Asia ex-Japan Strategy - Caveat venditor - Macquarie

A correction, not an inflection
§ Risk aversion is back again – for the moment – with this week‟s volatility in the commodities and energy complex, but the medium-term outlook for growth/reflation plays still strikes us as well-supported by both monetary conditions and demand fundamentals. Another trading correction, another dipbuying opportunity.
§ Calling a precise bottom in this environment would be guesswork, but with the Asia ex-Japan index at just 12.3x forward PER (amid positive overall 2011 consensus EPS revisions) – and with MSCI Asia ex-Japan Materials and Energy both in the 11.0–11.5x range -- we would be comfortable buying beta after as little as another 5% index downside (Figure 6, below).

Monetary accommodation + ongoing global expansion
§ We only expect a concerted and more sustainable USD rally and a rockier path for emerging markets once the prospect for a genuine US monetary tightening becomes more clear and present. But at this stage, such risks remain comfortably distant, in our view – a story for 2012 that markets may not need to discount until, say, 4Q11 at the earliest. The coming June end of the Fed‟s quantitative easing („QE2‟) exercise will not equate to the “start of tightening” – and may yet even prove a windfall boost for equities if it motivates asset allocators to reduce fixed income exposure, as we expect.
§ Meantime, low/negative real interest rates remain the single most critical variable still pointing lower for the dollar and higher for the „reflation trade‟ medium-term. The real Fed Funds rate, at -2.4%, is 120bp lower today than at end-2010, and is almost certain to decline further in the second half as the Fed continues to stand pat. China‟s real base lending rate, meanwhile, is just 0.7%, and the GDP-weighted real policy rate for all Asia ex-Japan has similarly declined 22bp YTD (Figure 1). Even gold‟s correction this week has taken it back only to mid-April levels (roughly US$1,480/oz.), still up 23% YoY.
§ We also remain generally constructive on global demand expansion into the second half, seeing 1) the 1Q11 US GDP pullback as a temporary „soft patch‟; 2) robust core European (especially German) growth largely undiminished by the noise from sovereign flare-ups in the smaller peripheral euro-area economies; and 3) China nearing the point at which it will be able to back off from the credit tightening that has fuelled investor caution recently.

Your neighbour may be buying this dip
§ In any case, as discussed separately in our May 6 Weekly Fund Flow Tracker, the past week has by no means been a period of indiscriminate foreign dumping of Asian stock: Although Wednesday (May 4) did see one-day foreign net-selling of US$499m among the six Asian markets that provide daily data (Korea, Taiwan, India + the TIPs), daily aggregate net-buying was recorded Monday, Tuesday and Thursday – with cumulative week-to-date buying in positive territory as of Thursday‟s close, at US$175m (Figure 5).
§ In Hong Kong, admittedly, short-selling this week has risen back to highs around 8% that have only been exceeded once in the two years since the Global Financial Crisis. But the two previous post-Crisis instances of shorting at these levels have prefigured HSCEI rallies averaging 20% and lasting roughly 10 weeks (Figure 2).
§ For investors willing to grasp the nettle and buy the latest market dip, we note that the cheapest beta in Asia ex-Japan by sector (in terms of current forward PER vs. 10-year average) is now found in Property, Capital Goods, Tech and Transport (Figure 3).