What a difference a month makes….we thought that complacency was getting dangerous in March and took some protection in the form of cash and volatility hedges, but did not expect quite such an abrupt turn in sentiment. The talking heads on CNBC who were waxing lyrical about strong US corporate profits and the ‘strong fundamentals of the global economy’ (I kid you not) in March are now staring into the abyss and recommending cash. Yet we fail to see what is dramatically different in the current environment versus that of two months ago. The ECB bailout of Greece has weakened the Euro and this is a minor positive for global growth (if not US multinational profits) due to the asymmetry of sensitivity to the level of the currency between the US and the Eurozone. The bankruptcy of a Spanish Caja (savings bank) can be no surprise to anyone who has had access to any form of media over the last eighteen months, and the revelation that the South Korean frigate that sank earlier in the year was torpedoed by the North dates back to March. The reality is that the economic ‘recovery’ in the West will remain anaemic. Central banks are moving explicitly to counter the deflationary threat of fiscal tightening with aggressive money printing. Asia will suffer much less, though the exporters will face some headwinds. The Chinese will not send their economy into a sharp slowdown by regulation. They will also continue to buy resource assets round the world, and if they are cheaper so much the better (thank you Mr. Rudd). Volatility is likely to remain a feature of the markets for the foreseeable future, but one should take advantage of this in a contrarian fashion. Remember the Chinese characters for ‘crisis’ incorporates those for both danger and opportunity……

At the beginning of the year we were inundated with investor concerns about the Chinese bubble. Now the worries centre upon Beijing braking too hard and thus compounding the “growth scare”. It appears that Goldilocks is a blonde and therefore can never be Chinese!!

As media coverage shifts from evidence of ‘the Chinese property bubble’ to evidence of price falls in major cities and a sharp reduction in sales volume country-wide, we cannot help concluding that this is clearly the desired outcome for the Chinese Government. But just as Beijing did not want a bubble nor does is it keen for the property market to implode. Luckily, and in stark contrast to the West, a stable property market is to a large degree in the Government’s gift. This is because the downturn – and the rebound last year – has been driven by changes in regulation, not economics. Regulation in China can, and does, change overnight. This is a very different situation to the excess leverage/negative equity situation in the West, which is not amenable to rapid change. The majority of Chinese property purchases are still done with 50-100% cash, and banks’ attitudes to granting credit are not pro-cyclical as in the UK or the US.

“Why should Beijing stop tightening and why now?” As to “Why?” well, the tightening has now had an effect (see above) and this will be seen explicitly in the official figures that will be published in the coming weeks. As to “Why now?” we interpret Premier Wen’s recent exhortation to his regulators that the time has now come for “more coordination between departments” as a clear signal to give their tightening policies a breather.

Property stocks in the region are now very oversold and at large discounts to NAV. We are selectively buying the quality names in Hong Kong, Taiwan and Singapore (sold off primarily as collateral damage to the Chinese developers, exacerbated by some minor changes to selling practices in Hong Kong), and starting to look at the quality end of the Mainland Chinese developers.

In order to sell the Euro to a sceptical German public, the farcical ‘Growth and Stability Pact’ was conceived a decade ago to constrain European budget deficits to 3%. The Germans now want a rule to prevent any deficit more than .35%. One does wonder what planet they are living on. Nevertheless, the ECB’s decision to push the ‘inflate’ rather than the ‘self-destruct’ button will have significant consequences in weakening the Euro and making European exporters more competitive – a good thing as it helps offset the fiscal contraction. Unfortunately it won’t be enough to prevent a Greek default down the track, but the macro path is now clear. The Bundesbank has been out-manoeuvred, and inflation is coming. Disaster for bonds, selectively better for equities, great for precious metals and Asian currencies.

So why have Asian currencies depreciated vs the USD over the last few weeks? We can only assume it is a function of risk aversion, as it would be very hard to characterise the fiscal position of the US as materially better than much of the Euro-zone periphery. We are inclined to think that this presents a buying opportunity, particularly for the Australian Dollar, where the fundamentals – immaterial sovereign debt, a large interest rate differential and a budget realistically forecast to be in surplus in the next few years – are immeasurably superior. The recent adoption of a few anti-mining recommendations from the Henry tax review has cast a near-term pall over the perception of investment in the country, but we note that corporate activity continues and the reality is that there is unlikely to be a sufficient majority to pass the legislation in any case. From the perspective of the mining equities it appears that a worst-case scenario was immediately priced in, making the risk/reward equation much more favourable. We have removed most of our short positions and taken off our partial hedge of the A$ vs the US$.