Indonesia Equity Strategy - Resilience Being Tested: Consumption Basket Continues to Outperform - JP Morgan

· Indonesia equity markets finally follow the region down, but continue to outperform: After behaving defensively for most of the last couple of months, Indonesia succumbed to pressure and has followed the region, declining 11% from its peak on 1 August. Notably though Indonesia has continued to outperform the EM & AxJ benchmarks on the way down by 4-6%. Indonesia was possibly the largest recipient of
equity inflows among Asian EMs YTD ($2.5bn), and we see outflows as the reason for the recent decline rather than any fundamental changes or linkages to external events.

· Bonds & F/X have been relatively stable – but bonds started to wither: Through the course of the last week – while equities have sold off, the rupiah has remained stable (down 0.6%) and the bond markets were untouched – lending some confidence that country perceptions were undiminished – and hence the equity dip could prove temporary. Ten-year bond yields, however, moved 13bps higher on Tuesday, and
coupled with the 7bps increase in CDS spreads could portend for a continuation of the correction in equities. We point out that while our bond strategists view Indonesia as overbought and possibly stretched after a recent rally, we think fundamentals remain robust – with inflation continuing to trend lower and the Finance Ministry forecasting that debt/GDP could fall below 25% by end FY11.

· What worked in 2008? So far in the decline, consumer staples have outperformed, while Mining and linked names (UNTR & Hexindo) have lagged. Discretionary & financial stocks have paced the index fall. We looked at sector performance in FY08 (Aug-Dec) for cues on the sector in an environment where external stresses and weak commodity markets dominate the outlook. While defensive sectors clearly outperformed
(Staples, Utilities & Telcos) – the surprise to us was the substantial outperformance of Financials compared to the JCI (see table on page 2) as well as the neutral performance of property. At this time, we continue to see Domestic facing defensive sectors as safe havens – Staples standing out, but investors seeking to play a bounce by adding Beta could consider financials (BRI down 12.5%, BMRI 10.5% BCA 8%).

· The JPM Indonesia consumption basket – efficient exposure: The JPMorgan thematic consumption (JPHIJCON Index) has outperformed the JCI both on the way up and on the way down (by 2.9%) since we launched it in late August. We see the basket as an efficient way to gain exposure to Indonesian domestic demand, which we largely anticipate as being insulated to global events. We would continue to expect it to
outperform the broader market on the downside and into a rally.