· Sakthi Siva (Report attached): We are positioning for a 2H rally. While it would have been good to see greater foreign investor capitulation (historically a good indicator of a bottom), we are positioning our GEM model portfolio for a 2H rally as we saw in 2004 and 2010. While early 2004, 2010 and 2011 were all associated with a peak in global leading indicators, we believe 2011, like 2004 and 2010, will also be associated with a soft landing. In our report of 24 May Re-Introducing Double Dip Watch, we highlighted that all seven indicators that we watch are suggesting a soft landing. In addition to the business cycle, another similarity between all three years is valuations – we are currently 14% undervalued versus 17% undervalued at the 2004 lows and 10% undervalued at the 2010 lows.
· We are Overweight sectors that outperformed in 2H 2004 and 2H 2010 rally. The sectors that did well then were Consumer Cyclicals, Industrials, Materials and Energy and we are Overweight all four of them. We are Overweight countries where inflation is peaking. Using the monthly momentum in inflation, we can divide GEM into three groups. We favour countries in the first group where monthly inflation is either flat or negative. The first group consists of Korea, Taiwan, China and Indonesia. In the second group is Russia where monthly inflation is around 0.5%. Despite attractive valuations in Turkey (second cheapest in GEM) and Brazil (fifth cheapest) and less stretched valuations in India, we are not as keen on the third group where monthly inflation is still stubbornly high at around 1%.
· In Indonesia, having added Astra Motors on 3 March to the GEM portfolio, we are adding Indofoods. While this stock is not cheap, it is at least less overvalued than Chinese Staples and is likely to benefit from the peaking in input prices.