‘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.

Official pronouncements from China maintain that ‘strict vigilance’ over property prices will be maintained. The reality is that banks are lowering mortgage rates, at the behest of the self-same government. The RRR has been cut as inflation has undershot expectations, and an increasing number of functionaries are pointing out the undesirability of a prolonged property slump, particularly inasmuch as it affects Local Government finances. The rhetoric has to stay tough, but policy is clearly shifting as official indices now show house prices in modest decline, while inflation has now, for official purposes anyway, been conquered. We are also seeing a loosening of restrictions over property purchase in Korea and the first rumours of the unusually severe measures in Hong Kong being re-evaluated. However, moving south, and despite the stockmarket forecasting economic Armageddon, the Singapore Government is still worried about a property price bubble. Not content with having imposed a 16% (of proceeds, not profit) tax on re-sale within one year, tapering to 4% 4 years out, it has now imposed a 10% extra initial stamp duty on foreign buyers , making a cool 13% up front levy for alien purchasers. You will not be surprised to hear that speculative activity in the property market is at a somewhat low ebb. Equally predictably, the listed property stocks took a beating on the (totally unexpected) announcement, though for the larger players such as Capitaland and Keppel Land, residential exposure to Singapore is only around 15%. Once again the market seems worried over a lack of demand while the authorities are worried about the exact opposite. Arbitrary regulations such as these can be removed at a moment’s notice if the political calculation swings from voters being more exorcised by income inequality to worries over the broader economy. This is sadly not a luxury that Western property markets enjoy.

We have been wary of Indian macroeconomics for some time, finding them at odds with the long-term bullishness that demographics and sheer size of growth potential seem to imbue market valuations with. This is now changing rapidly, and producing a bifurcated market where the consumer staple names have retained nose-bleed valuations while virtually everything else has cratered. Political paralysis and tight money have clearly been negative for growth expectations, and valuations now generally reflect this low level of optimism. The clear exceptions remain the likes of ITC and Hindustan Lever, though we struggle to see how their prospects have improved in absolute terms in recent months to justify their increased ratings. We are finding value now in selected areas of the market, particularly in capital goods where pessimism has become extreme, but would be very wary of the consumer bellwether blue chips.

December has been a somewhat mixed month for Asian equities, with Taiwan and Hong Kong regaining some ground while Indian and Chinese bourses marked year lows. Market volumes have been extremely thin, thus magnifying the response of individual equities to news. The Singapore property stocks were poor performers on the month, due to the measures outlined above, as were some of the resource names, particularly Lynas, primarily driven by sentiment after some downgrades of peer Molycorp. On the positive side of the ledger there was a modest recovery in some of the HK property names (SHK Props) and we switched our HK Land to Wharf on grounds of relative performance and valuation as well as a more retail focused portfolio.

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.

Within the market the significant outperformance of small/mid caps in 2011 continues to stir debate. Given the more solid earnings prospects of these companies it would not be surprising to see this trend continue until global macro factors improve and liquidity, especially in terms of renewed foreign buying, returns although the mean reversionists would argue strongly against this. Valuations of many of the large companies are now very low and therefore patience is required albeit that further significant absolute share price weakness looks unlikely. Furthermore we would not be surprised to see analysts reducing their March 2013 earnings forecasts but this is arguably in the share prices of many such stocks.

Our fund enters 2012 with a similar thought process to this time last year, namely a continued focus on more domestic stocks where considerable upside is expected in terms of profits and returns, notably ROA, as restructuring initiatives bear fruit. We also expect certain domestic managements to be forced to unlock value at a faster pace than in recent years. Global manufacturers still occupy a small proportion of the NAV for reasons described above especially as a final rout within the Eurozone will likely result in further yen appreciation especially as the Swiss Franc is not longer seen as a valid safe haven.

Return on equity is one of the market’s favourite parameters for measuring corporate profitability and management competence. Frequently and erroneously mentioned in the same context as price/earnings rather than price/book, its overuse in analytical terms relies on capital being reinvested in the business at the same rate as that currently extant (often wrong for cyclicals, businesses in niche markets or with franchises or intellectual property that do not lend themselves to expansion via financial capital alone and where the ‘book value’ does not include these intangibles), and like any ratio is prone to manipulation – in this case both numerator and denominator are vulnerable. A low ROE can be a function of low stated profits or a ‘lazy’ balance sheet. Call us old fashioned, but in the current climate we view strong balance sheets as good things. For the banking sector we would say they are essential. We would also be wary of high stated banking profitability – dodgy borrowers paying munificent up-front fees, clever derivative strategies that could unwind or result in law suits….the list goes on. So we like Singapore Banks. ‘Boring’ and ‘overcapitalised’ are positive attributes, not insults. The banking regulator retains credibility for ensuring financial statements are not filed alongside their European brethren in the fiction department, and the market awards them a very low valuation – 10x per, 1.2x book – because the perception is that they have little scope for growth. Yet the likely wholesale departure of European bank capital – from good credits – back to a domestic ‘haven’ leaves a potential hole in Asian credit markets that the Singaporeans could fill, and at higher than current margins as credit availability shrinks. These are virtually the only banks worldwide that we are enthusiastic about.

In volatile markets, any stock that disappoints is likely to be punished. Committing the cardinal sin of failing to spoon feed the analysts with near-term data is met with savage retribution as a minor quarterly miss is seamlessly extrapolated into perpetuity as valuations are eviscerated. Yet this great success for efficient market theory presents opportunities, and we are seeing quite a few in China at present, especially in the previously highly rated domestic names. Many of the retail and a few staple and healthcare names have seen their multiples halve over the last few months as near term growth decelerates by a small fraction of the price movement. Several companies have seen their tax rates normalise from concessionary levels to the standard rate and had this treated by the markets as an event worthy of a multiplier rather than the one-off it obviously is. Rapid expansion of new stores with an associated ramp-up period or changes to distribution channels are not given the benefit of the doubt as far as future returns go. Shandong Weigao, Ports Design, China Resources Enterprise and Parkson are all now in the portfolio at multiples of 30 to 60% of those extant earlier in the year.

Taiwanese politics have not figured on investors’ radar screens much in recent years, but this may be about to change. The Presidential election is due in January, and the DPP is gaining ground in the polls – in fact it is ahead in several of them, and this is before one factors in a possible split of the KMT’s vote between Ma and the (evergreen) James Soong. The DPP may have mellowed since Chen Shui-Ban went to jail, but is unlikely to generate a positive response from Beijing if successful. Insults would be hurled and missile batteries and aircraft carrier(s) redeployed. The polls are public, yet there has been little credence given in the performance of the domestic stocks to a market-unfriendly outcome. We counsel caution, particularly in domestic, non-tech names which tend to act as a political bellwether at times of cross-straits tension.

Doom and gloom on the economic front is not dampening animal spirits in resource company board rooms. Anglo is buying more of De Beers, Mitsubishi is spending $6bn on Chilean copper assets and committing to billions in Australian iron ore infrastructure spending, the Chinese are actively pursuing exploration assets such as Meridian and Rio and Cameco are locked in a bidding war over Hathor. New Hope has put itself up for sale and has attracted multiple bidders. Irrespective of the travails of the Eurozone, the rapidly industrialising half of the planet, and the companies that sell to them, remain acutely conscious of supply issues for essential commodities (though we confess that gem diamonds’ ‘essentialness’ may be subject to some gender bias). This theme will not go away, and we remain positive on selected material and energy stocks.

India has been a market largely absent from our portfolios over the last eighteen months. High valuations, sclerotic politics and the last of the inflation-fighting central banks have produced an unattractive investor proposition. Some of this is now changing. The market has fallen and the currency has sold off aggressively, leading to the appearance of some genuinely cheap equity opportunities, at a time when it seems likely that monetary tightening may have run its course. Policy paralysis is now everybody’s base case, and the relatively insulated nature of the economy compared to some of its more export dependent regional peers may now be seen as a positive. We are attracted to some of the weak rupee beneficiaries that either export or compete with imports in the domestic market, and that are selling at some of the lowest valuations seen in a decade.

For Japan Inc. 2011 is shaping up as one of the most difficult on record. Having just recovered from the earthquake, the manufacturing sector has now had to contend with floods in Thailand and, despite forex intervention, a persistently strong Yen which is starting to act as a major drag on profits. We continue to attribute the latter partly to the recent withdrawal of the Swiss franc as a safe haven currency. The recent share price trend of Samsung Electronics provides a telling indicator of how competitive advantages within Asia appear to be changing. Whilst it is therefore easy to be gloomy, given the previous comments, let us now consider the other side of the coin.
The BOJ, as evidenced again this month, has ample scope to further ease monetary policy and to weaken the currency through intervention. Corporate Japan continues to restructure aggressively with large companies putting in place meaningful restructurings. TDK for example has just announced a 12% global headcount reduction and an exit from several unprofitable businesses. Economic growth in 2012 will be the strongest for many years as the reconstruction spending feeds into the real economy. The silver lining from the strong Yen could emerge in the form of a commitment to join the Trans Pacific Partnership trading bloc which would profoundly improve the competitive position of Japanese manufacturing companies, especially against their Korean counterparts. Although the farming community will agitate, the Government may well override their concerns, as Korea did recently, given the greater benefits accruing to the manufacturing sector.

From a portfolio perspective we have made almost no changes. The sudden sell-off in cyclicals started to present an opportunity but the bounce came too quickly. Given our concerns on global economic growth, we still prefer companies that will offer durable earnings growth over the next 18 months as we see little prospect of an aggressive reacceleration in global growth that would necessitate a change on our view. Furthermore the scope for significant domestic industry consolidation tends to imply a better prospect of enhanced returns at many more domestic companies.

On the supply side of the equation, there are quite a few major projects under way in the Pilbara, Brazil and (eventually) in Africa. Yet at current prices (circa $130/tonne, 62% Fe), approximately 200m tonnes per annum of domestic Chinese production is marginal (compared to cash costs for the Wallabies and the Brazilians of around $50). Prices may dip below this Chinese cash negative cut off for a while, especially as one can now speculate in the futures, but won’t stay there for long. Yet the stock market is valuing many of the mining stocks on the basis of prices being around 35% below current spot into perpetuity. Too harsh, we feel.

While new sources of iron ore have been identified, there are several minerals that do not enjoy this prospect. Rare earths are once again interesting to us as we mentioned in last month’s missive, but we would add zircon and the titanium rich mineral sands into the mix as well. For the mining cognoscenti the supply demand imbalance of zircon and high quality rutile (a mineral composed primarily of titanium dioxide) is well known, but the recent fall in markets (as the risk off/China is finished trade took hold) provided an opportunity to get set. Zircon is a required material for ceramic tiles and refractory materials while titanium dioxide is the essential ingredient for white pigment. The paint industry has had a free ride on cheap rutile for years. This is now changing as legacy contracts at artificially low prices run off and are replaced by market based ones. Supply is constrained primarily by geology and a new pricing paradigm seems set for the foreseeable future. Listed producers of these materials should do very well over the next few years.

Asian markets are full of companies with holding company structures and most of these have well defined and often mean reverting levels of discount to NAV. In periods of intense volatility it is quite common to see holding companies and their listed investments move in opposite directions and this frequently throws up some interesting investment opportunities on both sides of the ledger. Korea is particularly well endowed with these structures, though good opportunities also exist in Singapore and Taiwan. It is common to see 15-30% moves in discount terms in fast moving markets with no change in corporate governance or cash return to shareholders, which are two of the main reasons for these structures selling at perennial discounts. For the patient investor these represent some of the best opportunities in markets at present.

Armageddon averted or Acropolis Now? The Europeans have done just enough to meet (extraordinarily low) market expectations and triggered a sharp, short-covering rally. While Merkozy et al may be preening their feathers for now, sadly the announcement is both short on detail and deficient in providing any material help to stagnant economies, while the banks and rating agencies will argue about whether this is a default (good job total insolvency doesn’t appear to be a sufficient condition) and whether they can avoid raising fresh capital by purging their balance sheet of the few loans that are likely to remain good. Not sure how this gives them a cushion on the bad stuff, but then bank accountants are a clever bunch….bit like their delta one traders. We have clearly not heard the last from this soap opera, and with markets well off recent lows (look at some of the European Banks), some profit taking seems in order, though the change in tone from China and a slightly better US housing environment are positive developments. Expect volatility to remain in global markets, but take a (silver) leaf out of our book: Asia remains the cheapest and best option within the equity universe.

A lot of comparisons are being drawn between 2008 and the current situation. Market sentiment (suicidal) is the key similarity. Yet the difference in the underlying economic situation is clear. In 2008, every company that one talked to was in panic-stricken conversations with their banks to keep credit lines alive. After the last 3 years of corporate de-leveraging, few companies are beholden to banks and many have an embarrassment of cash. Stock buy-backs and M&A continue regardless (e.g. Berkshire Hathaway). In the last week we have met companies in cyclically challenged industries (such as bulk shipping) which can still access (without pre-agreed credit lines) bank funding for expansion at sub 4% rates. Three years ago one couldn’t get an LC for a single bulk shipment. The other major difference is an absence of inventory in the system. US Steel highlighted to us last week that in 2008, customer orders stopped for nearly 6 months as inventory was liquidated. ’We had to burn the furniture’ as the CEO put it. Now all customers are running lean (backed up by commentary from companies in nearly every industry), and the underlying demand is ‘OK’ – again a direct quote from the same source, whose major customers are the auto, construction and white goods sectors. Jobs aren’t being created and profits may not be rampant, but the world hasn’t ended.

Commodity stocks have been some of the worst performers in the recent market rout, as the carry trade unwound and concerns over end-demand have risen. Yet most of the worries are over Western demand, which for many commodities is now a rounding error compared to the East, and the big mining houses are still reporting strong demand from China. The markets may be correctly pricing a sharp fall to come from there too…or they may just be panic-stricken. Either way, an awful lot of bad news is now discounted, and commodity prices will have to fall a very long way (50% plus) to make most mining equities expensive. It is also clear that a lot of planned investment in the sector is now at some risk, while further moves by Governments from Mongolia to Zambia to increase taxation/state ownership of new projects will also sharpen the bankers’ and miners’ pencils when they evaluate multi-billion dollar investments. All in all, future supply is likely to undershoot expectations. Geology will not come to the rescue and Asian companies are still busy acquiring assets, while their domestic production is typically high cost and in some cases already marginal. There is a particular opportunity in rare earths, as spot prices have declined from a clearly unsustainable $220/kg to $150/kg in a few months…but are still up from under $100 at the turn of the year and $15 from two years ago. Lynas and Molycorp are fully funded and within six months of production. Lynas has halved this year, and is on a PER of between 1 and 3 in a couple of years if the basket price should fall to between $60 and $35, with ten years plus of production ahead of it. We have bought back into the stock.

As Europe has been hogging the economic headlines recently, one might surmise that the worst performing asset you could buy would be a European bank with peripheral sovereign exposure. Yet in recent weeks as the panic has reached a crescendo, BNP and (amazingly) UBS have been reasonable relative performers. Indeed, they have significantly outperformed some of their Asian peers with relatively spotless balance sheets and equally low valuations. This is clearly nonsensical, and underlines the primacy of funds flow over valuation in times of extreme stress. Yet ultimately valuation will out, and history is on the side of picking up the high quality names having a bad month.

After several years of a regulatory tourniquet being applied to its neck, the Chinese residential property market finally looks to be suffering. Beijing has started to specifically target the shadow banking system, particularly trust loans, and this is causing developers to cut prices to shift inventory that has become too expensive to hold. In the context of an economy which is mildly decelerating and a property buying public that has had a tough time in the equity market, it should come as no surprise that house prices are falling. For the geared mainland developers with little recurrent investment income, these are challenging times. For the cashed-up HK and Singaporean developers, Christmas has come early as they now have their pick of new sites with virtually no competition from domestic developers. The bears may push an apocalyptic US or Japanese-style property recession as an inevitable consequence, but we disagree. The developers have always been the financially weakest link in the chain, and consolidation is welcome. The property buyers have very little debt and rising incomes, so negative equity and jingle mail are phrases which should remain without mandarin equivalent. Another reason to be cautious on Chinese banks and property companies, but much more optimistic on their southern cousins.

Against this backdrop, Japan has many appealing attributes, not least of which are the strong cash positions in the corporate sector and a banking system awash with excess liquidity. Whilst weak economic growth overseas will inevitably slow domestic economic growth and corporate profits, we still expect corporate earnings in 2012 to prove the most resilient within developed markets whilst allowing certain companies the opportunity to improve their global positioning through overseas M&A whilst domestically the focus remains on industry consolidation and restructuring. In terms of the stock market we continue to believe that emerging evidence of a strong recovery in return on assets resulting from the domestic corporate strategies will result in a positive re-rating of individual companies by narrowing the currently high price to book discounts.

At this stage we see only a minor possibility of a weaker Yen in light of the decision of the Swiss Central Bank as the Yen has become the only deep currency alternative to the US dollar. However investors should appreciate that the Bank of Japan has further significant tools to ease monetary policy and we expect to see this in the coming months if the global economy continues to deteriorate.

In the context of the stock market the prospect of Japan outperforming other developed markets appears very likely given the above reasons and therefore we are not discouraged by the recent foreign selling as the prospect of foreigners coming back to the market looks quite plausible. The skeptics, who consider Japan to be only a global cyclical, may be forced to revisit this opinion once the evidence of real fundamental reform in the corporate sector becomes more visible.

Many commentators are keen to compare current market action with that of 2008, and this has clearly rattled a lot of investors who (us included) would rather not relive that period. We would agree that we are in a different phase of the same crisis, with the excessive debts having migrated primarily to sovereign borrowers. We would also agree with the consensus that policy options are few and likely to be ineffective. However, there are some major differences. Companies are cashed up and not beholden to their creditors. This is a crucial difference as we invest in the private sector, not in politicians. The second significant difference is that we know that whatever liquidity is required will be provided to keep the banking sector functional, which is why the cost of interbank funding has moved only moderately. This was the key unknown in September 2008.
The economic prospects for the West were grim 2 months ago. They still are, but now this gloomy outlook is priced in to a greater or lesser extent. At the bottom end of its trading range, Asia is a buy.

Year in, year out, analysts start the year too bullish and revise numbers down as the year progresses. In current straitened times, the pace of downgrades is likely to be accelerated so we have a preference for using more robust and less volatile metrics such as Price to Book or Replacement cost, price to sales or NAV. However, there are some industries where the reverse may be the case. We fail to understand why market participants take any notice of ‘guidance’ from companies whose profits depend on the direction and activity level of markets. Investment banks and exchanges have NO visibility for large parts of their revenue, yet expectations are set around their forecasts which move in a coincident fashion with markets – which is fair enough as they have no better a crystal ball than any other market participant. This does mean, however, that expectations tend to be very low in this type of environment. When coupled with low valuation, an investment opportunity is born. We like Macquarie as its value is underwritten by fund management and stakes in listed vehicles (mainly MAP), while forecasts for broking and investment banking are low balled.

On a related but opposing tack, we are befuddled by Asian analysts’ confidence in the available returns from UK utilities which have become popular targets for Li Ka Shing of late. There has been a revolving door of owners of these assets since privatisation, with few happy experiences. They have been bought from solvent and willing sellers at full valuation in a regulatory environment which is likely to become increasingly hostile as utility bills are now a major source of consumer – and voter – stress. They may not be ‘bad’ acquisitions, but supernormal returns are not likely to be on offer either. The euphoric share price action of the HK vehicles to the deals, exacerbated by a perceived ‘safety’ premium, is a great opportunity to reduce exposure.

Pfizer has spent over $60bn on R&D over the last nine years and has 9 commercial drugs to show for it. Along with most big pharmaceutical companies, it is changing its business model to be more of a conduit for bought-in innovation, and is very risk averse in choosing these opportunities. Far better (apparently) to pay a big premium for regulatory certainty and guaranteed revenue after FDA approval than to take a risk earlier in the process for a much lower cost. This changing dynamic is a huge positive for the smaller biotech companies with well advanced molecules or devices in the trial process, as the end game on successful completion is now both quicker and more lucrative. The equity market tends to be wary of these names as they are difficult to understand and value and everyone can point to a string of historic biotech disasters. As a result there is asymmetry in the risk/reward profile and we can find quite a few prospects with potentially disruptive new technologies where the equity market could not care less. We rather suspect that the successful ones will end up being acquired expensively by industry players with fund managers having been almost totally by-passed. As an added bonus, the fate of the Eurozone or the credit rating of the US government are rarely material to price action in this sector. We retain a very significant exposure to a selection of these names, focussing on later stage drugs and devices with proven efficacy and safety profiles and in a few cases revenue generation as well.

The reporting season in Australia is in full swing and in general results have been satisfactory, the majority of companies coming in with numbers in line with recently lowered expectations. The more interesting dynamic is the reaction of share prices to these numbers and in particular the performance of some of the domestically focussed names. A small (3-4%) improvement on consensus forecasts has been greeted with a 10-20% rise in share price – a testament to how low expectations are and to how negatively (large short exposure) funds are positioned. Buy-backs and asset disposal announcements are also being positively received. We continue to be perplexed at how negative the global view of Australia is. Learned articles continue to proliferate prophesying the imminent collapse of the housing market and the resources boom, neither of which is in immediate prospect but seem at least in part embedded in valuations. No material sovereign debt, monetary flexibility and a solvent banking system are major positives routinely given short shrift by the global investor, despite policy makers in the rest of the OECD who would kill for Australian macroeconomic fundamentals in their own bankrupt countries.

On the political side, the Labour-led coalition is beginning to look short-dated, and any prospect of a return to power of the business-favoured Liberals would be a very significant positive for the market.

Corporate Japan is looking very solid, with the abundant net cash positions likely to lead to a more concerted overseas M&A boom as managements continue to look overseas to generate new growth especially in emerging markets. Critics will point to recent examples of high prices paid, as in the case of Kirin in Brazil, but they fail to understand that the purchase price represents only two years of cash-flow; hardly a major gamble. We expect financial companies to follow suit given that in some cases considerable cash reserves have been amassed for this purpose.

The recent yen appreciation is not especially material for the competitiveness of Japanese manufacturers as many have already moved costs very aggressively overseas and hence can compete in foreign currency contract bidding with overseas competitors. The impact is more relevant to the translation of overseas earnings. The domestic sectors currently hold most attraction for us given further signs of imminent industry consolidation and specific company restructuring. Our recent meetings with senior managements of several companies confirmed that this process still has a long way to go from here. There was confirmation too that the bureaucracy, METI, are actively encouraging this trend, an interesting new policy objective given their historic concern about the impact on employment that has for so long extended the obvious over capacity issues in many industries. Whilst unlikely to proceed, the very thought that Hitachi and MHI might engage in a partial merger offers concrete evidence of this new management strategy. On the subject of employment practices, the president of one our holdings produced his own evidence to support the changing employment mindset – the company’s early retirement programme this summer solicited nearly twice the number of intended applicants. The overriding view from many corporate managers is that they cannot afford to wait for government policy and / or yen weakness to improve their profitability. In this sense the expected approval for the imminent steel merger of SMI and Nippon Steel could prove a watershed moment and pave the way for similar activity in other sectors. The forthcoming decision on TPP membership will be an interesting indicator of whether the government share the same level of urgency as the corporate managers. We are also intrigued by the gradual emergence of more lively MBO activity, again an indicator of the abundant availability of low cost funding from the banking system at present. The final point is that the domestic economy should receive a strong fillip in 2012 from the earthquake reconstruction efforts, in marked contrast to the direction of economic activity in most other developed countries.

The other and striking change that emerged relates to corporate strategy on China. Whilst clearly companies have aspirations to grow sales there is also a hardening view amongst corporates that further significant manufacturing capacity expansion is not desirable given the sharply escalating wage pressures and many companies are now actively looking at other Asian locations. This is a major change from say 12 months ago and has profound implications for many component suppliers who have benefited in recent years from the expansion of the manufacturing capacity. Indeed one management that took a decision to more than double capacity in China last year is already reining back such plans and admitted ruefully that a decision taken today would have led to a very different outcome.

Where does this leave us on the stockmarket? In the nearterm the overseas environment – global growth and the Eurozone in particular – looks very troubling and clearly this is leading to selling pressure as domestic institutions continue to reduce cross shareholdings whilst foreigners reduce their weightings from the earlier surge of interest in late 2010. We remain confident that a highly selective stock picking approach, centred on the issues raised above, will generate very interesting returns over a 12-18 month timeframe.