Glenn Maguires Asia Sentry Dispatch

July 31, 2012

I wish I had saved my Slower, Lower, Weaker headline from last week for today.
It seemed funny last week. It is, however, very much more appropriate today given a slate of significant data underwhelmed across the region. As we briefed in our DataBytes email this morning, those data points were: * Taiwanese GDP contracted in Q2, falling by -0.16%YoY (well short of the consensus expectations for a 0.5%YoY gain) led by a sharp ongoing contraction in gross capital formation and renewed weakness in net exports. * South Korean industrial production came in weaker than expected, falling by 0.4% over the month of June. The consensus looked for a 0.1% gain. * Japan's Markit/JMMA Manufacturing PMI registered a hefty fall, dropping by a chunky 2.0ppt from 49.9 in June to 47.9 in July - well below the 50 contraction/expansion line. * Japan's overall household spending, another disappointment, was up by 1.6%YoY in July, compared to a consensus estimate of 2.9%YoY and following a 4.0%YoY increase in May. * Japan's labour market was broadly unchanged from May to June. The flailing global trade cycle we have been flagging is clearly starting to sap Asian exporting economies growth. Asian manufacturing ended the second quarter on a weak footing and appears to be weakening markedly as we enter the third quarter. Though the adjustment in output so far has probably been managed by more flexibly managing hours worked, we believe headcount adjustment (rising unemployment across the region) will become a more salient feature of the manufacturing slowdown through Q3. Cyclical assets continue to levitate in the face of a marked deterioration in the fundamental backdrop. The MSCI Asia Pacific was up for a fourth day on anticipation that the US and Europe will do something on policy this week, as opposed to their generous policy accommodation of the past three years, that will actually materially improve the growth outlook. If there was a gold medal for optimism, Asias equity markets would have it cornered.

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Sentry Dispatch: The High Frequency Letter of Asia Sentry Advisory.

South Korean IP contracts in June.

The decline in South Korean IP over the month of June was consistent with the already released Q2 GDP figures that showed growth had moderated from 2.8%YoY in Q1 to 2.4%YoY in the second quarter. Given the sharp deterioration in South Korean business sentiment over August we wrote about yesterday, not only should further declines in Korean IP be expected, the pace and magnitude of those declines should also be expected to pick up.

We continue to believe this regional slowdown is being led by the ICT (electronics) sector.
The deterioration in business sentiment to a three year low highlights the fact overseas demand conditions are likely to deteriorate further over the third quarter, not stabilise or bounce back, as the consensus on Asia would still hold. Given the evidence presented by the Japanese and Thai IP figures for June, we believe that this deterioration will be led by the electronics sector which accounts for over 21% of Korean manufacturing production. Indeed, that decline in Japanese industrial production also looks to be embedding with the Markit JMMA Manufacturing PMI released in Japan this morning posting a hefty 2ppt plunge from 49.9 in June to 47.9 in July, i.e., it has fallen deep into output contracting territory. Completing the picture of a region that is losing steam, Taiwanese GDP contracted by 0.16% over the year to June following a 0.39% expansion over the year to March. The downside surprise in Taiwanese growth was driven by the ongoing correction in fixed capital formation and a renewed weakening in Taiwans external position with Taiwanese exports having now weakened for four months in a row. Now whilst this very ordinary picture that is emerging in Asia would at other times ratchet up the probability of the Reserve Bank of Australia seeking to take out greater insurance against the knock-on impact to Australia of a materially weaker Asia region, the RBA is likely to remain content with the more prudent behavior of Australian households and not dangle temptation in front of them by aggressively easing rates.

Australian households continue to behave themselves, for now.

The June credit aggregates reveal that the recovery in business appetite for credit continues, indeed, it appears to have strengthened in recent months. Households, however, remain extremely cautious seeking to bolster equity in their housing stock, primarily but a cumulative overpayment of mortgage principal. Household credit growth, at around 5.0%YoY for the past six months, is running at just half the 10%YoY rate of credit growth considered normal in the halcyon days of 1994-2007. On another note, if households are indeed using any reductions in mortgage rates to pay off debt at a faster pace, than the transmission mechanism for monetary policy (via the household sector) becomes increasingly muted. The effectiveness of further rate cuts must be considered as the only effect would be an indirect confidence effect as households are able to reduce leverage (bolster their own equity) at an even faster pace. This would be a
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Sentry Dispatch: The High Frequency Letter of Asia Sentry Advisory. consideration for a marginal further adjustment to monetary policy. Certainly, the RBA would be loath to reduce rates to such an extent that households felt gearing-up (given the cheap price of money) was once again attractive.

Singapores GIC quadruples cash allocation in year ended March-12.

We were becoming a little bit concerned that we were the only ones noticing the recent disconnect between a deteriorating global trade backdrop and the improvement in cyclical assets, particularly emerging Asian equities and the AUDUSD. Hence, it was with a degree of reassurance that we read today that the Government of Singapore Investment Corporation (GIC) has weighted cash more heavily now than it was during the 2008 financial crisis. The annual report, released today, revealed that GIC had almost quadrupled its cash allocation from 3% over the year-to March 2011 to 11% in the year to March-2012. GIC reduced its weighing on equities from 49% to 45% and its weighing on fixed income from 22% to 17% over the same period.

Todays Conclusion: The disconnect between the price-action of cyclical assets and the global trade cycle downturn we are observing is becoming greater. The slate of data released today reinforces our view that a pronounced downturn in global ICT trade, led by the electronics sector, is underway and the pace of that downturn is accelerating as we enter the third quarter.

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Sentry Dispatch: The High Frequency Letter of Asia Sentry Advisory.

Asia Sentry Advisory Pty Ltd Suite 9, Level 40, Northpoint Tower 100 Miller Street, North Sydney, NSW, 2060, Australia. Ph: +61 2 9931 7820 Fx: +61 2 9931 6888 M: +61 401 548 820 www.asiasentry.com gbmaguire@bloomberg.net glenn@asiasentry.com

Asia Sentry Advisory Pty Ltd is a boutique economic consultancy established to meet the growing demands of clients seeking greater exposure to the most dynamic economic region in the post-crisis global economy, Asia. Asia Sentry Advisory marries keen judgment with a rigorous model-based approach and a deeply intuitive understanding of Asia that can only come from on-the-ground experience to deliver market out-performing analysis and forecasts.
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