It seems increasingly consensual that the weak dollar/ strong everything else trade will continue to year end, spurred by ‘liquidity’ and the vested interests of the financial community. While this is by no means impossible, it looks to us more like a case of wishful thinking than any underlying positive economic dynamic. Try as we might, we find it very hard to square the longer term damage done to the western economies by the circa 10% rise in genuine unemployment (i.e. the series that does not churn job seekers off the register when benefits run out) over the last year or so, the weak trend of wages and the ease with which employers can now actually cut salaries and benefits (a relatively new phenomenon in our view) and the catastrophic state of Government finances all around the world with anything other than an anaemic recovery. Yet market valuations and in some cases stock prices themselves are scaling recent highs, as if the events of the last eighteen months were merely a bad dream. Being bullish when markets are priced for Armageddon is easy and normally correct. Staying bullish when valuations are well above long-term norms requires a bit more than hoping for a greater fool.

It seems de rigeur to analyse the future of the dollar in isolation these days, but as currencies are by definition valued relative to something else, it is worth considering one’s options. The unexploded financial bomb that is central and eastern Europe is not front of mind at the moment but is getting worse, not better. Ireland seems completely bankrupt. The Germans may talk about income tax cuts but they are putting VAT on sewage and heating bills and trying to disguise the true extent of their deficit. Italy and its Prime Minister defy serious commentary of any sort. Spanish unemployment is nearly 20%. Outside of the Euro zone, Sterling remains a disaster while the Swiss Franc has attracted funds despite the impending demise of its tax haven status, the prognosis for which has not changed by grassing on Roman Polanski to the Feds (not Mr. Bernanke this time). The fiscal travails of the Yen have been put into sharp focus by the revelation of JGB issuance now exceeding tax take and the inability of their best exporters to make any money. The Yuan remains pegged to the dollar in all but name, the Brazilians no longer want your money at all and the New Zealand dollar seems a rather small vessel to park the world’s excess funds in, even if you are bullish on milk prices. In this context we are not as suicidal about the dollar as the consensus, and are cognisant of what a bounce in the dollar would do to risk assets of all sorts – equities, bond spreads, gold, Chateau Petrus etc. Another reason for a more cautious near-term stance.

The Australian (and possibly Canadian) Dollar does seem to offer the perfect haven of higher interest rates, a stronger economy and a commodity linkage. After a recent sojourn down-under our credit card bills are a testament to quite a lot of this being in the price already. As we approach parity with the US unit, the pain of the manufacturing sector is escalating rapidly (viz the recent decision by Bridgestone to cease manufacturing operations in Australasia), and the volte face of the investment community en-masse from ‘just another bust Anglo-Saxon economy’ to ‘the undiscovered jewel of the Orient’s backyard’ is bringing out the contrarian in us. We have hedged nearly all of our domestic Australian currency exposure as a result.

One of the oft-cited reasons for bullishness on the Aussie is the massive quantum of investment going into huge LNG projects. The recently greenlit Exxon-led Gorgon project carries a $50bn price tag on its own, and there are 6 or 7 well beyond the drawing board which in total would add up to another $100bn on completion. This does rather beg the question of whether the world can handle an increase of this magnitude in energy supply, especially when one considers the volume of uncommitted gas from Qatar that is also looking for a home. We have made good money in this sector but are now increasingly uncomfortable with both valuation and longer term project risk if customers have not been signed up, so we have exited stage left and require materially lower prices to go back in.

En route to Australia we spent some time in Hong Kong, and spurred by recent media coverage went to see some of the more high profile recent property launches. ‘The Masterpiece’ has a striking location in the middle of Tsim Tsa Tsui, but we were somewhat surprised to be shown what looked like a collection of unfurnished box rooms and told the price tag was U$3m. If it hadn’t had a view of the Peninsula’s helipad we would have assumed it was the maid’s quarters. This may appear cheap relative to the asking price of U$13,000/ft that a penthouse on Conduit Road sports, but here we are in such rarefied territory that the buyers probably have agendas above and beyond looking for good value property. No doubt Mrs Mugabe and the odd oligarch are rubbing shoulders in the developers’ office, competing with faceless mainland corporations for bragging rights over the world’s most expensive property. Now that $3m seems to get you only a middle of the range product and real luxury starts in excess of U$50m, we can understand the Government taking the unusual step of commenting publicly on prices. They are not in a position to do much about it as tightening deposit regulations does not work when the buyers pay cash – sometimes in suitcases – but it does point to likely changes in land supply policy. Given that the listed stocks are not cheap against physical property, and that the real estate itself is now looking very pricey, we remain wary of the sector.

There appears to be a lot more activity within private equity circles these days – and it is all about selling whatever is saleable. We note with interest a number of IPOs on the drawing board where the PE investors are selling out entirely, and where valuations look anything but cheap. On the basis that these sellers are a) entirely motivated by maximising proceeds, b) know a lot more about the asset than any buyer and c) have employed a lot of financial engineering to tart up the numbers, we would strongly advise potential investors to exercise extreme caution when looking at these opportunities. We shall watch TPG’s float of Myer with interest. At the same time our recycling bin is groaning under the weight of prospectuses from a multitude of undifferentiated Chinese property companies all looking to tap the market. Again, not a good sign…

What is the similarity between bankers and a well known cosmetics brand? Because ‘they’re worth it’, at least if you believe the official line of having to retain ‘talent’. Anyone would think that the city had become a meritocracy, despite the evidence of the last two years. It is now politically expedient for politicians to wage war on the banks, and this will have an impact on stock market values as taxes increase and capital requirements rise – and the more whingeing there is from the City and Wall St, the worse it will be. As the beneficial effects of trading in an environment of unusually wide spreads dissipate, what will be left is the depressing reality of consumer loan losses and a drip feed of bad news from ‘restructured’ loans that eventually can’t be rolled over anymore. We have no net exposure to the banking sector, and that’s in an Asian context where these issues are much less important. If we were running money in the US and Europe, we would be far more negative.

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