Credit Suisse Asia Equity Focus Asian inflation scare creates strategic entry opportunity

Summary
􀂃 CHINA RAILWAY CONSTRUCTION (CRC) - H (HOLD): Parent's take over of Saudi Mecca project is only a short-term catalyst
􀂃 NEW ORIENTAL EDUCATION (BUY): Aggressive expansion strategy will reward big eventually
􀂃 EZRA HOLDINGS (HOLD): Expect stronger earnings on deployment of new vessels
􀂃 GOOGLE (BUY): Q4-results: strong beat on earnings, driven by higher sales and low tax rate
􀂃 GOLDMAN SACHS (HOLD): Disappointing Q4 2010 results driven by lower fixed income revenues

Strategy comments
Short-term dips triggered by Asian inflation fears provide an entry point The MSCI Asia ex-Japan Index pulled back 1.9% last week, led by Indonesia (–5.3%), Hong Kong-listed H shares (–3.2%), Thailand (–2.5%) and Singapore (–1.9%), due to widening investor fears that inflation in Asia will get out of control
and lead to a hard landing in the Asian economy. Last Thursday's higher-thanexpected Q4 GDP growth and December industrial production growth announced by China further fuelled market concerns about an overaggressive monetary tightening and speculation about an imminent interest rate hike by Beijing before the Chinese New Year holidays. We think Asian equities are likely to be range-bound in Q1 2011, while Asian central banks accelerate monetary normalization to battle inflation and asset bubble risks. Notably, Q1 is also a seasonally weak quarter for non-Japan Asia fund flows and this likely means that Asian equities will lag the performance of the developed markets in the short term. Based on the seasonal pattern of Asian equity performance in previous years, we recommend investors use any short-term market consolidations to add positions in our recommended Asian equities.

Our Asian Economics Team reiterates our base-case scenario of a policy-induced soft landing in the Asian economy in 2011, as we anticipate Asian central banks will accelerate monetary normalization in the coming months and frontload interest rate hikes in H1 2011 to contain inflation expectations and defuse asset bubble risks. It is worth highlighting that non-Japan Asia inflation is running at below the median rate of all the recovery cycles in the past three decades. Based on historical evidence, CPI inflation in Asia always rebounds between the 16th and the 22nd month after the market trough and then moderates again due to the monetary tightening of Asian central banks. The current surge in Asian inflation is in line with the historical trend.

Despite the liquidity impact of the Federal Reserve's second round of quantitative easing and the subsequent USD weakness, we do not expect Asia's runaway inflation in 2008 to be repeated in 2011, as we think crude oil prices are unlikely to trade much higher than USD 100 per barrel due to high inventories and spare capacities, though rising global food prices remain an uncertain factor. We expect non-Japan Asia CPI inflation to peak around mid-2011 and soften towards H2 2011 due to the high base effect. We forecast China and non-Japan Asia CPI inflation to surge to an average of 4.8% and 5.2% respectively in 2011,
nowhere near the last cycle peak levels of 8.7% and 8.0% in 2008. In our view, the monetary tightening measures are much needed and positive steps to defuse the overheating risk in the region. We do not expect interest rate hikes in the coming months to derail Asia's growth story and we forecast resilient GDP growth of 8.8% for China and 7.6% for non-Japan Asia in 2011.

Based on our expectations of accelerated monetary normalization in the next few months and peaking Asian inflation around mid-2011, we expect the Asian equity markets to deliver a stronger performance after the seasonally weak Q1 quarter for non-Japan Asia fund flows. The MSCI Asia ex-Japan delivered a flat performance in the first three weeks of 2011, slightly lagging the 1.8% gain of the MSCI World and the 2% return of the S&P 500. In the same way that the double-dip recession fears faded in 2010, we expect the Asian inflation scare will ease later this year, once the markets are more convinced about the effectiveness of antiinflation policies in China and other Asian countries. Based on a 6–12-month investment horizon, we maintain our constructive strategic view on Asian equities in 2011 due to the region's robust growth outlook, positive liquidity conditions due to QE2, USD weakness, healthy earnings cycle and attractive valuations. Investors should stay focused on the inflation and growth themes for 2011, including the winners of asset price inflation (property stocks in Hong Kong and Singapore), quality commodity plays (upstream oil, iron ore and coal producers) and EM consumer plays in Asia, which are our favorite inflation hedges and beneficiaries of the rising inflation environment. We continue to favor Asian high-yielding stocks, which offer an attractive
investment vehicle for yield-seeking investors to gain exposure to the Asian markets at a controlled risk.
Cheuk Wan Fan, Phone: +852 2841 4841, cheukwan.fan@credit-suisse.com