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Investors should assume that Merrill Lynch is seeking or will seek investment banking or other business relationships with the companies in this report.
Refer to important disclosures at the end of this report.
Asian Tigers - Alive and RoaringDecember 2003
Asian Tigers - Alive and RoaringDecember 2003
Ade Odunsi
Investors should assume that Merrill Lynch is seeking or will seek investment banking or other business relationships with the companies in this report.
Refer to important disclosures at the end of this report.
Part 1Global Backdrop
Part 1Global Backdrop
3Refer to important disclosures at the end of this report.
Global Backdrop
Like it or not, Asia is deeply entangled in the US’s massive external imbalance
Willingness of Asia to extend cheap credit to the US government and consumer
Asian saving has helped fund tax cuts and credit growth in the US
A post-bubble US recession has largely been avoided
This has supported US consumption of Asian manufactured goods
The “mother of all vendor financing deals” (David Bowers, Merrill Lynch Research)
Imbalances however are reaching worrisome levels
4Refer to important disclosures at the end of this report.
Asian Resurrection
Asia is only 11% of the world economy but is growing 2.5x as fast
Over the 2001-2003 period China represents only 4% of Global GDP but contributed 17.5% to Global GDP growth!
5Refer to important disclosures at the end of this report.
If You Scratch My Back...
Asian trade deficit with US excluding Japan $179bn (of which China $114bn!)
Current Account = Capital Account
Asia purchased $161bn of US securities over the past 4 quarters (30% of CA deficit)
6Refer to important disclosures at the end of this report.
A Quick Word on China
US Bilateral trade surplus has jumped by 50% over the last 3 years (>$100bn) 50% of exports to US are foreign companies - FDI Imports from China are not direct substitutes for US goods China has emerged as the leading manufacturer of labour-intensive goods China runs a trade deficit with the rest of the world The shift in manufacturing jobs abroad has been happening since the 1950’s The money comes straight back - China owns >$120bn of Treasuries
02010099989796959493929190898887868584
20
15
10
5
0
-5
20
15
10
5
0
-5
Percent Percent
Source: OECD. Merrill Lynch.
Export volume/Export market for total goods
Investors should assume that Merrill Lynch is seeking or will seek investment banking or other business relationships with the companies in this report.
Refer to important disclosures at the end of this report.
Part 2 Why are We Concerned?
Part 2 Why are We Concerned?
8Refer to important disclosures at the end of this report.
The Elephant in the Corner
CA deficit reaches $520bn - never bet against the US consumer!
9Refer to important disclosures at the end of this report.
US Dependence on Foreign Capital
“Foreign capital” increasingly means Asian capital
Asia bought $23bn of US assets in September alone
10Refer to important disclosures at the end of this report.
“Hot Money” Dominates
The upturn in the US stock market this year has not convinced foreigners to make long-term investments in the US
At the peak of the bubble, US equity inflows from overseas reached $200bn
11Refer to important disclosures at the end of this report.
It’s a Little Known Fact...
Significant funding of the CA deficit is by foreign Central Banks (>$1 trillion)
Bank of Japan is the largest buyer of Treasury securities (> $130bn this year)
Net foreign buying of corporate bonds has outstripped Treasury securities over the last 12 months - the search for yield
A worrying development: foreign net purchases of US financial assets dropped from $62bn in August to $16bn in September
The rally in the US Equity market is domestically driven!
TIC = US Treasury International Capital System
12Refer to important disclosures at the end of this report.
Pent-up Demand Not in US
There are three common conditions to a lasting pickup in private demand Rising confidence and low real interest rates are met in each of the G3 Private financial surpluses in Japan are 5% of GDP; 3% in the Eurozone (2003);
-1% in the US
+12m+9m+6m+3mEndStart-3m-6m-9m-12m
6
4
2
0
-2
-4
-6
6
4
2
0
-2
-4
-6
Months Pre-Post Recession
% of GDP % of GDP
Source: Our calculations. NBER business cycle dates.Private sector financial balance in the US, previous eight cycles.
Average of Past Cycles Current Cycle
Investors should assume that Merrill Lynch is seeking or will seek investment banking or other business relationships with the companies in this report.
Refer to important disclosures at the end of this report.
Part 3 What Does This All Mean?
Part 3 What Does This All Mean?
14Refer to important disclosures at the end of this report.
Reality Check
This financing arrangement between Asia and the US has benefited both
Asia needs US demand just as much as US needs Asian capital
Talk of protectionist policies by the US are largely political
The ‘basic’ problem with the deficit is that it is HUGE
Low yields on US assets make the deficit increasingly difficult to finance
How does the US recovery sustain itself?
The problem ‘officially’ recognised at the G7 meeting in September 2003 - this likely marks the beginning of the end of this dynamic
15Refer to important disclosures at the end of this report.
What Is Our View?
Rising local activity will enable Asia to grow out of its CA surplus
‘Competitive reflation’ has boosted Asian economies– Aggressive FX intervention by Asian Central Banks to limit currency appreciation and
maintain competitiveness (also limited ability to sterilise)
– Lower interest rates
– Massive growth in Asian FX reserves (Treasuries: $15bn/month on average)
But rising employment and utilization rates pushing up inflation
Business is booming and Asian consumers have a large pool of savings
Strong economic outlook will be the catalyst for acceptance of currency appreciation in Asia
THE END GAME: redistribution of growth from the US to Asia. Asian consumers will be the main drivers of demand
16Refer to important disclosures at the end of this report.
The Flip Side
Slower US growth (…but Q3 GDP growth 8.2%)
Higher returns in Asia attract capital from US securities markets
US interest rates adjust higher resulting in lower demand
Fed committed to keeping short-term interest rates low
The US dollar must devalue to maintain balance
Imbalances correct gradually
17Refer to important disclosures at the end of this report.
Deja Vu The Plaza Accord (1986)
Trade weighted USD index peaked in Feb ‘01 and has fallen 23% EURUSD FX rate has fallen 42%
18Refer to important disclosures at the end of this report.
What Else Could Happen?
Massive US recession?– Fed to keep interest rates ultra-low for an extended period
Competitive reflation in Asia results in a major inflation shock, impacting real rather than nominal exchange rates
A combination of all 3 factors
In everyone’s interest to engineer a slooowwww adjustment
Investors should assume that Merrill Lynch is seeking or will seek investment banking or other business relationships with the companies in this report.
Refer to important disclosures at the end of this report.
Part 4 Money Talks
Part 4 Money Talks
20Refer to important disclosures at the end of this report.
The FX ‘Virtual’ Market
Huge (For comparison, US Treasuries $400bn/day)
Liquid
Sophisticated
Highly automated
Fast
Unregulated (!?*)
24 hour global marketSource: BIS Central Bank Survey 2001
570
750
990
1,400
1,200
-
200
400
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800
1,000
1,200
1,400
1989 1992 1995 1998 2001
FX Daily Turnonver ($bn)
UK 31.10%USA 15.70%Japan 9.10%Singapore 6.20%Germany 5.40%Switzerland 4.40%Hong Kong 4.10%
21Refer to important disclosures at the end of this report.
FX as an Asset Class
Massive increase in interest in FX as an asset class i.e. currency speculation
Driving component of many investment bank’s recent profitability
FX is not cyclical - consistently profitable!
1) Trending markets - US dollar in a long-term structural decline
2) Quest for alpha
3) A search for ‘alternative’, non-correlated assets
4) A little known fact - FX is a less risky assetAnnualized Standard Deviation
EURUSD FX Rate 10.0%P&G 15.0%S&P 18.0%Dow 18.0%FTSE 21.0%IBM 25.0%
What are chances of the FX rate going to zero?
CB’s tend to intervene if volatility gets too high
22Refer to important disclosures at the end of this report.
But FX is a Zero-Sum Game, Right?
Another little known fact - not every participant in the FX market is a profit maximizer!
Central Banks
For example:- Bank of England ‘defending’ the pound in 1992
- Bank of Japan sales of Yen for US dollars this year have exceeded $130bn Yen has still strengthened by over 12%!
International corporations
Private individuals
Professional currency managers make up less than 1% of daily turnover
SIGNIFICANT PROFIT POTENTIAL!
23Refer to important disclosures at the end of this report.
Show Me the Money Buy Asian equities
– India– Thailand– Taiwan
Spot Dec ‘03 Mar ‘04 Jun ‘04 Sep ‘04 Dec ‘04Latin America
USD-BRL 2.93 3.10 3.10 3.20 3.25 3.40USD-MXN 11.35 10.80 11.00 11.25 11.40 11.25
Emerging Europe
USD-ZAR 6.59 7.00 6.85 6.85 7.20 7.50USD-PLN 3.95 3.87 3.69 3.52 3.28 3.23EUR-PLN 4.65 4.61 4.50 4.40 4.30 4.30USD-TRL1 1,476 1,450 1,570 1,630 1,700 1,755USD-HUF 222 216 209 206 198 196EUR-HUF 262 257 255 257 260 261
Asian Bloc
USD-KRW 1,203 1,170 1,100 1,060 1,020 1,000JPY-KRW 10.97 10.93 10.73 10.60 11.09 11.11USD-TWD 34.11 33.80 33.50 33.00 32.50 32.00USD-SGD 1.72 1.73 1.72 1.71 1.70 1.70USD-HKD 7.77 7.80 7.80 7.80 7.80 7.80Source: Merrill LynchForecast as of November 26, 2003. Spot exchange rate at previous NY close. The left of the currency pair is the denominator of the exchange rate. 1 (000) per USD.
24Refer to important disclosures at the end of this report.
Show Me the Money Chinese Renminbi (CNY) is a pegged currency (8.2771 CNY per USD)
Active ‘off-shore’ forward market (non-deliverable market)
25Refer to important disclosures at the end of this report.
Disclaimers
The analyst(s) responsible for covering the securities in this report receive compensation based upon, among other factors, the overall profitability of Merrill Lynch, including profits derived from investment banking revenues.Copyright 2003 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). All rights reserved. Any unauthorized use or disclosure is prohibited. This report has been prepared and issued by MLPF&S and/or one of its affiliates and has been approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is regulated by the FSA; has been considered and distributed in Australia by Merrill Lynch Equities (Australia) Limited (ACN 006 276 795), a licensed securities dealer under the Australian Corporations Law; is distributed in Hong Kong by Merrill Lynch (Asia Pacific) Ltd, which is regulated by the Hong Kong SFC; and is distributed in Singapore by Merrill Lynch International Bank Ltd (Merchant Bank) and Merrill Lynch (Singapore) Pte Ltd, which are regulated by the Monetary Authority of Singapore. The information herein was obtained from various sources; we do not guarantee its accuracy or completeness. Additional information available.Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related investments"). MLPF&S and its affiliates may trade for their own accounts as odd-lot dealer, market maker, block positioner, specialist and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side of public orders. MLPF&S, its affiliates, directors, officers, employees and employee benefit programs may have a long or short position in any securities of this issuer(s) or in related investments. MLPF&S or its affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this report.This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance.Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk.