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KBank multi asset strategies   feb 2011

KBank multi asset strategies feb 2011






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    KBank multi asset strategies   feb 2011 KBank multi asset strategies feb 2011 Document Transcript

    • .Mean S Multi Asset Strategies KBank Strategies Macro / Multi Asset USD/Asia: cyclically constructive, structurally destructive February 2011 Volume 45 As we are in the year of the Rabbit, the markets will tend to be jumpy…with events in Tunisia and Egypt along with fear that Kobsidthi Silpachai, CFA –Kasikornbank Asia is behind the curve on fighting inflation is again highlighting kobsidthi.s@kasikornbank.com USD perceived safe haven stature and risk in EM assets Susheel Narula – KSecurities Our main theme for USD/THB downside remains unchanged…but susheel.n@kasikornsecurities.com our 4Q11 USD/THB target is scaled back to 29.00 from 28.00 Kavee Chukitkasem – KSecurities kavee.c@kasikornsecurities.com Indications from the central bank along with its perceived preference for a less stronger baht coupled with rising KResearch kr.bd@kasikornresearch.com commodity prices prompts us to revise up our 4Q11 BOT repo target to 3.25% from 2.75% Our full-year 2011 GDP forecast remains unchanged at 4.5% YoY Disclaimer: This report but some components have been revised to better accommodate must be read with the higher oil price risks Disclaimer on page 47 The divergence of economic cycles between EM and Developed that forms part of it economies calls for a sector re-allocation towards ‘Services’ and ‘Commodities’ Strategic Thesis “KBank Multi Asset It looks like the US dollar can do no wrong…that seems to be what the market is Strategies” thinking for the time being. But markets have rather short memories and gives more can now be accessed on weight to cyclical / shorter horizon factors. US data points continue to show recovery in Bloomberg: KBCM <GO> the business sector. The labor market seems mixed but attention is being paid to the falling unemployment rate. Structurally, the verdict might not be utterly convincing since more people are leaving the labor force than more people getting jobs. Another structural impediment is with the spiraling debt levels in the US federal government which is seen to reach 140% in the not too distant future since Uncle Sam is spending money it does not have…not to mention the 50 states. The events in Tunisia and Egypt have turned on the risk switch of EM assets, that is political risk and inflation risks and hence favoring the US dollar. Inflation can be thought as the depreciation rate of money or the rate at which all people become poor. So countries that look to be “behind the curve” will be shunned by investors. China’s move on interest rate again is an admission that controlling money supply alone is not as effective as is hoped. Sooner or later, it will have to look to letting the yuan flow its fundamental course , that is to strengthen. Until then, USD/Asia will remain volatile as seen by the jump in USD/THB vols. But the textbook response is on the wall: higher inflation, higher interest rates. Hence, we can still see the Thai yield curve bias towards a bear flattener. On equities, the continued rally we called last month did not happen and the market fell to 950, also below what we predicted to be the support level at 980. The market psychology has changed and we now no longer expect a sharp directional trade. The SET is shifting pace and will become sideways. We recommend a sector re-allocation towards ‘Services’ and ‘Commodities’. We are Overweight on energy, agricultural, media, hotel, hospital, commerce, contractor and industrial estate.111 WWW.KASIKORNBANKGROUP.COM
    • Key Parameters & Forecasts at Year-end 2003 2004 2005 2006 2007 2008 2009 2010E 2011E GDP, % YoY 7.1 6.3 4.6 5.2 4.9 2.5 -2.3 7.6 4.5 Consumption, % YoY 6.5 6.2 4.6 3.0 1.6 2.7 -1.1 4.0 3.7 Investment Spending, % YoY 12.1 13.2 10.5 3.9 1.3 1.2 -9.2 9.5 8.8 Govt Budget / GDP % -0.2 -0.2 0.3 -0.7 -1.5 -1.0 -5.6 -3.2 -3.8 Export, % YoY 18.2 21.6 15.2 17.0 17.3 15.9 -14.0 27.0 10.0 Import, % YoY 17.4 25.7 25.8 7.9 9.1 26.5 -25.2 35.0 15.0 Current Account (USD bn) 4.78 2.77 -7.6 2.3 14.1 1.6 21.9 14.2 7.5 CPI % YoY, average 1.8 2.8 4.5 4.6 2.3 5.5 -0.9 3.3 3.3 USD/THB 39.6 38.9 41.0 36.1 33.7 34.8 33.3 31.4 29.0 Fed Funds, % year-end 1.00 2.25 4.25 5.25 4.25 0.25 0.25 0.25 0.25 BOT repo, % year-end 1.25 2.00 4.00 5.00 3.25 2.75 1.25 2.00 3.25 Bond Yields 2yr, % year-end 1.73 2.78 4.94 5.02 3.91 1.98 2.17 2.35 3.75 5yr, % year-end 2.8 4.0 5.3 5.1 4.5 2.2 3.6 2.75 4.00 10yr, % year-end 4.9 4.9 5.5 5.4 4.9 2.7 4.3 3.25 4.25 USD/JPY 107.5 102.5 118.0 119.1 111.8 90.7 93.0 82.0 89.0 EUR/USD 1.26 1.36 1.18 1.32 1.46 1.40 1.43 1.40 1.30 SET Index 772.2 668.1 713.7 679.8 858.1 450.0 734.5 1040 1220 Source: Bloomberg, CEIC, KBank, KResearch, KSecuritiesKBank Thai Government Bond Rich / Cheap model 30.00 20.00 10.00 0.00 -10.00 -20.00 3 mth avg Now -30.00 LB296A LB113A LB116A LB11NA LB123A LB133A LB137A LB145B LB14DA LB155A LB15DA LB167A LB16NA LB175A LB183B LB191A LB196A LB198A LB19DA LB213A LB24DA LB267A LB283A LB396ASource: Bloomberg, KBank222
    • KBank THB NEER Index KBank USD/THB – FX Reserves / USD Majors model KBank USD/THB model Jan 1995 = 100 KBank THB Trade Weighted Index 48 110 46 44 42 100 40 + 1 std 38 d 36 90 34 average 32 80 30 -1 std dev 28 01 02 03 04 05 06 07 08 09 10 11 12 70 00 01 02 03 04 05 06 07 08 09 10 11 actual modelSource: Bloomberg, KBank Source: Bloomberg, KBankFX reserves – USD/THB model DXY – USD/THB model USD/THB USD/THB since 2001 48 50 46 y = -7.6277Ln(x) + 69.875 44 2 45 42 R = 0.872 40 40 38 36 35 y = 27.699Ln(x) - 86.289 34 2 R = 0.756 32 30 30 28 25 26 70 80 90 100 110 120 130 25 50 75 100 125 150 175 200 225 DXY FX reserves, USD bn DXY to USD/THB mapping current FX reserves to USD/THB mapping current 2011 forecastSource: Bloomberg, KBank Source: Bloomberg, KBankKBank BOT repo model SET forward dividend yield vs. 10yr bond yield % % 5.5 9 5.0 8 4.5 4.0 7 3.5 6 3.0 5 2.5 4 2.0 1.5 3 1.0 2 0.5 1 0.0 0 01 02 03 04 05 06 07 08 09 10 11 12 00 01 02 03 04 05 06 07 08 09 10 11 actual model 10yr yields SET forward dividend yieldsSource: Bloomberg, KBank Source: Bloomberg, KBank333
    • Thai inflation parameters Thai contribution to GDP growth % y oy Contribution to growth 25% 15.0 20% 10.0 15% 5.0 10% 5% 0.0 0% -5.0 -5% -10.0 -10% -15.0 -15% 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 01 02 03 04 05 06 07 08 09 10 11 Priv ate consumption Gov ernment consumption Gross fix ed capital CPI Core CPI PPI Change in inv entories Net ex ports GDPSource: CEIC, KBank Source: NESDB, KBankImplied forward curve: swaps Implied forward curve: TGBs % Implied forward rate shifts (IRS) % Implied bond yield curve shifts 5.00 4.50 4.50 4.00 4.00 3.50 3.50 3.00 2.50 3.00 2.00 1.50 2.50 1.00 2.00 0.50 - 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 0 1 2 3 4 5 6 7 8 9 10 Feb-11 May-11 Aug-11 Jan-12 tenor (yrs) Feb-11 May-11 Aug-11 Feb-12 tenor (yrs)Source: Bloomberg, KBank Source: Bloomberg, KBankUS 2yr yields and implied forward US 5yr yields and implied forward 7.0 8 6.0 7 5.0 6 4.0 5 3.0 4 2.0 3 1.0 2 0.0 1 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 2yr yields, % implied forwards 5yr yields, % implied forwardsSource: Bloomberg, KBank Source: Bloomberg, KBank444
    • KBank EUR/THB model KBank JPY/THB model EUR/THB JPY/THB 43.0 56.0 54.0 41.0 52.0 39.0 50.0 37.0 48.0 46.0 35.0 44.0 33.0 42.0 31.0 40.0 29.0 38.0 36.0 27.0 34.0 25.0 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 actual model actual modelSource: Bloomberg, KBank Source: Bloomberg, KBankKBank GBP/THB model KBank CNY/THB model GBP/THB CNY/THB 5.8 78.0 5.6 73.0 5.4 68.0 5.2 63.0 5.0 58.0 4.8 4.6 53.0 4.4 48.0 4.2 43.0 4.0 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 actual model actual modelSource: Bloomberg, KBank Source: Bloomberg, KBankKBank THB/VND model KBank AUD/THB model THB/VND AUD/THB 750 35.0 700 33.0 650 600 31.0 550 29.0 500 27.0 450 25.0 400 350 23.0 300 21.0 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 actual model actual modelSource: Bloomberg, KBank Source: Bloomberg, KBank555
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    • The shortest distance between two points is a straight line Kobsidthi Silpachai, CFA - Kasikornbank …or so they say. Low USD liquidity is a cue for the rise in USD/THB kobsidthi.s@kasikornbank.com volatility Warunee Sithithaworn – Kasikornbank As we are in the year of the Rabbit, the markets will tend to be warunee.si@kasikornbank.com jumpy…with events in Tunisia and Egypt again highlighting USD Nalin Chutchotitham – Kasikornbank perceived safe haven stature and risk in EM assets nalin.c@kasikornbank.com Resumption of political activities following end of emergency decree is giving a good excuse for foreign investors to take some money off the table …and reintroduces more uncertainty in the USD/THB picture Our main theme for USD/THB downside remains unchanged…but our 4Q11 USD/THB target is scaled back to 29.00 from 28.00 Indications from the central bank along with its perceived preference for a less stronger baht coupled with rising commodity prices prompts us to revise up our 4Q11 BOT repo target to 3.25% from 2.75%Yesterday’s darling might be today’s out of favor child2010 was a great year for the Thai baht gaining about 11.07% against the USD. Thecurrency was ranked fourth after JPY, AUD and MYR. That is looking into the rear viewmirror. Looking in front passed the windshield with the year of the Rabbit in full swing, theUSD/THB has proved so far to be as jumpy as the rodent. The Thai stock market, SET,gained about 48% in 2010 is prompting investors to take some money off the table.Hence, looking at the following statistics, foreign investors have sold about USD 1053mn, YTD, the most in the region after India.Table 1. Foreign Institutional Investment in Regional Equities Day WTD Net MTD Net YTD Net YTD Net As of (Mil US$) (Mil US$) (Mil US$) (Mil US$) YoY% India -117.1 -117.0 -25.8 -1,413.0 -88.6 08/02/2011 Indonesia -49.7 -34.2 -3.7 -290.9 -6.2 09/02/2011 Japan 2,418.9 2,418.9 2,418.9 10,418.7 -44.8 04/02/2011 Philippines -16.5 -15.6 -55.5 -149.2 -315.9 10/02/2011 S.Korea -451.6 -487.1 -603.9 -20.8 -108.4 09/02/2011 Taiwan -191.2 -117.7 -117.7 3,321.0 233.5 09/02/2011 Thailand -49.7 -191.4 -121.1 -1,053.8 -267.5 09/02/2011 Vietnam 2.5 5.9 5.9 64.0 13.7 09/02/2011 Pakistan 0.7 0.8 5.8 68.9 332.9 09/02/2011Source: Bloomberg777
    • It is not rocket science that resumption of rainbow political activities, post the end of theemergency decree is giving a good excuse to take profits from Thailand and rotate itelsewhere in the region. The political implosions in the likes of Tunisia and Egypt willbring back memories of the recent past of the Bangkok events in the middle of last yearand hence, a growing distaste for Thai financial assets. The risk premium is a tad higher,suggesting that the financial markets are expressing a sense of unease. Amidst growingrisk averse coupled with a tight USD liquidity environment, the upward move in theUSD/THB was accentuated further.Fig 1. Thai 5yr credit default swap…a gauge of risk Fig 2. USD/THB: 30, 60, 200 day moving averagespremium bps over Libor Thai CDS 5Y 38 190 37 36 170 35 34 150 33 32 130 31 110 30 29 90 28 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 70 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 USD/THB 30 day avg 60 day avg 200 day avgSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankUnfolding events prompt a rethinkThere is a saying that “the shortest distance between two points is a straight line”. Thereintroduction of the Thai risk premium in light of the idiosyncratic political characteristiccomplicates our call for a USD/THB target of 28.00 by 4Q11.We have taken notice that the central bank’s stance on FX intervention as toughenedsince mid November. Fig 3 shows that foreign portfolio flows have been instrumentalaccentuating the moves in USD/THB. The data points include USD/THB versus the sumof foreign flows on Thai equities and fixed income securities with the latter being larger.Based on statistics, correlation between USD/THB and foreign investment flows up tomid November were highly correlated up to 97%.Fig 3. Relationship between USD/THB & foreign Fig 4. Relationship between USD/THB & foreignportfolio flows (equity & fixed income) Jan to Nov 2010 portfolio flows (equity & fixed income) Jan 2010 to now 250 29.0 400 27 29.5 350 200 28 300 FX intervention was stepped correlation was nearly 98% between 30.0 250 up causing a break in pattern 29 150 Jan 2010 to mid Novebmer 2010 30.5 31.0 200 30 100 150 31.5 31 50 32.0 100 50 32 32.5 0 0 33.0 33 1- 2- 3- 4- 5- 6- 7- 8- 9- 10- -50 1- 2- 3- 4- 5- 6- 7- 8- 9- 10- 11- 12- 1- -502010 2010 2010 2010 2010 2010 2010 2010 2010 2010 33.5 2010 2010 2010 2010 2010 2010 2010 2010 2010 2010 2010 2010 2011 sum of foreign equity / fixed income flows USD/THB, right axis, inverted sum of foreign equity / fixed income flows USD/THB, right axis, invertedSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank888
    • The breakdown in the relation became more obvious post mid November. Table 2 shows our estimate that in December 2010 the Bank of Thailand most likely bought an additional USD1.9 bn in excess of the balance of payments to steer the USD/THB in a new direction. This could be a game of “chicken”. The name might sound childish but it actually is an important concept in economics…primarily game theory.Table 2. Thai balance of payments, FX reserves and estimated FX intervention levels USD mn Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Exports fob 13,610.4 14,254.7 16,083.8 13,831.7 16,434.7 17,876.5 15,475.1 16,291.6 17,954.9 17,045.5 17,584.0 17,220.0 Imports cif -13,041.9 -13,801.8 -15,082.1 -14,032.5 -14,143.7 -15,334.2 -16,266.3 -15,439.8 -14,712.2 -14,772.9 -17,093.8 -15,911.0 Trade Balance 568.5 452.9 1,001.7 -200.8 2,291.0 2,542.4 -791.3 851.7 3,242.7 2,272.7 490.2 1,310.0 Current Account Balance 2,107.6 1,655.9 1,779.9 -299.2 1,164.0 820.9 -1,000.8 280.5 2,767.0 2,739.6 1,019.0 1,750.0 Capital and Financial Account Balance 2,743.4 -698.6 1,732.6 2,964.5 -2,607.8 741.2 2,979.8 3,205.9 1,125.8 2,404.6 Overall Balance of Payments 4,965.5 119.3 3,137.3 3,749.0 -989.3 2,166.4 1,412.2 3,589.4 4,269.8 5,821.7 820.3 2,263.0 FX Reserves 142,403.5 141,797.5 144,094.1 147,588.1 143,518.6 146,759.2 151,524.7 155,186.8 163,235.3 171,061.6 167,973.9 172,128.9 Change in FX Reserves 3,985.9 -606.0 2,296.6 3,494.0 -4,069.5 3,240.6 4,765.5 3,662.1 8,048.5 7,826.3 -3,087.7 4,155.0 Estimated intervention -979.6 -725.3 -840.7 -254.9 -3,080.2 1,074.2 3,353.3 72.7 3,778.7 2,004.6 -3,908.0 1,892.0Source: CEIC, BOT, KBank The popular source of cyber knowledge, “Wikipedia” defines and discusses “chicken” as follows: The game of Chicken, also known as the Hawk-Dove or Snowdrift game, is an influential model of conflict for two players in game theory. The principle of the game is that while each player prefers not to yield to the other, the worst possible outcome occurs when both players do not yield. The name "Chicken" has its origins in a game in which two drivers drive towards each other on a collision course: one must swerve, or both may die in the crash, but if one driver swerves and the other does not, the one who swerved will be called a "chicken," meaning a coward; this terminology is most prevalent in political science and economics. The name "Hawk-Dove" refers to a situation in which there is a competition for a shared resource and the contestants can choose either conciliation or conflict; this terminology is most commonly used in biology and evolutionary game theory. From a game-theoretic point of view, "Chicken" and "Hawk-Dove" are identical; the different names stem from parallel development of the basic principles in different research areas. The game has also been used to describe the mutual assured destruction of nuclear warfare, especially the sort of brinkmanship involved in the Cuban Missile Crisis. The game is similar to the prisoners dilemma game in that an "agreeable" mutual solution is unstable since both players are individually tempted to stray from it. However, it differs in the cost of responding to such a deviation. This means that, even in an iterated version of the game, retaliation is ineffective, and a mixed strategy may be more appropriate. 99 9
    • In 1997, the Bank of Thailand and hedge funds had locked horns in a game of “chicken”,with the hedge funds shorting the baht while the Bank of Thailand bought baht to defendthe peg. As bystanders became more biased towards the hedge funds, the defensecrumbled since the peg was built on a house of cards with the odds stacked against theThai central bank such as the long list of imbalances: persistent current account deficits, rising financial leverage, land / real estate speculation, mounting short term foreign currency debt facilitated by the Bangkok International Banking Facilities (BIBF), Thai firms conducting interest rate arbitrage by issuing euro convertible debentures (ECDs) encouraged by the fallacy of no FX exchange risksFor the present situation, it looks like luck has sided with the central bank as the foreignflows are swerving into outflows. By stepping up the FX intervention, foreign investorswere discouraged from aggressively putting more money into the Thai markets sincelosses on FX will reduce their returns on the financial assets i.e. local currency capitalgains and interest rate differentials.We agree that FX intervention and sterilization should be conducted on foreign portfolioflows since by not doing so, Thai juristic and natural persons would becomeunconsciously indebted to foreign funds, since we do not have the funds’ ownership.Conversely, the point that we have consistently stressed is that flows belonging to Thaijuristic and natural persons i.e. current account flows should not be intervened for thefollowing reasons: It represents a cross subsidy between the external side and internal side of the economy i.e. exporters gain at the expense of the general population …correspondingly, it facilitates wealth concentration. Said another way: “Spread the pain and concentrate the gains” Supports moral hazard as Thai exporters would be discouraged from improving on productivity and quality for gaining a competitive advantage and continue to look to the Bank of Thailand to be competitive based on the price function alone.101010
    • We are scaling back our USD/THB targets: 30.00 for 2Q11 and 29.00for 4Q11The new stance expressed by the Bank of Thailand on FX management reflects a morehands on style, being more aggressive in limiting the USD/THB downside and morelenient on the capping the USD/THB upside. This is a significant change from what wesaw for the earlier part of 2010. With consideration to these points, we are scaling backour targets for USD/THB and revising them to: 30.00 for 2Q11 29.00 for 4Q11Fig 5. KBank USD/THB model Fig 6. USD/THB Fibonacci levels KBank USD/THB model 48 34 46 33 44 42 32 40 31 38 36 30 34 29 32 30 28 28 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 01 02 03 04 05 06 07 08 09 10 11 12 USD/THB Min Max 23.6% actual model 38.2% 50.0% 61.8% 76.4%Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankWe have not changed our major thesis for the USD/THB. The risk of the USD has beentemporarily dismissed from the markets for the time being. Japan’s sovereign downgradefrom AA to AA- by Standard & Poor’s is an attestation that countries can not go onforever without fiscal discipline. Greece is a reminder and so as with the rest of the PIIGSin the Eurozone.The Greenback, cyclically constructive…structually destructiveThe cyclical data points for the US economy seem constructive. The ISM index (theInstitute for Supply Management,http://en.wikipedia.org/wiki/Institute_for_Supply_Management ), suggests that both themanufacturing and services continue to expand. A print north of 50 pts indicates that thebusiness sectors anticipate expansions whilst a print south of 50 pts indicatesexpectations of contractions. Another litmus paper indicator is shown on fig 8. This is acalculation of the top and bottom line of companies listed on the broader S & P 500. Thechart shows that both that current revenue and net income levels are about 96% of peaklevels leading up to the financial crisis.111111
    • Fig 7. ISM service and manufacturing Fig 8. S&P 500, revenues & net income 70.0 10,000 900 65.0 9,000 800 60.0 8,000 700 55.0 50.0 7,000 600 45.0 6,000 500 40.0 5,000 400 35.0 30.0 4,000 300 97 98 99 00 01 02 03 04 05 06 07 08 09 10 00 01 02 03 04 05 06 07 08 09 10 ISM Non-Manufacturing (service) ISM Manufacturing revenue, USD bn (mkt cap / PSR) net income, USD bn (mkt cap / PER)Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankThe previous should provide encouragement that the “I” part of “Y” of GDP (economistswould denote Y = C + I + G +(X-M)), is looking better and better. The other and moreimportant facet of final demand is consumption, which no doubt is hinged on prospect ofcurrent income, namely wages. January’s employment data points were ratherconfusing…should be call it heads or tails? Heads was the lower unemployment ratemoving from 9.40% to 9.0%. Tails was the lower than expected absolute levels of jobcreation, namely “non-farm payrolls”, where the shoal of economists was looking for 146kbut the reality was only 36k. The optimists blamed the lower reading on snow storms andweather related challenges rather than on the reluctance of US companies to add humanresource costs. Fig 10 shows a worrying structural trend which is a continually declininglabor participation rate. This is the ratio between the size of the labor force (peopleworking and are looking for work) divided by the size of the total population. The declinecan be due to a couple of reasons we can think of: Americans are discouraged from looking for work since it during the past two years it has proven futile. The demographic shifts towards an aging population as the baby boomers (Americans born post WWII) entire retirement.Fig 9. Number of Americans out of work, unemployment Fig 10. US labor participation rate declinesrate 68 16000 11% 67 14000 10% 66 12000 9% 65 8% 64 10000 7% 63 8000 6% 62 6000 5% 61 4000 4% 60 2000 3% 59 0 2% 58 00 01 02 03 04 05 06 07 08 09 10 11 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 unemployed, k, left unemployment rate, % , right participation rate, % of total US populationSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankOur concern here is that retirees are not active consumers which do not bode well for theAsian export market from a structural basis. Reconsidering these facts, the US is lookingmore and more like Japan. The other similarity is the “G” part of GDP. According to theCongressional Budget Office (CBO), the US Federal (excluding state) governments willrack up a USD 1.4 trillion budget deficit or about 9.8% of GDP. The aging population is121212
    • definitely a factor and hence the need for healthcare reforms. But after 2011, the USfederal government is still expected to spend money it doesn’t have i.e. more fiscaldeficits which means that the mountain of debt will continue to climb… as long as Asiancentral banks remain naïve to lend on the premise that such debt will not be monetized.Sure, the US federal government will not default…when the debts become matured…Asian central banks will trade in one piece of paper for another piece of paper. Note thatthe US federal debt to GDP will exceed those severe levels during WWII.Fig 11. US federal budget deficit to GDP Fig 12. US federal debt to GDP 4 160 2 140 0 120 -2 100 -4 80 -6 60 -8 40 -10 20 -12 0 40 44 48 52 56 60 64 68 72 76 80 84 88 92 96 00 04 08 12 16 20 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020 US budget surplus / deficit as % GDP projected US Federal Debt to GDP, % calculated, with Congressional Budget Office estimatesSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankBeside the US Federal Government, the growing concern with the US (the United States)is with the state and local governments’ ability to keep themselves afloat amidst mountingdebt. The following function in Bloomberg (MIFA <GO>) shows that the likes of California,Texas, New York are experiencing ever larger deficits. This means the Fed is unlikely toshift its ultra accommodative monetary policy anytime soon (please see the annex to theFOMC’s recent statement). More US dollars can eventually only mean lower prices.Table 3. The arguments for and against USD/THB directions USD/THB positives USD/THB negatives Resumption / escalation of political unrest, which Current account surpluses of Thailand, meaning, prompts a more extended outflows of foreign portfolio exporters outnumber importers. This is a result of flows out of Thailand irregularities in the Thai political and social landscape Increasing probability that the Eurozone breaks up, which thwarts domestic demand hence reallocation of foreign currency reserves back Expectation of further USD/CNY downside as to to the USD supplement the fight against inflation Service account outflows from SET dividend Continued Fed accommodative monetary policy, repayments / Japan fiscal year closing meaning more USD, lower USD price Increasing perceived political risk of emerging markets Better economic growth prospects in Asia relative to as seen in Tunisia, Egypt and the spreading to other the West parts of the Middle East and possibly Asia Political clarity on Constitutional amendments and Concerns that Asian central banks are behind the general elections curve in controlling inflation. Inflation is the Return of Thai portfolio flows e.g. from Korean bonds depreciation rate of money.Source: KBank131313
    • Fig 13. The USA or USB, the United States of BankruptcySource: Bloomberg, KBank Federal Open Market Committee (FOMC) Statement January 26, 2011 Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer term inflation expectations have remained stable, and measures of underlying inflation have been trending downward. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow. To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its141414
    • securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset- purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate. Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.Playing “chicken” with inflation?Economics is the study of opportunity costs and hence any decisions taken by economicagents will incur a trade off. The inconsistency in monetary policy of pricing baht withrespect to other currencies (FX exchange rates) and with respect to time (interest rates)might be causing more problems than it solves. The riots in Tunisia and Egypt is said tobe partly attributable to rising inflation. In layman’s term, inflation simply means that oneis getting poorer as to oppose to gaining prosperity.The rise of China in the global economy is proving to more like a double edge sword. Onthe positive side, it is serving as a large production base as well as becoming a largemarket for goods and services. On the other hand, it is clear that the planet is beingstrained to supporting a population with over 1.36 billion with growing wealth of nearly10% a year.Coupled with more frequent supply shocks from nature i.e. floods, drought, diseases, it isno wonder as to why the prices of commodities, whether it is metals, energy oragriculture have consistently climb. Fig 16 shows that before the fall of Lehman Brothers,there is a high correlation between China’s nominal GDP and the CRB (CommodityResearch Bureau) index of 19 commodities including agriculture, energy and metals.Fig 14. China’s nominal GDP & CRB commodity index Fig 15. Not just coincidence CRB index 100000 500 500 90000 450 80000 450 70000 400 y = 0.0044x + 121.16 400 60000 350 2 R = 0.8826 50000 350 40000 300 30000 300 250 20000 250 from Dec 99 to Jun 08 200 10000 0 150 200 99 00 01 02 03 04 05 06 07 08 09 10 150 10000 20000 30000 40000 50000 60000 70000 CH nominal GDP 4Q moving sum, CNY bn, left CRB index, right CH nominal GDP, CNY bnSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank151515
    • Fig 16. …neither is this: China’s nominal GDP & Thai Fig 17. …as well as explaining a lotCPI TH CPI index 100000 115 115 90000 110 80000 110 y = 0.0004x + 77.118 70000 105 2 R = 0.9389 105 60000 100 50000 100 40000 95 30000 95 90 20000 90 85 10000 0 80 85 00 01 02 03 04 05 06 07 08 09 10 80 10000 20000 30000 40000 50000 60000 70000 80000 90000 100000 CH nominal GDP 4Q moving sum, CNY bn, left TH CPI index, right CH nominal GDP, CNY bnSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankThe question is, how can an increase in Thai policy rates control Thai inflation if inflationis more of a function of regional supply and demand rather than just Thai supply anddemand? After all, this is by design via all the Free Trade Agreements sign for regionaleconomic integration. Fig 17 shows that size of the Chinese economy has a largeinfluence on Thailand’s inflationary environment.So, it seems that by playing “chicken” with portfolio flows, the central bank is also playing“chicken” with inflation. By allowing the baht to weaken amidst rising commodity prices,the transmission of imported inflation will be much more rapid.The Bank of Thailand’s recent inflation report strongly indicates a fear of rising inflationand that core inflation might get out of hand if interest rates remained low. The followingtable is the probability distribution for core inflation going forward. With the assumptionthat the repo remains at 2.25%, there is a 43% probability that core inflation will exceedthe 3% upper band in 3Q11 and a 55% probability for 4Q11.Table 4. BOT Inflation Report, Core CPI probability distribution Ranges: % 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 >3 0% 12% 43% 55% 11% 6% 3% 3% 2.5 3.0 2% 26% 31% 28% 24% 17% 11% 11% 2.0 2.5 22% 34% 19% 13% 32% 31% 25% 26% 1.5 2.0 51% 21% 6% 3% 23% 29% 32% 32% 1.0 1.5 23% 6% 1% 0% 8% 13% 21% 20% 0.5 1.0 2% 1% 0% 0% 2% 3% 7% 6% <0.5 0% 0% 0% 0% 0% 0% 1% 1%Source: BOT Inflation Report, Jan 2011The major source of unease for the central bank is that economic growth has closed theoutput gap. In layman’s term, fig 20 shows what an output gap is. If the actual growth isabove trend (in this figure, it is a simple best fit regression line), it suggests that theoutput gap has closed, meaning that there is little slack left in the production side. Thiswould then indicate that the pass through of inflation (the depreciation rate of money)would be more readily transmitted. A case in point is our current problem with palm oil. Ifthere is not enough slack on the supply side, there will not be enough goods to go around161616
    • and prices have to rise anyways. Actually price ceilings might exacerbate the problem asblack markets form where the price sold is higher than the price ceiling.Fig 18. Output gap has closed Fig 19. KBank BOT repo model 5,000,000 % 6 4,500,000 5 4,000,000 above potential growth 4 3,500,000 3 long term trend 3,000,000 2 below potential growth 2,500,000 1 2,000,000 0 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 01 02 03 04 05 06 07 08 09 10 11 12 Thai GDP, 1998 price, 4Q moving sum Linear (Thai GDP, 1998 price, 4Q moving sum) actual modelSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankWe have inputted the assumptions suggested by the BOT Inflation Report which webelieve that the MPC also believes in these assumptions, after all, BOT scholarships arenot cheap and easy to come by. Fig 21 shows our repo model which is a behavioralmodel. Simply it gauges how the MPC responds to key economic data points (e.g. growthand inflation) as reflected in the repo rate. With the new assumptions, we view that theBOT is likely to take policy rates up to 3.25% by the end of the year, as opposed to ourearlier call of 2.75%. The release of the MPC minutes (the first ever) shed a lot of light oftheir concerns for growing potential financial imbalances. Minutes of the Monetary Policy Meeting of the Monetary Policy Committee Bank of Thailand 12 January 2011 Publication date: 26 January 2011 Members Present Prasarn Trairatvorakul (Chairman and Governor), Atchana Waiquamdee (Vice Chairman and Deputy Governor, Monetary Stability), Suchada Kirakul (Deputy Governor, Corporate Support Services), Ampon Kittampon, Praipol Koomsup, Siri Ganjarerndee, Krik-krai Jirapaet Financial Markets The Thai baht was volatile, appreciating relative to the US dollar on the back of capital inflows while depreciating in the beginning of 2011 due to sales of equity by foreign investors after better-than expected US economic data. Going forward, investors are expected to give greater weight to recovery in major countries, resulting in greater two-way movement of the baht as opposed to continued appreciation pressure observed in the previous year. In addition, the yield curve shifted slightly upwards following the previous MPC meeting reflecting market pricing of an interest rate hike this meeting. The majority of market participants surveyed expected the current MPC meeting to result in a rise in the policy rate by 0.25 percentage points while some expected an overall rise of 0.50-1.00 percentage points in 2011. International Economic Conditions Risks to global economic growth have fallen. The US economic recovery continued to strengthen. A survey of economists indicated that the majority viewed that the US economy would grow faster than forecasted and that employment would improve although risks from house prices remained. Nevertheless, certain MPC members expressed concerns regarding the171717
    • continually high rate of unemployment. The European economy stabilized although money markets remained volatile due to concerns over sovereign debt. However, core member countries, especially Germany, are projected to become drivers of growth. The Japanese economy still faced deflation while the appreciating yen may impede growth going forward. The Asian economy continued to grow on the back of domestic demand and exports destined to both within the region as well as new markets with high growth potential. Overall, the region is becoming less reliant on the G3 economies. However, the risk to inflation for the region as a whole increased significantly. The uneven growth of advanced economies and emerging markets has led to varied monetary policy responses. Advanced economies pursued accommodative monetary policy to safeguard economic recovery while emerging markets tightened to maintain price stability and are expected to accelerate the pace of interest rate normalization in 2011. As a result, challenges for Asia going forward are likely to come from capital flow volatility and the appropriate pacing of monetary policy tightening. Domestic Economic Conditions Thai economic growth was projected to return to its long-term trend. The Thai economy continued to expand in Q4 of 2010 from the previous quarter in line with domestic and external demand. Going forward, growth will be supported by 1) private consumption expansion on the back of both agricultural and non- agricultural income, increase in the minimum wage, low unemployment and robust consumer confidence and 2) private investment, which despite some slowdown after accelerating in the prior period, should expand going forward due to favorable business confidence, high capacity utilization in many industries, and future investment plans to meet internal and external demand for goods in services and 3) fiscal stimulus from government income support programs for mostly low-income earners and government investment for both large projects and state enterprises which was expected to increase from the previous year. Export growth in the previous year exceeded expectations and was expected to continue its growth trend into 2011 due to Chinese and ASEAN economic expansion as well as the rising trend in advanced orders. In addition, various research houses projected strong export growth in 2011 supported by a rising export prices (except for fisheries where there is low pricing power) which was expected to partly mitigate the adverse effects of baht appreciation. Tourism activity was solid and was expected to expand going forward. In the monetary sector, private credit expanded well together with overall economic growth. The expansion in commercial bank credit was primarily due to demand from households. Corporate loans also increased and were projected to grow continuously in 2011. Commercial banks rapidly raised both deposit and loan rates following the policy rate hikes. In regards to price stability, inflation pressure increased from the previous period. Headline inflation accelerated in line with the rise in wages while core inflation picked up due to the pass-through of production costs into goods prices, especially prepared food and seasonings and condiments. The MPC assessed that inflation pressure going forward has increased due to both cost-push and demand pull factors. Cost-push factors include: 1) upward trend in oil and commodity prices on the back of global economic expansion; 2) increased pass- through from the Production Price Index (PPI) into Consumer Price Index (CPI) as authorities allowed price increases in many product categories; and 3) gradual pass-through of production costs to consumers as producers’ ability to absorb such costs became more limited. Demand-pull factors include: 1) a diminishing181818
    • output gap as output growth neared potential while producers have revised their inflation expectations upwards for some time. These factors would speed up price adjustment going forward. In addition, some MPC members expressed concerns over the possibility that inflation may breach its target this year. Considerations for Monetary Policy. The MPC viewed that the risk to inflation had increased relative to the risk to growth compared to the previous meeting. The global economic recovery strengthened compared to the previous meeting. The risk of a double dip recession in the US declined while Asia faced the challenge of rising prices, particularly those of commodities. The Thai economy continued to return to its long-term growth trend. The MPC viewed that domestic demand would become the principal driver of growth in the coming period. In addition, strong export performance pointed to Thailand’s economic resilience in face of the baht appreciating in the previous period. Inflationary pressure clearly increased due to rising oil and commodity prices, the return of the Thai economy to its long-term growth trend and pent-up pressure from delayed price adjustments. At the same time, increases in the minimum and civil service wages may boost consumption expenditures more than expected and lead to a rise in inflation expectations going forward. Some MPC members were concerned that low real interest rates may foster financial imbalances, depress savings and lead to asset bubbles in the future. MPC members were unanimous in seeing the need to maintain continuity in signaling rate normalization. Robust economic expansion together with significantly increased inflationary pressure led to some members discussing the possibility of a rate hike of 0.5 percentage points. Nevertheless, the majority of MPC members viewed that policy rate adjustment should be gradual while taking into account that the neutral rate depends on changing economic circumstances. The MPC therefore decided unanimously (7 to 0) to raise the policy interest rate by 0.25 percentage points per annum, from 2.00 to 2.25 per cent per annum, effective immediately.191919
    • Pricing in inflation risks BoT’s message is simple – bring prices under control and correct the level of real returns to savers Investors had been reducing portfolio duration of portfolio during past 3 months while the yield curve is pricing in 100bp rate hike In Asia, monetary tightening likely to be greater in economies that delayed rate actions – a negative for their bond markets Local near-term inflationary threat looks benign, but Thai people’s consumption basket shows continued increase in food prices have greater impacts on low income and rural households Yield curve outlook remains one of a bear-flattening We expect consecutive policy rate hikes during the next three meetings while Q3 may see a further 25bp increaseLocal interest rates updateThe Bank of Thailand (BoT) had raised its policy rate for the fourth time since July 2010and signaled that further hikes are in the pipeline to preempt acceleration in actual pricelevels and expectations. Such expressions were reiterated in its quarterly publication,Inflation Report, released on January 24th. The BoT left forecast of core inflation rateunchanged at 2.0 - 3.0% this year and indicated a high probability (>40%) of themmissing policy target in the third and fourth quarters. That is, given the assumption thatpolicy rate remained unchanged at 2.25% for the next 8 quarters. Moreover, the BoTcontinued to express concerns over negative real deposit rates that could form the basisof imbalances in the economy over the medium-run. The implication is simple - apartfrom bringing prices under control, there is a need to correct the level of realreturns to savers. So far, the adjustments of fixed deposit rates and minimum lendingrates had been rapid. At least when compared to the previous policy rate up-cycle.Fig 20. Changes in deposit rates Fig 21. Government bond yields change % % 2.50 8.0 7.0 2.00 6.0 1.50 5.0 4.0 1.00 3.0 2.0 0.50 1.0 0.00 0.0 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 T-bill 3M Fixed 1Y deposit Repo Repo MLR Bond yield 5Y Corporate bond 5Y BBBSource: Bloomberg, KBank Source: Bloomberg, KBankWith the repeated signals from the policymaker, local markets are continually pricing innew expectations as well. Interest rates had been on a gradual but steady up-trend202020
    • recently, with substantial liquidity continually keeping bond yields from overshooting thechanges in the policy rate. Nevertheless, there had been a series of more aggressiveswings in bond yields and swap rates as well. This was especially so about a week priorto the monetary policy decision day as investors adjust portfolios more actively. Inparticular, investors continued to reduce their portfolio durations in expectation of furtherinterest rate hikes. This could be observed via the trading volume of government bondsduring the recent three months. Outright trading volume of bonds that have maturitiesmore than 7 years had declined by 46% from November to January while trading volumeof 1-3 year bonds increased by 44% during the same period. At the same time, bondswith maturities 3-7 years saw a less significant change. Table 5. Thai yield movements and curve spread Month-end 1Y (%) Chng (bps) 2Y (%) Chng (bps) 5Y (%) Chng (bps) 10Y (%) Chng (bps) 2-5 spread 2-10 spread Oct-10 1.98 3▼ 2.31 4▼ 2.83 27 ▲ 3.18 6▲ 52 ▲ 87 ▲ Nov-10 2.11 13 ▲ 2.38 7▲ 2.98 15 ▲ 3.59 41 ▲ 60 ▲ 121 ▲ Dec-10 2.38 27 ▲ 2.8 42 ▲ 3.26 28 ▲ 3.77 18 ▲ 46 ▼ 97 ▼ Jan-11 2.54 16 ▲ 2.96 16 ▲ 3.40 14 ▲ 3.85 8▲ 44 ▼ 89 ▼ 9-Feb-11 2.60 6▲ 2.99 3▲ 3.49 9▲ 3.86 1▲ 50 ▲ 87 ▼ Source:Bloomberg and KBankFig 22. Outright trade volume of government and BoT Fig 23. Government bond yields changebonds by bond maturity million baht bp 1 month period change in yields 160 40 T-bills Gov t and BoT Bonds 1-3Y 140 35 Gov t and BoT Bonds 3-7Y Gov t Bonds >7Y 120 30 25 100 20 80 15 60 10 40 5 20 0 0 1 6m 1 2 3 4 5 7 8 9 10 15 20 tenor (yrs) Sep-10 Oct-10 Nov -10 Dec-10 Jan-11 Bond Change IRS ChangeSource: Bloomberg, KBank Source: Bloomberg, KBankInflation theme is a dominant theme in the regionInflation risks and monetary tightening had become more prominent in Asia in recentmonths. Although most economies exhibit inflation rates below 4%, the up-trend incommodity prices, especially agricultural items, are making central banks nervous. At thesame time, high levels of liquidity in the financial markets continued to bolster asset priceincrease in many of Asian economies. This suggests that central banks would have tostay extra vigilant against economic imbalances for quite some time. The two figuresbelow show three things: headline inflation rates, policy rate change since central banksstarted hiking in the year 2009, and market’s expectation of 1-year forward change inshort-term interest rates. We note that expectation for monetary tightening this year isgreater for the economies that were relatively slower in raising policy rate during the pastcouple of years e.g. Philippines and Indonesia. This does not bode well for the bondmarket in such economies. In fact, investors had started to unload some of their mediumto long-term bond holdings in the Indonesian and Filipino bond markets. Yields of 5-yearsovereign bonds saw substantial increase during the first two months of the year relativeto regional bond market.212121
    • Fortunately, we think, spikes in yields are less likely to happen in Thailand. The BoT islikely to be ahead of the curve for its policy rate adjustment this time round and thereremains ample liquidity in the hands of investors to help absorb impacts of bond yieldsfrom higher inflation rates going forward. We do have concerns, however, about thecontinued price controls in Thailand. Government’s subsidies and regulations arebeneficial in the short-run as the public needed time to adjust but prolonged price controlshad in the past led to less efficient use of resources and delays in demand adjustment ofthe people. In other words, inflationary pressure are only postponed and not likely to bereduced in the medium term by exercising more cautious spending. Fig 25. Market expect more hikes from central banksFig 24. Market’s expectation of interest rate increase that moved relatively slower bp expected chng in short-term rate 1Y forward (bp) CPI % yoy % bp expected chng in short-term rate 1Y forward (bp) Change in policy rate since crisis (bp) 250 10 250 200 8 200 150 6 150 100 4 100 50 2 50 0 0 0 South Korea South Korea Thailand Singapore Indonesia Thailand Singapore Indonesia Philippines Philippines Hong Kong Hong Kong Japan Australia Japan Australia Taiwan India Taiwan India China China Malaysia MalaysiaSource: Bloomberg, KBank Source: Bloomberg, KBankFig 26. 5-year sovereign bond yields % 9 8 7 6 5 4 3 2 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 S.Korea Thailand Philippines Indonesia MalaysiaSource: Bloomberg, KBank222222
    • A few more reasons to be concerned about inflationIn Thailand, there are indeed concerns with price pressure going forward, especially withfood prices. While the 3% headline inflation rate during the past two months seemedbenign, compared to the inflation rates during the 2008 oil price crisis, impacts onhouseholds and business people may not be much different. Next, we go back to theconstruction of the consumer price index (CPI) and attempt to obtain a clearer view ofwhat the CPI can tell us on top of change in general price level. At the same time, wecompare price changes of each product category to magnify the magnitude of food priceinflation and finally show why we are concerned about the lower income and ruralhouseholds.From the figures below, we could make a few easy observations. The price index oftobacco and alcohol as well as the price index of food and beverages experiencedsubstantial gain since December 2008. Meanwhile, growth rate of transport andcommunication items had been among the highest as well, but note also that its slump in2008 had also been large. Comparing current price indices with record high levels, weobserved that cost of transportation and communication is the farthest from its record-high level - not that costs are low, but this goes to show that a large change during thepast two years was not accompanied with costs breaching new highs.Fig 27. Thailand’s policy rate and inflation Fig 28. Gains in price indices since Dec 2008 % chng Price lev el changes in the past tw o y ears 10% 15.0 8% 6% 10.0 4% 5.0 2% 0% 0.0 -2% I -5.0 CP du e ev ar re ge l m ho ur ca e &E &B m ra nit lco tw Co -4% ve al io n od r oo &a Fu on rt & be Fo &F at o rs -10.0 & d& o cre cc in g in g pe sp -6% ba foo Re an h& us oth To n- Tr Ho a lt Cl No 01 02 03 04 05 06 07 08 09 10 11 He -15.0 CPI Core CPI Policy rate Dec09 - Dec08 Dec10 - Dec09Source: Bloomberg, KBank Source: Bloomberg, KBank232323
    • Fig 29. Price indices of individual category of product 2007=100 FB – food and beverages 130 CF – Clothing and footwear 120 HF – Housing and furnishing 110 HP – Healthcare and personal care 100 TC – Transport and communication 90 RR – Recreation, reading, education and religion 80 TA – Tobacco and alcohol 70 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 FB CF HF HP TC RR TASource: CEIC, KBankWe combine the above findings with the weights of different product category in the CPIbasket (see table below). Since the CPI basket is based on actual household expenditure(based on National Statistical Office’s Social and Economic Survey), we can approximatethe burden on household expenditure. The top three highest weights, in descendingorder, are 1) food and beverages, 2) transport and communication, and 3) housing andfurniture. From here, we may begin to worry about the rising prices of food andbeverages.Indeed, we should be so worried about food prices. The next figure below shows thegrowth rate of the Food and Agriculture Organization’s (UN) food price index as well asThailand’s producer price (PPI) and consumer price inflation rates. As we would expectthat global prices may take a few months to affect local prices, we pushed forward theFAO food index series by 3 months and found that its growth pattern coincides withThailand’s PPI and CPI growth. Unfortunately, this also indicates that local prices mayrise higher during the next few months. CPI Type % Share in CPI basket (proxy share of household expenditure) Food & Clothing & Housing & Health & Transport & Tobacco & Recreation & Non-food & Beverages Footwear Furniture personal care communication alcohol education beverage CPI (2000) 36.06 3.40 23.86 6.04 21.99 2.83 5.82 63.94 CPI (2007) 33.01 2.96 23.48 6.87 26.80 1.66 5.21 66.99 Low income CPI 41.21 2.58 24.62 6.11 19.07 2.30 4.10 58.79 Rural area CPI 41.81 3.45 21.35 5.81 22.10 1.75 3.74 58.19 Source: MOC, KBank242424
    • Fig 31. Inflation: rural areas and low incomeFig 30. UN FAO food price index and local inflation households % yoy 60 50 15 40 30 10 20 10 5 0 -10 -20 0 -30 -40 -5 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 00 01 02 03 04 05 06 07 08 09 10 Food Index pushed forward 3m (yoy) Thai PPI Thai CPI (yoy) CPI Low Income Rural areaSource: Bloomberg, KBank Source: CEIC, KBankNext, we compare the CPI baskets of different types of household to highlight heprobability that price pressure would hit those who least could afford it. First, observe thatnationwide inflation rate is substantially below those that belonged to the rural area andlow income households. While we have not the in depth analysis of this divergence, theunderlying reason should be rather intuitive. The increases of energy and food prices,which are the more volatile items in the CPI basket, should have a greater impact on theconsumption power of the rural and lower-income households. (A re-visit to the CPIbasket weight in the table above would help) The two categories of goods make upnecessary consumption for day-today living and short-term adjustment in overallhousehold expenditure is likely to be difficult. At the same time, there is less flexibility interms of product substitution for food and energy, unlike items like clothing and furniturewhere a lower-income household could opt for more affordable choices. Hence, we arelikely to continue seeing such price-impact divergence among the different groups ofhouseholds. This is also another reason why the central bank is concerned about risinginflation and the necessity to curb the pace of price acceleration and inflation expectation.252525
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    • Economic Update Key economic indicators for Dec-10 were mixed. Exports fell, following a sharp gain in the previous month. However, Thanyalak Vacharachaisurapol - KResearch figures beat the consensus forecast. Thanyalak.v@kasikornresearch.com Business sentiment displayed growing wariness toward rising Kevalin Wangpichayasuk - KResearch production costs, while private investment and consumption eased. Kevalin.w@kasikornresearch.com The tourism sector showed a broad-based recovery from flooding, with the number of foreign tourist arrivals hitting a historic high. Kangana Chockpisansin - KResearch A base effect kept the Headline CPI stable YoY, but the MoM rate of Kangana.c@kasikornresearch.com increase accelerated on higher prices for fresh foods and energy. Better-than-expected figures in Nov-10 and Dec-10 have led us to revise our 4Q10 and 2010 GDP upward slightly to 3.5% and 7.8% YoY, respectively. Although our full-year 2011 GDP forecast remains unchanged at 4.5% YoY in our ‘most-likely’ predictive case (4.0-5.0% range), some components have been revised to better accommodate higher oil price risks, following political turmoil in some Mideast countries.Table 1. Thailand Key Economic Indicators Units: YoY %, or indicated otherwise 2009 2010 2010 2011 3Q10 4Q10 Nov Dec JanComposite Private Consumption Index -2.5 5.7 4.9 2.9 4.5 3.8 • Sales Volume of Benzine and Gasohol 5.7 -1.4 0.8 2.4 7.6 1.2 • Value-added Tax at 1995 prices -10.2 15.5 13.0 8.3 9.7 10.3 • Imports of Consumer Goods at 1995 prices -6.2 22.6 16.3 13.7 16.9 12.7 • Passenger Car Sales 4.2 54.7 58.6 36.6 40.9 28.5 • Motorcycle Sales -13.0 22.9 21.1 9.5 9.3 18.2Private Investment Index (PII) -11.2 17.6 20.1 11.0 15.5 11.0 • Sales Volume of Domestic Cement -2.4 4.2 0.8 -3.1 -1.8 -0.3 • Sales Volume of Commercial Cars -19.2 39.2 39.5 31.6 36.3 29.8 • Imports of Capital Goods at 1995 prices -15.9 24.9 27.1 15.3 20.5 13.8 • Value of BOI Applications 47.6 -29.9 -18.6 -51.5 28.7 -74.7Manufacturing Production Index -7.2 14.5 9.8 2.9 5.7 -2.5 • Industrial Capacity Utilization 56.1 63.4 64.2 63.6 63.6 63.4Agriculture Production Index -0.3 -3.2 -6.6 -2.9 -5.3 3.1 • Agriculture Price Index -10.5 25.7 30.2 25.8 26.0 22.7Exports (in $) -14.0 28.5 22.2 21.1 28.7 18.6 • Unit Value 0.3 9.1 7.4 7.3 7.5 6.7 • Volume -14.3 17.7 13.8 12.9 19.6 11.1Imports (in $) -25.2 36.8 30.7 18.8 35.0 8.8 • Unit Value -2.5 8.1 6.0 6.5 6.1 7.0 • Volume -23.2 26.6 23.3 11.5 27.3 1.6Trade Balance ($ millions) 19,388 14,031 3,303 4,072 490 1,310Current Account ($ millions) 21,866 14,784 2,047 5,509 1,019 1,750Broad Money 6.8 10.9 9.9 10.9 11.2 10.9Headline CPI -0.9 3.3 3.3 2.8 2.8 3.0 3.0$/THB (Reference Rate) 34.335 31.727 31.634 29.991 29.886 30.118 30.584Source: BOT, MOC, OAE, and OIE272727
    • Exports consolidated MoM, after a healthy gain in Nov-10Although exports for Dec-10 softened MoM to $17.2 billion, down from the $17.6 billionin Nov-10, they managed to beat the expectations of many analysts that thought a morenotable correction was likely after the healthy gain in Nov-10. This MoM drop, coupledwith a base effect, helped force the growth of exports down to 18.6% YoY, compared tothe 28.7% YoY growth seen in Nov-10. Excluding gold, adjusted export growth wasalso down to 15.7% YoY, compared to the 25.7% YoY recorded in Nov-10.Fig 1. Dec-10 exports consolidated MoM, after a sharp Fig 2. MoM decreases largely concentrated withingain was seen in Nov-10 leading export products 20,000 60% 2,000 Export Value (USD Million) 40% 1,500 15,000 USD Million 20% % YoY 1,000 10,000 0% 5,000 500 -20% 0 -40% 0 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Gold Vehicles & Parts Computer & Parts Exports Exports (excluding gold) Petroleum Products Electrical Appliances Rice % YoY for Exports % YoY for Exports exclud. Gold IC and Parts Base Metal ProductsSource: BOT, MOC, KResearch Source: BOT, CEIC, KResearchLooking into the details of key export products, apparent MoM decreases were largelyseen within leading export product categories – including vehicles, parts and accessories;electrical appliances; jewelry & gold; and petroleum products. However, agriculturalproducts – e.g., rice, rubber and tapioca products – continued to reap MoM gains, duelargely to their seasonality, plus extra demand for rice amid food shortages elsewhere.Classified by export market, MoM decreases were seen in ASEAN, the Mideast, U.S. andJapan. However, when compared to the previous year, a base effect contributed to adifferent picture on exports to Japan and India, where accelerating growth YoY over Nov-10 figures was seen, while exports elsewhere had recorded decelerating growth.For the full year of 2010, more active intra-regional trade per free trade agreements,coupled with relatively healthy economic growth in Asia, resulted in a gradual shift inThailand’s export structure to a greater dependency on ASEAN, India and China.However, countries with sluggish economic recoveries during 2010 – including in theU.S., and EU – caused drops in exports to those destinations. China thus managed toclimb to the top in export recipient rankings (11.0% share, versus 10.6% in 2009), beatingJapan (10.5% share, against 10.3% in 2009) and the U.S. (10.3% share, versus 10.9% in2009).282828
    • Fig 3. Most major export markets, except Japan and Fig 4. China has become our top trade partners, beatingIndia, saw decelerating YoY growth in Dec-10 Japan and the U.S. 50 25 22.7 21.3 40 20 30 15 11.0 % Share 11.9 11.2 % YOY 10.6 10.5 10.9 20 10.3 10.3 10 10 5.7 4.9 0 5 2.1 2.2 (10) 0 U.S. China Japan EU (27) ASEAN (9) India Middle East China Japan U.S. India Middle East EU (27) ASEAN (9) 2Q10 3Q10 Oct-10 Nov-10 Dec-10 2008 2009 2010Source: BOT, MOC, KResearch Source: BOT, KResearchImports plunged more deeply than exports in Dec-10 to $15.9 billion, down from the$17.1 billion in Nov-10. In addition, a base effect also contributed to a significantslowdown in the YoY growth of imports to 8.8% YoY, compared to the 35.0% YoY in Nov-10. In terms of import classification, major categories all showed broad-based falls MoMand YoY.As imports had plummeted more than exports, the Dec-10 trade surplus widened to$1.3 billion, down from the $490 million in Nov-10, thereby contributing to a highercurrent account surplus of $1.8 billion, versus the 1.0 billion achieved in Nov-10. Thiswas despite a slightly lower surplus in the service, income and transfer account to$441 million, down from the $529 million in Nov-10, in tandem with higher profitremittances that hazed healthier tourism revenue.The number of foreign tourist arrivals hit a record high in Dec-10The tourism sector enjoyed continued recovery in Dec-10. In fact, the number offoreign tourist arrivals managed to hit 1.8 million, which was a record high, improvingsignificantly over the 1.5 million in Nov-10 (despite cooling YoY growth in tandem with abase effect). Meanwhile, the hotel occupancy rate surged to 58.2%, compared to the55.4% in Nov-10, following higher accommodation take-up rates in the North, Northeastand South (which was hurt by flooding in Nov-10).Fig 5. The number of foreign tourist arrivals hit a record Fig 6. The hotel occupancy rate improved significantlyhigh in Dec-10 in Dec-10 2000 50 68 No. of Foreign Tourist Arrivals Hotel Occupancy Rate (%) 40 63 Foreign Tourist Arrivals 1500 30 58 (Million) (% YoY) 20 53 1000 10 48 500 0 43 -10 38 0 -20 33 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Foreign Tourist Arrivals (lhs) Hotel Occupancy Rate (rhs)Source: TAT, BOT, KResearch Source: TAT, BOT, KResearch292929
    • Manufacturing production slipped YoYAccording to data released by the Office of Industrial Economics (OIE), theManufacturing Production Index (MPI) for Dec-10 had edged slightly upward MoM(seasonally-adjusted), but drifting downward YoY into the contraction zone at 2.5% YoY,versus 5.7% growth YoY in Nov-10, in light of a high base of comparison.When looking into the details, the MPI for exports greater than 60% of their totalproduction went into decline (contracting 8.9% YoY, compared to the 2.2% growth inNov-10), because many industries – especially hard-disk drive assemblers – had sped upproduction during the months before. However, the MPI for exports between 30%-60%of their total productions and for exports lower than 30% of their total productionwere able to retain YoY growth momentum.The OIE’s capacity utilization rate for Dec-10 decelerated slightly to 63.4%, downslightly from the 63.6% in Nov-10.Fig 7. Manufacturing production cooled, with export-led Fig 8. Business sentiment showed growing concerngoods heading the decline toward rising production costs 35 70 BSI CCI & TISI 60.0 120.0 30 68 % Capacity Utilization Rate 66 55.0 110.0 25 64 50.0 % YoY of MPI 100.0 20 62 45.0 15 60 90.0 40.0 10 58 35.0 80.0 56 70.0 5 30.0 54 0 52 25.0 60.0 -5 50 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 BSI BSI (Expected for the next 3 mths) CCI TISI % Capacity Utilization (rhs) MPI (lhs)Source: OIE, KResearch Source: BOT, UTCC, FTI, KResearchBusiness sentiment weakenedIn Dec-10, private sector confidence soared at the business-end, however, the consumerfront was still recovering from flooding and there was wariness toward political turmoil,both hitting their confidence in Nov-10. Apparently, the Consumer Confidence Index(CCI) ended the previous two-month losses, by increasing to 80.8 in Dec-10, from 79.0 inNov-10. The Thai Industries Sentiment Index (TISI) increased to 109.7 in Dec-10,beating the 99.7 in Nov-10, thus reaching ‘expansion’ territory at above the 100-pointsthreshold, in tandem with growing optimism amid relatively healthy orders (during thehigh spending season), plus higher farm income and friendly political climate.However, concern toward rising production costs became more pronounced for business,which caused the Business Sentiment Index (BSI) to retreat from 52.5 in Nov-10 downto 51.6.303030
    • Fig 9. Private investment and consumption weakened in Fig 10. …Their YoY growth also cooledDec-10 5 25 % MoM, S.A. of PII and PCI 4 20 % YoY of PII and PCI 15 3 10 2 5 1 0 0 -5 -10 -1 -15 -2 -20 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 Oct-10 Nov-10 Dec-10 Private Consumption Index (PCI) Private Investment Index (PII) Private Consumption Index (PCI) Private Investment Index (PII)Source: BOT, KResearch Source: BOT, KResearchPrivate investment and consumption scaled backAlthough the flooding had eased, domestic spending remained in the doldrums in Dec-10. Both Private Investment Index (PII) and Private Consumption Index (PCI) hadplunged, seasonally-adjusted, with the PII contracting for the third time in 4 months. AYoY comparison suggests a similar pattern, with cooling PII and PCI moving downwardto 11.0% and 3.8% YoY, respectively, compared to 15.5% and 4.5% YoY previously.This slowing growth momentum was seen in passenger and commercial car sales, realimports of capital and consumer goods, as well as cement sales.Despite stable YoY growth, Jan-11 inflation continued to gain MoMIn Jan-11, the Headline CPI was held steady at 3.0% YoY. However, this was due to abase effect, as the MoM change in the Headline CPI had gained 0.54%, compared to the0.16% in Dec-10, following higher prices for fresh foods and energy (although diesel fuelprices had barely changed with a government subsidy). It was echoing a global inflationtrend that has recently been exacerbated by food shortages in many countries.Excluding the prices of fresh foods and energy, the MoM gain in the Core CPI eased to0.17%, from 0.35% in Dec-10. However, a base effect contributed to cooling YoY growthin the Core CPI, reaching 1.3% YoY, down slightly from the 1.4% YoY in Dec-10.Fig 11. Despite stable YoY growth, inflation continued to Fig 12. In addition to higher oil prices, escalating foodgain MoM prices MoM were behind a rising CPI 0.6 4.5 10.00 9.0% 1.60 OIL AND FAT (LHS) 1.40 0.5 4.0 8.00 FOOD AND BEVERAGES (RHS) 1.20 0.4 3.5 1.07 1.00 0.3 3.0 6.00 % YoY 0.80 % MoM 2.5 0.60 0.2 4.00 2.0 0.40 0.1 1.5 2.00 0.20 0.0 1.0 0.00 -0.1 0.5 0.00 -0.20 -0.2 0.0 -0.40 Jan-10 May-10 Sep-10 Jan-11 -2.00 -0.60 Headline CPI (MoM-lhs) Core CPI (MoM-lhs) Headline CPI (YoY-rhs) Core CPI (YoY-rhs)Source: MOC, KResearch Source: MOC, KResearch313131
    • Given a complete set of full-year key indicators, our 4Q10 and 2010GDP forecast has been revised slightly upwardFollowing some better-than-expected figures seen in Dec-10 (such as exports) and Nov-10, we have thus revisited our forecast on the 4Q10 and 2010 GDP that will be releasedon February 21, 2011. There seems to be a higher possibility that the 4Q10 economy willbe seen to have grown a 3.5% YoY rate, which is better than the 3.0% YoY anticipatedpreviously, implying definite QoQ growth (seasonally-adjusted). To this end, the 2010GDP could reach 7.8% YoY, compared to our previous projection of 7.6% YoY.Our 2011 GDP forecast stands pat at 4.0-5.0%, with ‘most-likely’case being 4.5%, but our mix has been revised to betteraccommodate higher oil price risksDuring the past month, G3 economies continued to move as expected, especially theU.S. that has gradually shown developments that are more positive in their key economicindicators. However, food shortages that have even reached the level of crisis in somecountries – like Egypt – have pressured not only soft commodity prices, but also oil pricesthrough mounting apprehension toward possible disruptions to oil shipments via the SuezCanal.Although the direct impact of the Egyptian turmoil on the Thai economy is expected to bemarginal (occupying only 0.4% of our total exports), as long as any domino effect doesnot work its way over to other countries in the Middle East, or Africa (that command an8.4% share of our exports); the Thai economy could be affected indirectly through higheroil prices. To this end, we have revised our forecast for the average Brent crude priceupward to $95/ bbl., from the $93/bbl. to better accommodate any possibility that Brentcrude might temporary drift upward above $100.Consequently, our 2011 import forecast has been revised slightly upward to 15.0% YoY,from 14.0% YoY previously, thereby pressuring our trade and current account surplusesdown to $6.5 and $7.5 billion, respectively, from our previous projections of $8.4 billionand $9.4 billion. However, our GDP projection for 2011 remains unchanged within arange of 4.0-5.0% YoY, with the 4.5% growth being noted as our most-likely case.As for the inflation outlook, although we are keeping our existing forecasts for the 2011Headline CPI and Core CPI figures, a base effect and heightened commodity prices willlikely drive the Headline CPI to a peak of around 4.0% YoY in the final months of 2011.This would be despite the fact that the public might see cooling inflation over the nextseveral months, for the same base effect reasons. As for the Core CPI, it could approachthe upper-end of the BOT’s Inflation Targeting range in the last several months of 2011,which implies a need for the authorities to tighten their policy rate further.323232
    • Fig 13. KResearch’s Quarterly GDP Forecast Table 3. KResearch’s Indicative Forecasts % YoY 2009 2010F 2011F GDP -2.3 7.8 4.5 Private Consumption -1.1 4.5 3.7 Total Investment -9.2 9.4 8.8 Gov. Budget (% of GDP) -5.6 -3.2 -3.8 Exports -14.0 28.5 10.0 Imports -25.2 36.8 15.0 Current Account (USD bn) 21.9 14.8 7.5 Headline Inflation -0.9 3.3 3.3Source: KResearch, Preliminary as of February 3, 2010, and NESDB Source: KResearch, Preliminary as of February 3, 2010.The Outlook for Next MonthIn Jan-11, export growth could continue to slide downward MoM, possibly bringing over-year growth down to around 17.0% YoY, from the 18.8% YoY seen in Dec-10. In themeantime, due to a base effect, the MPI will likely show growth YoY, compared to the2.5% contraction YoY in Dec-10; while the Headline CPI for Feb-11 is expected to staybelow 3.0% YoY (although higher prices for soft commodities and energy will continue topressure inflation MoM). Due to possible increases in prices of goods in the Core CPIbasket, it is expected to drift upward, reaching around 1.5% YoY, from the 1.3% seen inJan-11.333333
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    • Strategy: Market pace changes to sidewaysInvestment theme: Kavee Chukitkasem - KSecurities kavee.c@kasikornsecurities.com► The continued rally we called last month did not happen and the market fell to 950, also below what we predicted to be the support level at 980. The market psychology has changed and we now no longer expect a sharp directional trade. The SET is shifting pace and will become sideways.► The Thai economy is entering a later-stage recovery cycle, an environment that is less positive to the stock market. However, the fundamentals in terms of earnings and valuation have changed little, allowing us to maintain our 2011 SET fair level at 1220 but this target is now likely to be hit by 2H11 rather than 1H11 as originally thought.► In the environment of volatile USD/THB exchange rate, widening Baht and USD short term rates and inflows of maturing FIF bonds, spurts of short-term liquidity will be injected with potential to overflow onto the SET, triggering the index to spike. In the short term, we recommend investors to reduce equity holdings should the SET index crosses over 1055 (its recent high) and to accumulate on weakness at 950.► While Thailand and developing economies are speeding into an inflationary environment, the developed economies are showing stronger signs of sustainable economic recovery. The divergence of economic cycles calls for sector re-allocation towards ‘Services’ and ‘Commodities’.► We are Overweight on energy, agricultural, media, hotel, hospital, commerce, contractor and industrial estate.► Our top picks are BANPU PTT PTTCH KTB STA CPALL MINT MCOT BGH STEC and AMATA. We add MCOT to our top picks to replace TOP.Diverging economic cyclesThe SET index has climbed 140% since Mar-09 when the 2-year bull market started. Inthe last two weeks, the market has corrected by 6% from its recent peak at 1055.Although we thought the party would continue a little longer, driven by widening spreadsbetween Thai Baht and USD short term rates, foreign investors decided to end it soonenough and took profits. Their capital gains were also assisted by an additional 12% gainfrom the USD/THB appreciation over this period.We believe the liquidity dynamics have now changed although the fundamentals in termsof earnings and valuation have changed little. We are now entering a different phase ofan economic cycle and history shows that the stock market reacts differently to differentphases within a cycle. Before explaining our current position, we will explain what are the4 phases that we see:1. Early recession. At this stage, sentiments range from fear to terror. Industrial production plunges, interest rate falls rapidly and unemployment begins to rise. The stock market also takes a sharp dive of more than 50% from it peak.353535
    • 2. Full recession. Gross domestic product tumbles, interest rates keep continue to fall and unemployment rising. The market continues to drop but at a slower rate than in the early recession as investors have more or less absorbed the worst-case scenario.3. Early recovery. Consumer sentiment improves, industrial production turns up, interest rates hit bottom, inflation remains low and unemployment peaks. The stock market rebounds rapidly.4. Late recovery. Interest rates rise as the central bank fights to control inflation, consumer sentiment softens and industrial production becomes flat. The stock market starts to move sideways. The length of this stage depends on the success of authorities to regulate growth.We believe that the Thai economy is approaching the full recovery phase or in the late-stage of recovery as GDP growth trend weakens and inflation accelerates. The currentphase of the economic cycle resembles what we experienced in both 2000-2003 and2004-2007 (figure 1 and 2) when the SET spent most of its time moving sideways butwith an uptrend. The good thing about those two previous cycles is that after moving upsideways in 2000-2002 and 2004-2006, the market surged in 2003 and 2007,respectively as GDP growth did not slip back into the negative territory.We expect the Thai economy and stock market to follow the patterns of those twoperiods. KResearch expects 1Q11 sequential growth will be flat (only 1.6% growth) withgrowth expected to gain strength thereafter, 3.8%, 5.7% and 6.8% for 2Q11 to 4Q11respectively. On the other hand, headline inflation will peak, in 4Q11, at only 4% thisyear, much lower than that of our regional peers (see Figure 1). We do not think that theeconomy will follow the path set in 2008. The forward projected CPI and GDP forecastsare presented in figure 2 which show that both CPI and GDP growth are expected trendup consistently from 1Q11 to 4Q11 but inflation is expected to be slower going into 2012.However, we are expecting the Thai Baht policy rate will peak in July-August at 3.25%.In conclusion, we expect the SET index to trade sideways up but our fair 2011 SET indexlevel of 1220 will likely be met in 2H11 instead of our previous call in 1H11. Inflationaryconcerns are expected to rule sentiments while the central bank steadily increases itspolicy rate. But stronger GDP growth expected to pan out in 2H11 will convince investorsthat economic growth will not sputter and this will provide positive support to marketsentiment.363636
    • Figure 1: GDP growth VS inflation over the past 10 years 15.0 1200 GDP (%) CPI (%) SET (RHS) 10.0 1000 5.0 800 0.0 600 -5.0 400 -10.0 200 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12Source: BOT, KS, KR (dotted lines are based on KR’s forecasts) Figure 2: 2011 GDP and CPI forecasts (% YoY) Headline CPI GDP growth Jan 3.0 Feb 2.9 1.6 Mar 2.9 Apr 2.9 May 3.2 3.8 Jun 3.1 Jul 3.2 Aug 3.3 5.7 Sep 3.6 Oct 4.0 Nov 4.0 6.8 Dec 4.0Source: KRSector rotationBesides dictating market direction, different economic phases also provide differentenvironment for different sectors to thrive or disappoint. Over the last two years the SETindex soared 140%, but not all sectors performed equally. Some that dramaticallyoutpaced the market include petrochemicals, agriculture, construction materials, auto,commerce, banking and property and others have lagged significantly (figure 3). This isbecause of sector rotation.During the early stage of an economic recovery, low inflation and interest rates prevailed.This is a condition that the banking and property sectors perform well. Later, as recoverygains pace, inflation accelerates, cyclical sectors start to outperform. Finally, the servicesectors (hospital, hotel and media) begin to do well as economic growth slows andinflation reaches a peak.373737
    • Figure 5: Sector performance relative to SET index during Feb-2004 to Oct-2004 PROP. DEVELOPMENT ELECTRONICS AUTOMOTIVE PROF. SERVICES FINANCE MINING HOME & OFFICE PACKAGING TRANS & LOGIST CONST. MATERIAL BANKING SET INDEX COMMERCE PETROCHEM FASHION FOOD/BEVERAGE PAPER & PRINT AGRI-BUSINESS INSURANCE TOUR & LEISURE INFO & COMM TECH MEDIA & PUBLISHING ENERGY & UTILITIES PERSONAL & PHARM HEALTH CARE SERVICE -30.0% -10.0% 10.0% 30.0% 50.0% 70.0%Source: Bloomberg, KS (Entertain comprises only BEC, GRAMMY, MAJOR, MCOT, RS and WORK)The outperformance of service sector during a late-stage economic cycle can befundamentally explained by the fact that the sector is relatively unaffected by rising costpressures from inflation as most of its cost components are fixed in nature. Meanwhile,commerce companies can also relatively easily pass the higher costs from inflation on tothe customers. Visitors to hotels and hospitals are also less price sensitive, given thespending nature which is discretionary.Under the current economic trend, we see downside risks to the banking and cyclicalsectors. As shown in figures 4 and 5, the banking sector underperformed the market bothin 2000 and 2004.While Thailand and other developing economies are in the late-recovery phase, the USand EU are in the early-recovery stage. Their dominant size will require that energyprices will be on uptrend as demand rises. KResearch has revised up average Brentprice from USD93/bbl to USD98/bbl for 2011. We also like soft commodities which arerelated to food. Better standard of living in China and India and increasingly severe andunpredictable weather conditions are long term factors that will keep prices of softcommodities on the uptrend.In line with our theme, we recommend investors use this current consolidation to startaccumulating energy, tourism, healthcare, media, commerce and agricultural stocks aswe expect them to outperform the market over the next six months. They are ‘overweight’in our sector allocation. Energy stocks will benefit from the recovery of developed economies although we do not expect the oil price to climb significantly this year. Currently, brent price is 99.7/ bbl compared to our new brent forecast of USD98/ bbl. Our top pick is PTT.393939
    • Tourism and healthcare have had to deal with lots of bad news over the last two years, particularly local political disturbance which turned away foreign tourists and foreign patients. They are currently trading at deep discounts to their historical PERs. Our top picks are BGH and MINT. Media is expected to outperform as businesses spend more on advertising. Our top picks are MCOT and GRAMMY. The commerce sector has shown consistently strong track record in terms of increasing revenue and profit margins. They also provide high ROEs with significant upside. Our top picks are CPALL and HMPRO. The agriculture sector is expected to benefit from the rising agricultural products prices. We choose TVO and STA as our top picks.We are Overweight on energy, agricultural, media, hotel, hospital, commerce, contractorand industrial estate. Our top picks are BANPU PTT PTTCH KTB STA CPALL MINTMCOT BGH STEC and AMATA. We add MCOT to our top picks to replace TOP. Figure 6: KS’s portfolio Sector Current Weight Recom. Top Recommended / Sector Wt. Picks Banking Neutral 22.2% KTB Insurance Underweight .0% BLA Food & Agro Overweight 5.5% TVO STA Automotive Overweight .2% SAT Petrochemical + SCC Neutral 9.8% PTTCH Energy Overweight 41.6% Coal Overweight 4.0% BANPU E&P Neutral 9.3% PTTEP Integrated Overweight 19.7% PTT Refinery Neutral 6.1% TOP Utilities Underweight 2.4% RATCH Construction - SCC Underweight .0% Property Underweight 4.1% PS Contractor Overweight .8% CK Industrial Estate Overweight .9% AMATA Residential Underweight 1.9% PS Commercial Underweight .4% CPN Commerce Overweight 6.4% HMPRO Healthcare Overweight 1.9% BGH Media Overweight 1.9% BEC Securities Overweight .5% KEST Tourism + MINT Overweight 1.1% MINT Transport & Shipping Underweight .5% Shipping Neutral .5% PSL Transportation Underweight .0% Electronics Neutral 1.1% SMT IMM Overweight .0% KKC ICT Underweight 3.0% TRUE Total 100%Source: SET, KS404040
    • Limited downside of SET indexWe have toned down our bullish stance but continue to expect the SET index to besideway-uptrend through 2011 and maintain our fair index level at 1220. There arereasons to expect limited downside risk for the SET index.The net selling value of over Bt30bn YTD by foreign investors is simply seen as ‘profit-taking’. Compared to the net purchase of Bt81bn in 2010, foreign investors so far havesold about 32% of their net buy in 2010 for Thailand, 17% for Indonesia and 10% inPhilippines (figure 7). The extent of profit taking is somewhat consistent with the level oftotal equity performance in USD terms: 50.4% for Thailand and Indonesia and 42.8% forPhilippines.We highlight the significance of the foreign exchange movement as a major catalyst forprofit taking. The surge in volatility of the USD/THB so far this year (figure 8) may havealso contributed to the strength of selling Thai equities by foreign investors. We say thisas a cause rather than the result because there has been much more active buying intothe bond market with combined YTD inflow from both equity and bond at Bt45bn.The depreciation of USD/THB is so out-of-line in relation to the fall in the equity marketthat the USD/THB looks ‘over-depreciated’ compared to other regional currencies (figure9). This is potentially a source of catalyst to bring in new foreign capital, even though fora short term. Figure 7: Net foreign Buy/Sell YTD compared to 2010 (USDmn) 30000 120% 2010 25000 2011 100% (%) of last year buy 20000 80% 15000 60% 10000 40% 35.91% 34.89% 5000 20% 0 9.42% 0% 2.37% Indonesia South Korea India Japan Philippines Thailand Taiwan Vietnam -4.59% -5000 -10.50% -20% -17.15% -10000 -32.44% -40%Source: Bloomberg414141
    • Figure 8: The daily standard deviation of regional exchange rates against USD 0.9% 0.8% YTD From 2010 From 2009 from 2000 0.7% 0.6% 0.5% 0.83% 0.4% 0.72% 0.63% 0.62% 0.3% 0.49% 0.41% 0.41% 0.40% 0.39% 0.38% 0.38% 0.37% 0.37% 0.2% 0.36% 0.36% 0.32% 0.30% 0.30% 0.28% 0.28% 0.27% 0.27% 0.27% 0.24% 0.23% 0.22% 0.22% 0.21% 0.20% 0.20% 0.18% 0.18% 0.1% 0.09% 0.09% 0.07% 0.07% 0.0% THB India Indonesia Malaysia Philippines Singapore Korea China TaiwanSource: Bloomberg, KS Figure 9: USD/THB is now ‘over-depreciated’ compared to regional currencies -3.00% Thailand Currency Depreciation (-5.3%, -2.7%) India -2.00% -1.00% Philippine 0.00% China Indonesia Taiwan Malaysia 1.00% Korea y = 0.218x + 0.005 R² = 0.5642 Index Return 2.00% -16.00% -12.00% -8.00% -4.00% 0.00% 4.00%Source: Bloomberg, KSComparing the ratio between cumulative foreign net buy on the SET against the region(adjusted for changes in index level) since March-09 (when the last bull market began)with the estimated weight of the SET in the region (figure 10), it appears that foreigninvestors are underweight Thailand relative to the region. Since Mar-09 to May-10, whenthe political protests brought Bangkok to a standstill, the two lines moved similarly.However from May-10, the weight of the SET increased by 2% to 6% but foreign holdingson the SET dropped to 5% presently. Foreign investors are underweight.424242
    • Figure 10: Estimated SET weighting 8.00% 7.00% 7.00% 6.50% % Flow as of 17 Mar 09 (Adjusted) 6.00% Mkt Cap. Thai to Regional (RHS) 6.00% 5.00% 4.00% 5.50% 3.00% 5.00% 2.00% 4.50% 1.00% 0.00% 4.00% Dec-09 Dec-10 Nov-09 Nov-10 Apr-09 Apr-10 Jan-10 Jan-11 May-09 Jun-09 May-10 Jun-10 Sep-09 Sep-10 Mar-09 Feb-10 Mar-10 Jul-09 Aug-09 Jul-10 Aug-10 Oct-09 Oct-10Source: Bloomberg, KSHigh cash level among local equity fundsIn Dec-10, investors bought over Bt14bn of local equity funds, nearly doubled the Bt8bnin Dec-09 and Bt6bn in Dec-08. However, local funds activity in the secondary marketlast December was much slower than other years. We suspect one of the reasons whylocal fund managers were not active in the secondary market last month was because ofthe expectation of large LTFs’ redemptions in early 2011. But this has not happened. Onthe contrary, there was a net primary flows into local funds during Jan-11, although slight.The widening gap between the primary flows and the secondary flows is indicative ofcash levels, which is estimated to be high now. This implies a potentially large buyingpower among local institutions.Cash from Korea to fly backA large number of Korean funds that Thai investors bought through FIF are maturing. Weestimate that Bt170bn (USD5.5bn) of these will mature February to July this year. On topof this, the phasing in of Deposit Insurance Scheme (maximum amount of guaranteeddeposit reduces to Bt50mn this August) will supplement local liquidity. Local liquiditysurge will help support the SET index and put a limit to downside risk.434343
    • Figure 11: Expected maturing Korean bond funds (Btbn) 50 40 30 20 10 0 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12Source: Morning Star, KSBottom miningIn estimating the downside risk, we also look at the 12-month forward P/BV ratio as aconservative tool. Outside the crisis periods, P/BV hit the lowest point level at 1.56x in in2004. Using the same ratio, we imply SET downside at 950.We also look at the gap between the SET consensus target and the SET Index. Typically,the SET index trades at an average discount of 17.5% from such target and remainswithin the upper half of the 1SD band (shaded grey) shown in figure 12. This bandprovides us a trading range of between 990 and 1138. Figure 12: SET consensus target and the SET Index 800 1,200 Implied 700 SET Index 1,000 +1 SD From avg Target discount from 600 Implied SET 800 Index Target 500 600 400 -1 SD From avg discount from 300 Implied SET SET Index 400 Index Target 200 200 Foreign fund flow 100 - 0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11444444
    • Source: Bloomberg, SET, KSFinally, since Mar-09 when the bull market began, there have been 10 healthyconsolidation periods with an average correction of 9.3% and the maximum correction of12.9%. So far, the market is 7.7% lower from the last peak. Using 9.3% correction as abenchmark, the downside of the SET index should be at 958 and at the maximum, 920.Risks to our callWhile we expect the market to go side-way up and the downside risk limit to 950, themajor risk to our call is politics ie. if the border clash between Thailand and Cambodiagets worse or protestors in Bangkok take advantage of the border problems to stir upmore problems. Moreover, the government’s position and its demands to claimcompensations against private cellular phone operators could draw questions onThailand’s policy on foreign direct investment. Figure 13: KS sector valuationsSource: KS U – Underweight, O – Overweight, N – NeutralAs of 10th February 2011Figure 14: 2011 sector valuation Figure 15: 2011 Consensus earnings changes PER / EPS Growth (%) -1 M -3 M 2.0 30.0 ICT 1.8 25.0 Electronic Commerce 1.6 Agri&Foods 20.0 1.4 Media IMM 15.0 1.2 Healthcare 1.0 10.0 Banking 0.8 Commercial 5.0 Automotive 0.6 Industrial Estate - KS Residential Insurance SET Contractors 0.0 0.4 Const.Materials Energy TransportationTourism Petrochemicals 0.2 -5.0 Shipping ROE (%) 0.0 -10.0 5 10 15 20 25 30 Bank Energy Fin & Sec ICT Petrochem PropertySource: KS Source: Bloomberg454545
    • Figure 16: 2011 country valuations Figure 17: SET PER discount to region PER / EPS Growth 1.4 40 Regional PER Philippines 13/11% 30 Singapore 1.2 20 15/15% Taiwan 14/14% 10 1.0 SET PER 0 Jul-07 Jul-08 Jul-09 Jul-10 Apr-07 Apr-08 Apr-09 Apr-10 Jan-07 Oct-07 Jan-08 Oct-08 Jan-09 Oct-09 Jan-10 Oct-10 Jan-11 0.8 S. Korea 10/17% India 16/25% HongKong China 12/20% Indonesia 0.6 12/16% 13/27% 20% Thailand 11/19% 0.4 Malaysia 13/23% 0% -20% 0.2 -40% - -60% 9 11 13 15 17 19 21 23 Jul-07 Jul-08 Jul-09 Jul-10 Apr-07 Apr-08 Apr-09 Apr-10 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Oct-07 Oct-08 Oct-09 Oct-10 ROE (%)Source: Bloomberg consensus Source: BloombergNote: Country PER, EPS Growth, As of10th February 2011464646
    • Disclaimer For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained herein. Further information on the securities referred to herein may be obtained upon request.474747