EMI 120613

“In order to change the world, you have to get your head together first.” - Jimi Hendrix

Road Trip to Reno

Thanksgiving here in the US is a time when families strive to get together and eat turkey for the only

time of the year – before they do it again four weeks later at Christmas - and this year we were no

different. After having many times watched the cult film, “Planes, Trains and Automobiles,” in which the

artistic talents of John Candy and Steve Martin illustrate the pitfalls of this odd American custom, I

decided, NO WAY were we going to fly with the children to see the grandparents during the busiest

travel week of the year. This rash decision necessitated a four day, 1,700 mile (2,800 km) drive down

through the vast wasteland of five states to Reno, Nevada (itself a wasteland) and back. America was

built for driving and it is during long road trips like this that one is forced to come face to face with

whatever one strives to keep out of the house and away from polite company. I am talking about some

of the “real America.” Examples of this are things you don’t see in Hong Kong, London or Manhattan:

such as guys in trucks wearing dirty T-shirts proclaiming, “When I snap, you’ll be the first to go.” The

refined look is often finished off with an old baseball cap that says something like, “Drinkin’ Beers,

Shootin’ Deers,” or “Hardcore Carnivore.” You can bet there are guns in the truck and food stamps in the

glove compartment.

Naked Wine Tasting

While most of the highways and byways have been cleaned up compared to decades past there are still

a large number of billboards standing rather forlornly in the middle of nowhere scattered along deserted

stretches of road touting something of little or no value and usually covered with exclamation points.

When approaching one, like seeing a fat dude in a Speedo, I quickly avert my eyes and keep going.

However, one billboard in particular attracted my attention: “NAKED WINE TASTING!” Earnest efforts on

my part to find out more were sadly quashed by the wife who insisted we keep driving. Further on I

spied another intriguing business model, “River Rafting and Tax Preparation!” Americans are nothing if

not entrepreneurial/hilarious/desperate: choose your adjective.

In Reno we stayed at one of those ubiquitous hotels that provide free breakfast in the lobby. This is fine

for a family trip but I would not repeat the exercise on business. The 300 pound woman in her pajamas

breathing down my neck while I squirmed by the toaster caused me to abandon my bagel in some haste

and the unwholesome experience put me off eating for the rest of the day.

2014: Timeo Danaos et dona ferentes?

December and year end have already rushed up to us like a drunk’s face meeting a concrete sidewalk.

February ushers in the Chinese year of the “wood horse.” Before, like the naïve citizens of Troy, we

unwittingly welcome what could be a Trojan horse into the room, let us look inside at what exciting stuff

2014 may bring.

Like the poor, emerging markets will always be with us. Some years they boom and we make money and

other years, like this one, they are a sideshow. But like that rash of yours which can flare up without

warning, we do need to keep an eye on them. It looks like next year, however, does have some bright

spots.

The most change to position for in 2014 is going to be China. In our last note we discussed in detail what

we think Xi Jinping’s new blueprint means for China: it is good and it is real. But is it real good? All

bureaucrats in China worth their weight in Rolex watches mouth the word “reform,” as long as it

doesn’t affect them. Yet reform pretty much stalled under the wallflower Presidency of Hu Jintao. Ten

years ago the National Development and Reform Commission (NDRC) was formed by a forced

copulation of the State Development Planning Commission (SDPC) with the State Council Office for

Restructuring the Economic System (SCORES – the only cute communist acronym I have found. Of

course, it couldn’t last). This meant state planners and reformistas sharing the same bathrooms. That

didn’t work, reform stalled and there was much posturing and pouting in the halls of power instead.

Entrenched interest groups (local governments, SOEs and different ministries) as a result became more

powerful. To cut through this failed experiment and dead wood President Xi has created – outside the

government and beholden to him only – the Central Reform Committee (CRC) which will now spearhead

needed change. As Jimi says, Xi has “got his head together” and this makes me think he is quite serious.

A welcome flood

Perhaps the first sign of a thaw in regulation is the just announced lifting of the 13 month A-share IPO

ban. Reportedly there are 50 companies “ready to list” by January. The sudden flash flood of IPOs where

up to US$9.7 bn is to be drained from the market, or the speculation thereof, will certainly help put a lid

on A-share market performance in the short term – and there are 760 companies now in the IPO queue.

The CSRC’s role in the IPO process will shift from validating all information in the application and

determining a listing valuation to only that of a registration exercise of just verifying everything is

spelled correctly. Listing valuations will be decided by underwriters and the market. The last IPO in China

was Haixin Foods in October of last year - which collapsed 12% in the first two days of trading so maybe

they realize the regulator applying a ham-fisted central planning method of valuation just isn’t such a

good idea anyway.

These moves will be welcomed not just by the threadbare brokerage community but investors as well

will cheer if they are given more choice in the market. Greater representation of the private sector on

the bourse, which is what we can expect from this, is part of the change China needs to embrace. The

regulator is now drafting rules to allow for corporate issuance of preference shares as well. Longer term

the sudden smashing of the IPO logjam is bullish for many reasons and most importantly is hard

evidence, as outlined in the Third Plenum Communique, change is coming.

With a continuing slowing economy – BBG consensus GDP forecast for China is for continued

deceleration to 7.5% growth in 2014 and 7.2% in 2015 – market friendly reform is what is going to call

the punters back to the table and get equities moving. A slowing economy and stalled reforms

eventuating in 2014 would mean our time could be better spent elsewhere. Given Xi Jinping’s urgency to

get things rolling I think reform doubters in 2014 will be surprised and market performance will

positively reflect the welcome transformation.

Amerika is the major growth driver

Despite large women in pajamas wandering around hotel lobbies like barn animals, things here in the US

are not so bad. GDP growth just announced has blown the doors off expectations with Q3 growing at

3.6%. A rising stockmarket and housing market have helpfully repaired pinched private balance sheets

leading to the debt service burden falling to its lowest level since data was first compiled in 1980. When

fear recedes and savings grow the need to “buy stuff” returns and as the chart below indicates US

consumers can start borrowing again to buy more crap again. As the labor market recovers they

probably will. (Don’t do it, guys!)

The recovery in demand from developed economies should fuel greater GDP growth in export oriented

emerging markets. This means the focus is on N. Asia for 2014. The US equity market is up 27% so far

ytd, discounting further economic recovery ahead. Even “Old Europe” has edged a shaky step back from

the abyss. With global demand recovery, such that it is, it is reasonable to expect exports to the

developed world to be a growth driver for emerging markets in 2014.

The risks to EMs of early US tapering with Commander Yellen taking the controls of Spaceship Fed in

February are minimal for 2014, in my view. In fact, judging from Fed parsings and Janet Yellen’s recent

testimony before Congress, “secular stagnation” is now the main fear of our munificent monetary

masters. Words like “lost ground” in the economy are being used to hint that beyond the economy

“recovering” to a desirable employment and GDP growth level even more must be done to recoup what

was lost. In other words, it isn’t enough to just recover but we have to go further to put us back where

we “should” be. While Bernanke may be tempted to hint at a small reduction in Treasury purchases at

the January FOMC meeting, any negative market reaction would see him backpedal furiously by

completely deferring the issue to Yellen. The put remains. These are clear signals there is still far to go

before QE exits the scene.

While the exporting powerhouse that is N. Asia looks interesting for 2014, Taiwan, my old stomping

ground, looks particularly unexciting. The Taiwan Dollar AND the TWSE are now pretty much exactly

where they were a dozen years ago. I walked away from the place early 2002, thus avoiding a grim

couple of years. Weak political leadership has meant an absence of structural reform with the country

continuing to be overly-reliant on its cyclical tech sector and repatriated corporate earnings to keep the

florescent lights on. GDP growth this year is the lowest in Asia and looks like it might reach just 2.5% in

2014. Friends who live there tell me that since everyone has left Taipei is now a very nice place to live…

Taiwan has fallen far behind Korea regarding investment and R&D and as a result has seen an erosion of

competitiveness. Sadly, the island economy completely outwitted by China is already an also-ran.

But just a little further up north…

Mirae Korea strategist Seungsun Ryu writes in his 2014 outlook (here) that Korea will enjoy export

growth leading to slow domestic demand recovery with GDP reaching 3.8%, a little above consensus

forecasts of 3.5%. Export growth of 6% is forecast to be driven mainly by IT, autos and shipbuilding. The

currency outlook is benign (as long as Japan doesn’t implode) with an end year forecast of 1,050 KRW to

the USD. Intriguingly, the Korean equity market has outperformed the US by a large margin since the

financial crisis. A cursory glance at the stats also reveals Korea is outperforming in even-numbered years

while underperforming in odd-numbered years.

Mirae research forecasts KOSPI net profit for 2014 to grow 23%. Removing Samsung Electronics from

the calculation boosts the number to 30% growth as OP margins have now bottomed and the market

overall (ex-SEC) should revert to the last 10-year mean of 8% OP margins in 2014-2015.

All that may be well and good but if we are looking at developed market demand stimulating export-led

growth don’t most of Korea’s exports now go to emerging markets? This is true; the destination of 70%

of Korea’s exports are to emerging markets but roughly half of those are re-exported to developed

markets. Mirae estimates that when you sift and sort through the stats DMs account for roughly 50% of

Korea’s exports. Breaking it down further, mobile telecom equipment, autos and construction

machinery are the sectors with the highest direct exposure to DMs, with semiconductors, ships and

textiles shifting from DMs to EMs and steel and oil products shifting from China as an export destination

to ASEAN.

Companies with the highest exposure to North America: Samsung Electronics, SK Hynix, LG Electronics,

Hyundai Motors, Kia Motors, Hyundai Mobis, Hankook Tire, Kumho Tire and OCI.

Companies with high exposure to China: LG Display, Samsung SDI, Samsung Electro-Mechanics,

Hyundai Mobis and LG Chem.

Even though domestic demand in Korea is still weak an improving export picture leading to healthier

GDP growth does mean this too should begin to gain strength. I still like Amorepacific Corp (090430 KS)

at this level, which I wrote about in detail October 11th. The stock has gained about 10% since then on

the back of the corporate turnaround plan announced during Q3 results last month.

The Last Page

A lady goes to her priest one day and tells him, “Father, I have a problem…. I have two female parrots,

but they only know how to say one thing.”

“What do they say?” the priest inquired.

“They say, ‘Hi! We’re hookers! Do you want to have some fun?’”

“That’s obscene!” the priest exclaimed. Then he thought for a moment. “You know,” he said, “I may

have a solution to your problem. I have two male talking parrots which I have taught to pray and read

the Bible. Bring your two parrots over to my house and we’ll put them in the cage with Francis and

Peter. My parrots can teach your parrots to praise and worship. And your parrots are sure to stop

saying…. That phrase…in no time.”

“Thank you,” the woman responded, “this may very well be the solution.

The next day, she brought her female parrots to the priest’s house. As he ushered her in she saw that his

two male parrots were inside their cage holding rosary beads and praying. Impressed, she walked over

and placed her parrots in with them.

After a few minutes, the female parrots cried out in unison: “Hi, we’re hookers! Do you want to have

some fun?”

There was a stunned silence.

Shocked, one male parrot looked over at the other male parrot and exclaimed,

“Put the beads away, Frank. Our prayers have been answered!”

Cheers.

Derek Hillen, CAIA

Mirae Asset Securities

www.emergingmarketsillustrated.com