Even without much improvement in exports to the US, China’s V-shaped economic recovery is so obvious now that very dark glasses and a blindfold would be needed not to see it. Not only have fixed asset investment, retail sales, industrial production, and loan growth been strong and getting stronger, but for the average resident of Guangzhou, Chongqing or Beijing, there is an increasingly clear feeling that the economy will soon return to full health and rapid growth. This has now broadened out to include nearly all segments of the economy, dispelling previous concerns about sustainability. We have been talking about a full recovery in China since late last year, and our view has not changed. China’s economy is in good health, and the opportunities are multiplying. Where we differ is how fast we think China will tighten.

Among “sophisticated Asian investors” the view remains that China is structurally doomed to always tighten too late. This is of course because local governments and state owned enterprises do not invest on the basis of return on capital, but for bragging rights under an over-arching mandate to maintain full employment. It has also been China’s history over the past 10 years to only truly get down to tightening when the economy is dangerously overheated. We see a subtle difference this time, however, that we feel might become important. Very simply put, more of China’s policymakers now recognize China’s structural tendency to overheat, and may be prepared to do something about it. China’s liquidity picture may be clipped at a time when runaway asset inflation for the foreseeable future has become a strong consensus view among China investors. We still expect the overall liquidity picture to remain supportive of economic growth, but we don’t expect it to cause runaway asset inflation without a fight from policymakers.

We saw a sharp correction in the most policy-driven parts of the China markets in August – notably property stocks. Given our view that residential property investment is one of the more tangible drivers of Chinese growth once fiscal infrastructure investments slow down, we did not see this as likely to bear the brunt of any tightening measures, and found a few opportunities here.

Another recent topical area has been the potential for a rebound in the export sector. Whilst we were open to investing in this area before it became an investment focus, we do not have enough conviction on fundamentals to stay in it now that it has become “the next thing to buy” after basic materials and other heavy cyclicals. Consequently we are not in a hurry to add back to the Taiwan exposure we cut out of the portfolio some months ago. That said, it has become increasingly easy to convince investors that there truly is something going on in Taiwan. Unlike the handful of times in the past 10 years when Taiwan outperformed on cross-straits optimism, the two governments have begun to build a track record of successful agreement. Cross-straits flights are in place and being expanded. Chinese tourist numbers in Taiwan are growing, and a few Chinese corporations have established beachhead offices in Taiwan. Many other significant agreements are underway. The tone of China’s rhetoric is hugely different and unlike most of the other times, we have an administration in power whose political future depends on delivering the goods from China, at a time when bringing the Taiwanese economy closer to China is also very much in China’s interest. Our main reason for not buying heavily in Taiwan, however, lies in the very heavy burden of expectations that must be met by the end of the year to surprise Taiwan’s domestic investors on the upside. Given that Taiwan has not even decided what it wants to request from China, and the complications of WTO-style negotiations with multiple parties likely to express opinions, the dominant perception that China will shower Taiwan with economic gifts may need patience.

In the meantime, we have been busy thinking about the recent wave of IPOs that is planned for listing in Asia (mainly HK) over the coming few quarters. This should amount to at least US$30bn on current plans, not counting AIA (the Asian arm of AIG). While this includes many interesting opportunities (we like Lilang – China’s plebeian Armani), it should also exert a dampening effect on markets in the near term as any spikes up will be met by an acceleration in issuance.

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