Remember 1993? That’s how far back you have to go to have made any money (ignoring dividends, admittedly) in Hong Kong’s retail landlords. Retail capital values have risen over 3X in the intervening period. The sector is unaffected by government regulatory action (unlike the residential segment), and availability of space for high-end retailers in Central and Causeway Bay is essentially zero. Discounts to NAV have virtually never been bigger, and on the few occasions over the last 30 years when they have been comparable, Hong Kong has been in a state of acute depression. The Thatcher negotiations, 1987, Tiananmen, SARS, Asian Crisis, 2008…we were there on all of these occasions, and it doesn’t feel remotely like any of them. Chinese visitor arrivals are rising 20% plus YoY, and they are spending like LVMH might run out of handbags (watch and jewellery sales are up 40% plus). Wharf, the pre-eminent retail landlord, has underperformed even the UK retail property plays over the last couple of years, where we can see no good news at all. This is surely one of the best value plays in the region.

‘Asian markets down on concern over Europe’ is now a Bloomberg headline in danger of burning itself into one’s computer screen. In a year when the US markets are almost flat, Asia and Europe (the latter index crammed full of bankrupt banks) are level pegging, down circa 20%. It seems that Asian investors are interpreting all news as bad, as exemplified by the uniformly negative reaction to the (not that surprising) demise of the Dear Leader of North Korea. No one knows or can even usefully guess at what will happen, but the immediate reaction was to panic over a war breaking out. An equally or more likely outcome is some form of rapprochement and some degree of integration back into the world at large. Our base case is the status quo. Yet the default at the moment is to assume the worst, and with Asian markets suffering a double whammy of fund flows from both international capital and panic-struck retail investors (who are being influenced primarily by doom and gloom over Europe) and who still matter much more in markets such as Korea, Taiwan and China than in the institutionally intermediated Western markets, and who by their nature are high beta investors – all in or all out. Low market volumes exacerbate this effect. The good news is that it also works in reverse when sentiment stabilises. We do not need a ‘solution’ to European woes for this to happen. Indeed, anything other than a disorderly break-up of the Euro is probably enough to prevent disappointment from current expectations – and in that case Asian equity performance might be the least of ones worries. » Read more: Mark Fleming – December 2011

Following a traumatic year in Japan, ranging from the tragic earthquake to persistent yen appreciation, we enter 2012 convinced that the early part of the year will face similar problems. An unresolved Eurozone outlook accompanied by a severe European recession will continue to outweigh the positive signs of recent economic improvement in the US and a likely moderation in the Chinese slowdown and will translate into a limited risk appetite on behalf of investors. Global bonds appear expensive but still exhibit safe haven characteristics. The potential for a significant rethink for markets lies principally in the unlikely scenario whereby governments are able to finance growth as opposed to the current focus on austerity in order to trim budget deficits. Perhaps the ECB unleashes the dramatic QE but we sense this only occurs at a moment of maximum alarm and despair, which probably suggests that equity markets will be at much lower levels. Where does this leave the Japanese equity market?

Fortunately Japan has a few positive factors. The economy will respond to the significant post earthquake reconstruction spending that will offset the more sluggish manufacturing export conditions. Corporate balance sheets are awash with net cash and consequently remain well placed, especially given the yen levels, to accelerate their overseas acquisitions, a more noticeable trend from Q4 2011. Industry consolidation will accelerate as will the more aggressive restructuring at individual companies. Shareholder awareness will continue to maintain a level of pressure on corporate managements and hence share buybacks at many companies will occur for the first time although it would be premature to expect the Olympus debacle to change overall corporate thinking in the near term.
» Read more: Rupert Kimber – December 2011

Markets continue to demonstrate extreme volatility based on constantly changing expectations for the financial health and future of the Eurozone. In this environment those investors in Japan who see only cyclical attractions continue to trade accordingly and hence the market remains heavily correlated to external events. However the reasons for maintaining an exposure to the market remain quite different in our view. We are very heartened by the decision that Japan will enter talks to join the TPP as this represents an opportunity for the government to embark on longer term structural reform, especially in certain domestic sectors that are currently closed to foreign involvement. This should compliment the already aggressive restructuring in the corporate sector. Furthermore it can potentially provide foreign investors, the only marginal buyers, with a reason to expand their portfolios to include a wider non global cyclical component. Valuations in Japan are starting to look cheap with dividend yields in certain sectors not dissimilar to global competitors but the PB discounts require significant ROA improvements, a trend that we believe is well underway. A difficult 2012 global economic environment and a persistently strong yen will again provide further reasons for corporate management to implement further restructuring. It is also interesting to hear managements starting to effect share buybacks using the rationale that the discrepancy between bank funding costs and the cost of equity is now too great and that a slightly higher degree of balance sheet leverage is not such a bad idea. Given investor scepticism over these trends, encouraged by the lack of research on many of the companies and a continuing over emphasis on short term earnings trends, certain share prices may take longer to reflect these changes but ultimately these types of companies should generate the most significant longer term returns. We are shortly to visit Japan again and will report our findings in the next report in more detail.