President Obama may have received a political bloody nose from the good people of Massachusett and will no doubt have to put his already grotesquely mutated healthcare reform bill on hold but he has come out swinging and this time he’s taking on a very popular target – the bankers. A re-imposition of Glass Steagall type legislation will be very unpopular with Wall Street and therefore very well received by the other 99% of the population. It will no doubt be enthusiastically followed in Europe. Unfortunately it will do nothing to sort out the fundamental issues of over-indebtedness of the West, but then it is probably rather over-optimistic to expect any politician to think beyond the next popularity poll. Northern Rock, RBS and Lehmans did not go bust because of their trading activities – they bit the dust by over-leveraging their balance sheet to poor credits and whether this is done by plain vanilla lending or the retention of securitised products is irrelevant. Nevertheless, separation of trading activities from banking now seems likely as few Republican politicians are likely to want to imperil their careers by standing up for the banks – and the banks only have themselves to blame. It also seems likely that capital ratios will have to take account of an increasing range of off-balance sheet assets and this (more sensible) measure will have implications well beyond the European banks at which it is primarily aimed. All financial institutions will be under pressure to retain capital (lower dividends and rights issues) and shrink balance sheets to ‘risky’ borrowers (less lending and more sovereign bonds). Banking profitability is likely to be on a secular decline and this will have negative implications for global growth. We currently have zero banking exposure on the long side of our portfolios.

There has been the first indication from Australia that the Government wants a bigger slice of the resource pie and is looking at the imposition of an analogue to the oil industry’s Resource Rent Tax (RRT). Getting approval from the individual States will be very difficult and it may well be that this specific proposal goes the way of the Dodo, but it is clear that the Government wants more – and by hook or by crook, will eventually get it. We confidently predict that every other resource-rich country will be looking at similar revenue raising options, as the sad fact of the matter is that you can only raise taxation revenue from people or institutions with money. This is why the tax burden on the better-off is going to explode. Current (and overly bullish) expectations are for an economic recovery to the ‘normal ‘ trajectory of the last three decades. Unfortunately the new ‘normal’ is going to be very different from the old one as interest rates and savings rates rise while indebtedness gradually declines. Sentiment towards equity markets has returned to near peak levels and we would counsel caution until the degree of complacency has decreased materially. We advise purchase of instruments that gain under an environment of higher volatility.

The news out of the technology sector has been very good of late. PCs and flat screens have surprised with unusually strong volume growth, Intel and IBM beat expectations and DRAM prices have continued to defy both gravity and the economic consequences of Moore’s Law. Part of the explanation lies with strong Chinese demand, spurred by the expansion of the rural discount scheme. Another factor is undoubtedly a continuation of the inventory rebuild that is now so consensual. Market reaction has, however, been rather more muted with several high profile incidences of stocks selling off after good numbers. Given the elevated valuations that many of these businesses now sell on and the strong growth expected in profits for 2010 already baked into these numbers, we are cautious on the sector in general, but still looking for a few secular growth stories in select areas such as LEDs. We feel that the healthcare sector may also be of more interest as valuations in general are modest relative to history and we are finding some very exciting opportunities in the biotechnology arena. Normally this is a graveyard for investors as successful in-vitro results generate inflated market capitalisations which turn into in vivo disappointment and huge losses for investors. We are only interested in products with already demonstrable efficacy and safety and where market potential is large. Luckily some of these opportunities now exist – probably due to a complete lack of economic cyclicality which has been the only thing on most investors’ minds for the last nine months. Risks will always be high, but rewards can be enormous – look at Genentech. At the moment we view the upside as a multiple of the downside after a measured consideration of risk and have added some modest exposure to the portfolio.

Inflation has been a hot topic recently. Consumer prices in China, India and the UK are rising faster than market expectations, spurring a raft of excuses from the forecasters and deflationists. ‘It’s all food inflation’ was the knee-jerk reaction to the Chinese numbers, as if this made it irrelevant in a country where food is such a large percentage of consumption. In India it is a similar story, while the excuses offered over the failure to forecast the UK’s number centre around the ‘excessive discounting in December 2008′. After all they have only had twelve months to incorporate that into their numbers….January will show an even bigger rise as VAT reverts and the usual January price rises kick in. My proprietary ‘commuter price index’ jumped 5% on January 1st as rail tickets, newspapers and parking charges all rose. These are the types of service business which, if you follow economic theory, should be cutting prices due to slack in the economy. Doesn’t seem to work in practice though. Expect to see some CPI numbers of around 5% soon, which may give Central Bankers a few sleepless nights.

Google’s decision to offer uncensored search in China has put Beijing in a difficult position. While we are sure that it was not an entirely altruistic decision as China is one of the few geographies that Google cannot dominate in search applications and therefore of unusually low economic value to the company, it now mandates the Chinese to either allow unfiltered search (not very likely), or to actively kick Google out of the country for offering a service we take for granted in most countries. With the dispute now involving Washington, and with the allegations of cyber crime meat and drink to any Senator or Congressman looking for a few easy votes on a protectionist platform, the stakes have been raised. Coupled with the higher inflation referred to earlier, it may be harder for Beijing to avoid a modest upward revaluation of the Remnimbi. We remain optimistic over some of the cheaper domestic plays in China.

A few months ago we opined that there were few opportunities on the long side in Asian property outside of Australia. That call has proved prescient as physical markets have moved broadly sideways while equities have sold off quite aggressively, with falls of 25% from recent peaks commonplace. We are now much more relaxed about investing in property names in Hong Kong, Macao, Taiwan and Singapore and have been able to add several stocks that are trading at respectable discounts to NAV, in an environment where we expect stability in residential prices and modest upside in commercial rentals. Time to swap your Tuscan or Greek villa for some Asian property?

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