focus on the indirect plays on emerging
markets: mining/metals, consumer staples with high GEM exposure (Inbev, Nestle,
SAB Miller), luxury goods (Swatch, Richemont), banks with high GEM exposure (SAN,
KBC), technology (GEM account for 60% of handset demand, 47% of PC demand).
We are only cautious about those GEM that need global liquidity to fund large basic
balance of payment shortfalls (South Africa, Hungary).

(2) For the first time in eight years, equity sector risk appetite is much higher
than overall risk appetite and is still above average. The equity market,
especially in Europe, has not sold off the ‘growth’ plays aggressively. The
correlation coefficient between cyclicals and risk appetite is 0.73. Investment
conclusion: this is partly why we downgraded European cyclicals on 13th August.
The only cheap cyclical sectors where we remain overweight are metals/mining
and technology. We prefer US to European capital goods given less stretched
valuations, the dollar and less end-market sensitivity to liquidity conditions. Herein,
we screen for expensive cyclicals in continental Europe.

(3) When the LIBOR/Treasury spread has previously been this high, banks
were much more cheaply rated. The banks we currently prefer are those where
the customer is under-leveraged, the value of collateral is relatively ‘safe’ (with
property yields above bond yields) and loan/deposit ratios are below 95% (with
decent capital ratios adjusting for conduits). Country-wise, this highlights Greece,
Belgium, France, Italy, Japan and parts of NJA. We would highlight NBG, KBC,
Intesa, Postbank, BNP, Credit Agricole, Sumitomo Mitsui.

(4) The catch 22: The US forward curve is discounting 65bp off rates by year-end
(25bp cut in September) but consensus GDP growth numbers are still high at 2.6%
for 2H 2007 and 2.8% for 2008. Only in recession and the LTCM crisis have rates
been cut this quickly. We believe that consensus US GDP growth numbers are
vulnerable—we estimate that directly and indirectly from here housing weakness
takes up to 1.5% off GDP. The concern is bad economic news will probably come
before the good news on Fed rates. During the LTCM crisis the equity market
troughed on the second Fed rate cut. Investment conclusion: buy volatility (SwFr,
VIX) for September. We are bullish on equities for Q4 not necessarily very shortterm
(we reversed our 19th July downgrade of equities on 20th August). We find
European cyclicals with US exposure still quite highly rated (page 22) and believe
it is too early to buy US consumer cyclicals.

Korean Shipbuilding Industry

2007-09-07T00:33:00.001-07:00

Widening gap between Japanese and South Korean shipbuilders

■Visit to South Korean heavy machinery makers: We visited South Korea’s heavy machinery makers (Hyundai Heavy Industries, Samsung Heavy Industry and Doosan Heavy Industries & Construction) to research their business strategies, recent earnings conditions and shipyards. We believe South Korean shipbuilders are sailing ahead of their Japanese counterparts, buoyed by brisk earnings.

■Variance in order price: Japanese shipbuilders will likely struggle to take on short-term deliveries, given that their order books are generally full through to 2010-11. In contrast, South Korean shipbuilders still have room to respond to 2009 deliveries, and therefore have potential to reap lucrative orders. South Korean shipbuilders are generally said to refuse orders unless they yield an OP margin of at least 10-15%.

■Technological gap: South Korean shipbuilders hold a near-monopoly over construction of high-value added super-large LNG vessels (266,000 cubic meters). They have also introduced new technologies enabling construction of ships offshore using super-large cranes of 3,000 tons-plus (Goliath cranes normally used at shipyards are 300-1,000 tons). Also, the South Korean shipbuilding industry pays some of the highest wages in the country, enabling it to attract high caliber personnel.

■Two business models for the shipbuilding industry: The two types of business model evident in South Korea are the vertical-integration model (Hyundai Heavy Industries) and horizontal division-of-labor type (Samsung Heavy Industries). Hyundai Heavy Industries holds the world’s top share for ship engines, and produces key engine components such as crankshafts in-house. In contrast, Samsung Heavy Industries procures engines and main ship equipment from outside. However, orders for large LNG tankers and large-scale marine production facilities such as floating production, storage and offloading vessels (FPSO) are highly lucrative owing to its cutting-edge design.

■Implications for shipbuilding-related firms: Prices for ship equipment look set to significantly improve. Hyundai Heavy Industries commented that it has raised prices for ship engines by around 60% over the past three years. Hence, shipbuilding order prices are improving while price hikes for ship equipment are also being tolerated. Earnings are likely to be boosted by increased volumes and higher prices for ship engines and equipment such as valves. Companies handling ship equipment are Mitsui Engineering and Shipbuilding, Sasebo Heavy Industries, Daihatsu Diesel Mfg, Kobe Diesel, Akasaka Diesels and Nakakita Seisakusho.

Korea at a glance: Assessing the collateral damage to 08E earnings

2007-09-07T00:25:00.001-07:00

Watch the contagion
Focusing more on economic risk. We believe the ongoing US credit troubles pose a
risk to real activity in the wider US economy although the global equity markets seem no
longer to be pricing in a financial systemic crisis. US Fed’s swift liquidity injection may
have assured the global market participants that it has the tools to ensure that a full-blown
liquidity crisis is avoided. However, it remains uncertain that it has the ability to prevent a
slowdown in the US economy from tightening credit conditions. Weakness is most likely to
seep out of the credit market and spread to the US consumer and ultimately to the rest of
the global economy, in our view. According to our economists, what started as a UScentric
housing shock has started to move more noticeably toward a broader consumption
slowdown, and now arguably risks morphing into more of a “global-financial-conditions
shock” if the Fed response is inadequate. If so, our Asia Economics Research team thinks
we would no longer be dealing with just a slowdown in US residential investment, but with
a potentially greater threat to Asian growth.

Signs of softness in some global macro indicators before mid-August sell-off.
Adding to our concerns, the above transmission mechanism is playing out against the
backdrop of some signs of softness in parts of the global data including our GS global
leading indicator (GLI). Global macro news in late July and early August had been
signaling the increasing risk of a pause in equity markets. While our Global Economic
Research team maintained its view that the global industrial cycle was set to accelerate in
2H2007, the latest industrial news had hinted that the best news may be behind us for now.
As our global economist, Jim O’Neill discussed recently, we do still see strong growth
dynamics in the BRICs (China in particular) as providing an important offset to US
concerns. In our recent meetings with the US investors, many agreed with Jim O’Neill’s
view in our Global Markets Daily on Aug 15 that China’s retail sales are contributing about
as much to global growth as US retail sales (0.6% vs. 0.7%) and that retail sales for the four
BRIC economies are currently contributing nearly 1.5% to global growth, which is more
than twice the contribution from the US (see Global Markets Daily: Thank God for China!,
Aug 15). This provides the basis for the “Asia decoupling” argument that the US centric
credit problem and its threat to US consumers are a challenge for Asia that could be
managed with a limited impact on the underlying economic expansion.

But while few would argue against the current robustness of the global economy outside
the US (China in particular), US subprime and broader credit re-pricing related issues and
their contagion effect to US consumers and the rest of global economy should remain at
the center of many investors concerns for some time. If growth concerns increase as credit
conditions tighten, or financial systemic concerns increase, the equity markets including
the KOSPI will likely again come under pressure along with significant volatility spikes.
KOSPI has reclaimed two-third of the lost ground during the risk reduction in mid-August.
But the level of investor confidence implied by the KOSPI’s move seems weak.

Assessing the collateral damage.
There are two main pass-through channels to the KOSPI from the credit market
dislocations and US housing and consumer stress: de-risking to lower valuations and the
damage to earnings growth.

Citi Regional Strategy: The Asia Investigator

2007-09-07T00:05:00.001-07:00

Fed Cuts: What You Pay Determines What You Get (by Markus Rosgen)

Since 1980 we’ve had 7 Fed cuts, 2 at current valuations; both times markets fell — During the five periods of Fed easing when markets rose, the P/BV averaged 1.2 times. The two periods when markets fell, P/BV averaged 2.3x. P/BV is currently 2.6x. We are at a 116% premium valuations to periods when markets rose and a 13% premium to levels when markets historically fell by 1/3.
Interest sensitives and consumers outperform — Even though these sectors do well, they are amongst the least well owned by Asian investors. The biggest underweights are still banks, the utilities and the telecoms sectors. Ditto Korea, Taiwan and Thailand, which are relative outperformers. Only Thailand is an overweight. Korea and Taiwan remain investor underweights.
A falling OECD indicator is bullish, not a rising one — Whenever the OECD leading indicator has been falling and the Fed has cut, Asian markets have risen. The indicator is currently rising on a year-on-year basis. Historically this has been negative for returns. Composite valuations and earnings yield gap models are still elevated and witnessed Fed rate cuts only once at these levels.
Peak valuations since 1975 are 19% away — US markets and European markets peaked in 2000 when valuations reached 3 stdev above mean on either P/BV or P/E. Asia ex is 19% away from reaching 3 stdev above mean.

China: Delay in individual QDII – short-term consolidation expected (by Lan Xue)

India: Fed cuts generally good for Indian markets as well (by Ratnesh Kumar)

Thailand: Fundamental analysis meets Quants (by Nithi Wanikpun)

Stars (cheap with strong momentum) are RATCH, ATC and TTA. Note that ATC has been a Star since April 2007. Sell-rated EGCO is in our Stars list due to continued earnings upgrade momentum.

Fun With Flows: Global funds underweight Asia for first time in six years (by Elaine Chu)

Global Steel- Higher Asian prices needed

2007-09-06T23:30:00.001-07:00

Price rises lead by unwinding of Asian mispricing

Steel prices have started to rise in China in recent weeks. This comes after 6 months of falling domestic flat prices, as Chinese dealers delayed restocking. In 2008E, we are increasing our price forecasts by 16% in Asia to $630/t, in US by 5%, and by 9% in Europe, and in 2009, our forecasts in most regions have been increased by 13%. We have not changed our Chinese RMB prices.

Steel price should rise into 2009E

With rising raw materials costs, slab prices should rise. Steel companies could retain pricing power for the next 3yrs at least, in our view. Our supply demand suggests that the world would need Chinese steel, and as the RMB appreciates, and raw material costs rise, the world would have pay China to export steel through the currently high, and potentially rising, tax barriers

Raising steel price forecasts on higher raw material prices

We are now forecasting a 30% price rise for iron ore and a coking coal prices in JFY2008E - this will likely increase the slab production cost by around $45/t. We expect global steel supply/demand to remains tight, ensuring that the steel producers maintain their pricing power, allowing them to pass through these raw material price pressures via higher steel prices. On average we have raised our HRC forecasts by US$30/t in FY08 and US$15/t in FY09.

Stock selection by region:

Europe: ArcelorMittal - additional margin benefit from higher iron ore prices given produces 50% of its own requirements; consensus too conservative on medium term EBITDA hence trading on just 7x FY09E EPS.
Americas: Nucor and Steel Dynamics, Usiminas and CSN
Asia: Sumitomo, Kobe, and Bluescope