k bank multi asset strategies feb 2011

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.Mean S

Strategic Thesis It looks like the US dollar can do no wrong…that seems to be what the market is thinking for the time being. But markets have rather short memories and gives more weight to cyclical / shorter horizon factors. US data points continue to show recovery in the business sector. The labor market seems mixed but attention is being paid to the falling unemployment rate. Structurally, the verdict might not be utterly convincing since more people are leaving the labor force than more people getting jobs. Another structural impediment is with the spiraling debt levels in the US federal government which is seen to reach 140% in the not too distant future since Uncle Sam is spending money it does not have…not to mention the 50 states. The events in Tunisia and Egypt have turned on the risk switch of EM assets, that is political risk and inflation risks and hence favoring the US dollar. Inflation can be thought as the depreciation rate of money or the rate at which all people become poor. So countries that look to be “behind the curve” will be shunned by investors. China’s move on interest rate again is an admission that controlling money supply alone is not as effective as is hoped. Sooner or later, it will have to look to letting the yuan flow its fundamental course , that is to strengthen. Until then, USD/Asia will remain volatile as seen by the jump in USD/THB vols. But the textbook response is on the wall: higher inflation, higher interest rates. Hence, we can still see the Thai yield curve bias towards a bear flattener. On equities, the continued rally we called last month did not happen and the market fell to 950, also below what we predicted to be the support level at 980. The market psychology has changed and we now no longer expect a sharp directional trade. The SET is shifting pace and will become sideways. We recommend a sector re-allocation towards ‘Services’ and ‘Commodities’. We are Overweight on energy, agricultural, media, hotel, hospital, commerce, contractor and industrial estate.

Kobsidthi Silpachai, CFA –Kasikornbank [email protected] Susheel Narula – KSecurities [email protected] Kavee Chukitkasem – KSecurities [email protected] KResearch [email protected]

As we are in the year of the Rabbit, the markets will tend to be jumpy…with events in Tunisia and Egypt along with fear that Asia is behind the curve on fighting inflation is again highlighting USD perceived safe haven stature and risk in EM assets

Our main theme for USD/THB downside remains unchanged…but our 4Q11 USD/THB target is scaled back to 29.00 from 28.00

Indications from the central bank along with its perceived preference for a less stronger baht coupled with rising commodity prices prompts us to revise up our 4Q11 BOT repo target to 3.25% from 2.75%

Our full-year 2011 GDP forecast remains unchanged at 4.5% YoY but some components have been revised to better accommodate higher oil price risks

The divergence of economic cycles between EM and Developed economies calls for a sector re-allocation towards ‘Services’ and ‘Commodities’

KBank Multi Asset Strategies USD/Asia: cyclically constructive, structurally destructive

Strategies Macro / Multi Asset February 2011 Volume 45

WWW.KASIKORNBANKGROUP.COM

“KBank Multi Asset Strategies” can now be accessed on Bloomberg: KBCM <GO>

Disclaimer: This report must be read with the Disclaimer on page 47 that forms part of it

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Key Parameters & Forecasts at Year-end 2003 2004 2005 2006 2007 2008 2009 2010E 2011E GDP, % YoY 7.1 6.3 4.6 5.2 4.9 2.5 -2.3 7.6 4.5 Consumption, % YoY 6.5 6.2 4.6 3.0 1.6 2.7 -1.1 4.0 3.7 Investment Spending, % YoY 12.1 13.2 10.5 3.9 1.3 1.2 -9.2 9.5 8.8 Govt Budget / GDP % -0.2 -0.2 0.3 -0.7 -1.5 -1.0 -5.6 -3.2 -3.8 Export, % YoY 18.2 21.6 15.2 17.0 17.3 15.9 -14.0 27.0 10.0 Import, % YoY 17.4 25.7 25.8 7.9 9.1 26.5 -25.2 35.0 15.0 Current Account (USD bn) 4.78 2.77 -7.6 2.3 14.1 1.6 21.9 14.2 7.5 CPI % YoY, average 1.8 2.8 4.5 4.6 2.3 5.5 -0.9 3.3 3.3 USD/THB 39.6 38.9 41.0 36.1 33.7 34.8 33.3 31.4 29.0 Fed Funds, % year-end 1.00 2.25 4.25 5.25 4.25 0.25 0.25 0.25 0.25 BOT repo, % year-end 1.25 2.00 4.00 5.00 3.25 2.75 1.25 2.00 3.25 Bond Yields

2yr, % year-end 1.73 2.78 4.94 5.02 3.91 1.98 2.17 2.35 3.75 5yr, % year-end 2.8 4.0 5.3 5.1 4.5 2.2 3.6 2.75 4.00 10yr, % year-end 4.9 4.9 5.5 5.4 4.9 2.7 4.3 3.25 4.25

USD/JPY 107.5 102.5 118.0 119.1 111.8 90.7 93.0 82.0 89.0 EUR/USD 1.26 1.36 1.18 1.32 1.46 1.40 1.43 1.40 1.30 SET Index 772.2 668.1 713.7 679.8 858.1 450.0 734.5 1040 1220 Source: Bloomberg, CEIC, KBank, KResearch, KSecurities

KBank Thai Government Bond Rich / Cheap model

-30.00

-20.00

-10.00

0.00

10.00

20.00

30.00

LB11

3A

LB11

6A

LB11

NA

LB12

3A

LB13

3A

LB13

7A

LB14

5B

LB14

DA

LB15

5A

LB15

DA

LB16

7A

LB16

NA

LB17

5A

LB18

3B

LB19

1A

LB19

6A

LB19

8A

LB19

DA

LB21

3A

LB24

DA

LB26

7A

LB28

3A

LB29

6A

LB39

6A

3 mth avgNow

Source: Bloomberg, KBank

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KBank THB NEER Index KBank USD/THB – FX Reserves / USD Majors model

KBank THB Trade Weighted Index

70

80

90

100

110

00 01 02 03 04 05 06 07 08 09 10 11

Jan 1995 = 100

+ 1 std d

-1 std dev

average

2830323436384042444648

01 02 03 04 05 06 07 08 09 10 11 12

actual model

KBank USD/THB model

Source: Bloomberg, KBank Source: Bloomberg, KBank

FX reserves – USD/THB model DXY – USD/THB model

y = -7.6277Ln(x) + 69.875R2 = 0.872

262830323436384042444648

25 50 75 100 125 150 175 200 225

FX reserves to USD/THB mapping current 2011 forecast

USD/THB

FX reserves, USD bn

y = 27.699Ln(x) - 86.289R2 = 0.756

25

30

35

40

45

50

70 80 90 100 110 120 130

DXY to USD/THB mapping current

USD/THB

DXY

since 2001


KBank BOT repo model SET forward dividend yield vs. 10yr bond yield

0.00.51.01.52.02.53.03.54.04.55.05.5

01 02 03 04 05 06 07 08 09 10 11 12

actual model

%

0123456789

00 01 02 03 04 05 06 07 08 09 10 1110yr yields SET forward dividend yields

%


44

4

Thai inflation parameters Thai contribution to GDP growth

-15%-10%

-5%0%5%

10%15%20%25%

01 02 03 04 05 06 07 08 09 10 11

CPI Core CPI PPI

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10

Priv ate consumption Gov ernment consumption Gross fix ed capital

Change in inv entories Net ex ports GDP

% y oy Contribution to growth

Source: CEIC, KBank Source: NESDB, KBank

Implied forward curve: swaps Implied forward curve: TGBs

0.501.001.502.002.503.003.504.004.505.00

0 1 2 3 4 5 6 7 8 9 10Feb-11 May-11 Aug-11 Jan-12

%

tenor (yrs)

Implied forward rate shifts (IRS)

2.00

2.50

3.00

3.50

4.00

4.50

- 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Feb-11 May-11 Aug-11 Feb-12

%

tenor (yrs)

Implied bond yield curve shifts


US 2yr yields and implied forward US 5yr yields and implied forward

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

2yr yields, % implied forwards

1

2

3

4

5

6

7

8

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

5yr yields, % implied forwards


55

5

KBank EUR/THB model KBank JPY/THB model

34.036.038.040.042.044.046.048.050.052.054.056.0

01 02 03 04 05 06 07 08 09 10 11 12

actual model

EUR/THB

25.027.029.031.033.035.037.039.041.043.0

01 02 03 04 05 06 07 08 09 10 11 12

actual model

JPY/THB


KBank GBP/THB model KBank CNY/THB model

43.0

48.0

53.0

58.0

63.0

68.0

73.0

78.0

01 02 03 04 05 06 07 08 09 10 11 12

actual model

GBP/THB

4.04.24.44.64.85.05.25.45.65.8

01 02 03 04 05 06 07 08 09 10 11 12

actual model

CNY/THB


KBank THB/VND model KBank AUD/THB model

300350400450500550600650700750

01 02 03 04 05 06 07 08 09 10 11 12

actual model

THB/VND

21.0

23.0

25.0

27.0

29.0

31.0

33.0

35.0

01 02 03 04 05 06 07 08 09 10 11 12

actual model

AUD/THB


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6

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The shortest distance between two points is a straight line

…or so they say. Low USD liquidity is a cue for the rise in USD/THB

volatility

As we are in the year of the Rabbit, the markets will tend to be jumpy…with events in Tunisia and Egypt again highlighting USD perceived safe haven stature and risk in EM assets

Resumption of political activities following end of emergency decree is giving a good excuse for foreign investors to take some money off the table

…and reintroduces more uncertainty in the USD/THB picture

Our main theme for USD/THB downside remains unchanged…but our 4Q11 USD/THB target is scaled back to 29.00 from 28.00

Indications from the central bank along with its perceived preference for a less stronger baht coupled with rising commodity prices prompts us to revise up our 4Q11 BOT repo target to 3.25% from 2.75%

Yesterday’s darling might be today’s out of favor child 2010 was a great year for the Thai baht gaining about 11.07% against the USD. The currency was ranked fourth after JPY, AUD and MYR. That is looking into the rear view mirror. Looking in front passed the windshield with the year of the Rabbit in full swing, the USD/THB has proved so far to be as jumpy as the rodent. The Thai stock market, SET, gained about 48% in 2010 is prompting investors to take some money off the table. Hence, looking at the following statistics, foreign investors have sold about USD 1053 mn, YTD, the most in the region after India. Table 1. Foreign Institutional Investment in Regional Equities

Day WTD Net MTD Net YTD Net YTD Net As of (Mil US$) (Mil US$) (Mil US$) (Mil US$) YoY% India -117.1 -117.0 -25.8 -1,413.0 -88.6 08/02/2011 Indonesia -49.7 -34.2 -3.7 -290.9 -6.2 09/02/2011 Japan 2,418.9 2,418.9 2,418.9 10,418.7 -44.8 04/02/2011 Philippines -16.5 -15.6 -55.5 -149.2 -315.9 10/02/2011 S.Korea -451.6 -487.1 -603.9 -20.8 -108.4 09/02/2011 Taiwan -191.2 -117.7 -117.7 3,321.0 233.5 09/02/2011 Thailand -49.7 -191.4 -121.1 -1,053.8 -267.5 09/02/2011 Vietnam 2.5 5.9 5.9 64.0 13.7 09/02/2011 Pakistan 0.7 0.8 5.8 68.9 332.9 09/02/2011

Source: Bloomberg

Kobsidthi Silpachai, CFA - Kasikornbank [email protected] Warunee Sithithaworn – Kasikornbank [email protected] Nalin Chutchotitham – Kasikornbank [email protected]

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It is not rocket science that resumption of rainbow political activities, post the end of the emergency decree is giving a good excuse to take profits from Thailand and rotate it elsewhere in the region. The political implosions in the likes of Tunisia and Egypt will bring back memories of the recent past of the Bangkok events in the middle of last year and hence, a growing distaste for Thai financial assets. The risk premium is a tad higher, suggesting that the financial markets are expressing a sense of unease. Amidst growing risk averse coupled with a tight USD liquidity environment, the upward move in the USD/THB was accentuated further. Fig 1. Thai 5yr credit default swap…a gauge of risk premium

Fig 2. USD/THB: 30, 60, 200 day moving averages

Thai CDS 5Y

70

90

110

130

150

170

190

Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11

bps over Libor

2829303132333435363738

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

USD/THB 30 day avg 60 day avg 200 day avg

Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank

Unfolding events prompt a rethink There is a saying that “the shortest distance between two points is a straight line”. The reintroduction of the Thai risk premium in light of the idiosyncratic political characteristic complicates our call for a USD/THB target of 28.00 by 4Q11. We have taken notice that the central bank’s stance on FX intervention as toughened since mid November. Fig 3 shows that foreign portfolio flows have been instrumental accentuating the moves in USD/THB. The data points include USD/THB versus the sum of foreign flows on Thai equities and fixed income securities with the latter being larger. Based on statistics, correlation between USD/THB and foreign investment flows up to mid November were highly correlated up to 97%. Fig 3. Relationship between USD/THB & foreign portfolio flows (equity & fixed income) Jan to Nov 2010

Fig 4. Relationship between USD/THB & foreign portfolio flows (equity & fixed income) Jan 2010 to now

-50

0

50

100

150

200

250

1-2010

2-2010

3-2010

4-2010

5-2010

6-2010

7-2010

8-2010

9-2010

10-2010

29.029.530.030.531.031.532.032.533.033.5

sum of foreign equity / fixed income flows USD/THB, right axis, inverted

correlation was nearly 98% between Jan 2010 to mid Novebmer 2010

-500

50100150200250300350400

1-2010

2-2010

3-2010

4-2010

5-2010

6-2010

7-2010

8-2010

9-2010

10-2010

11-2010

12-2010

1-2011

27

28

29

30

31

32

33

sum of foreign equity / fixed income flows USD/THB, right axis, inverted

FX intervention was stepped up causing a break in pattern


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The breakdown in the relation became more obvious post mid November. Table 2 shows our estimate that in December 2010 the Bank of Thailand most likely bought an additional USD1.9 bn in excess of the balance of payments to steer the USD/THB in a new direction. This could be a game of “chicken”. The name might sound childish but it actually is an important concept in economics…primarily game theory.

Table 2. Thai balance of payments, FX reserves and estimated FX intervention levels

USD mn Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Exports fob 13,610.4 14,254.7 16,083.8 13,831.7 16,434.7 17,876.5 15,475.1 16,291.6 17,954.9 17,045.5 17,584.0 17,220.0 Imports cif -13,041.9 -13,801.8 -15,082.1 -14,032.5 -14,143.7 -15,334.2 -16,266.3 -15,439.8 -14,712.2 -14,772.9 -17,093.8 -15,911.0 Trade Balance 568.5 452.9 1,001.7 -200.8 2,291.0 2,542.4 -791.3 851.7 3,242.7 2,272.7 490.2 1,310.0 Current Account Balance 2,107.6 1,655.9 1,779.9 -299.2 1,164.0 820.9 -1,000.8 280.5 2,767.0 2,739.6 1,019.0 1,750.0 Capital and Financial Account Balance 2,743.4 -698.6 1,732.6 2,964.5 -2,607.8 741.2 2,979.8 3,205.9 1,125.8 2,404.6 Overall Balance of Payments 4,965.5 119.3 3,137.3 3,749.0 -989.3 2,166.4 1,412.2 3,589.4 4,269.8 5,821.7 820.3 2,263.0 FX Reserves 142,403.5 141,797.5 144,094.1 147,588.1 143,518.6 146,759.2 151,524.7 155,186.8 163,235.3 171,061.6 167,973.9 172,128.9 Change in FX Reserves 3,985.9 -606.0 2,296.6 3,494.0 -4,069.5 3,240.6 4,765.5 3,662.1 8,048.5 7,826.3 -3,087.7 4,155.0 Estimated intervention -979.6 -725.3 -840.7 -254.9 -3,080.2 1,074.2 3,353.3 72.7 3,778.7 2,004.6 -3,908.0 1,892.0

Source: CEIC, BOT, KBank

The popular source of cyber knowledge, “Wikipedia” defines and discusses “chicken” as follows:

The game of Chicken, also known as the Hawk-Dove or Snowdrift game, is an influential model of conflict for two players in game theory. The principle of the game is that while each player prefers not to yield to the other, the worst possible outcome occurs when both players do not yield. The name "Chicken" has its origins in a game in which two drivers drive towards each other on a collision course: one must swerve, or both may die in the crash, but if one driver swerves and the other does not, the one who swerved will be called a "chicken," meaning a coward; this terminology is most prevalent in political science and economics. The name "Hawk-Dove" refers to a situation in which there is a competition for a shared resource and the contestants can choose either conciliation or conflict; this terminology is most commonly used in biology and evolutionary game theory. From a game-theoretic point of view, "Chicken" and "Hawk-Dove" are identical; the different names stem from parallel development of the basic principles in different research areas. The game has also been used to describe the mutual assured destruction of nuclear warfare, especially the sort of brinkmanship involved in the Cuban Missile Crisis. The game is similar to the prisoner's dilemma game in that an "agreeable" mutual solution is unstable since both players are individually tempted to stray from it. However, it differs in the cost of responding to such a deviation. This means that, even in an iterated version of the game, retaliation is ineffective, and a mixed strategy may be more appropriate.

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In 1997, the Bank of Thailand and hedge funds had locked horns in a game of “chicken”, with the hedge funds shorting the baht while the Bank of Thailand bought baht to defend the peg. As bystanders became more biased towards the hedge funds, the defense crumbled since the peg was built on a house of cards with the odds stacked against the Thai central bank such as the long list of imbalances:

persistent current account deficits, rising financial leverage, land / real estate speculation, mounting short term foreign currency debt facilitated by the Bangkok

International Banking Facilities (BIBF), Thai firms conducting interest rate arbitrage by issuing euro convertible

debentures (ECDs) encouraged by the fallacy of no FX exchange risks For the present situation, it looks like luck has sided with the central bank as the foreign flows are swerving into outflows. By stepping up the FX intervention, foreign investors were discouraged from aggressively putting more money into the Thai markets since losses on FX will reduce their returns on the financial assets i.e. local currency capital gains and interest rate differentials. We agree that FX intervention and sterilization should be conducted on foreign portfolio flows since by not doing so, Thai juristic and natural persons would become unconsciously indebted to foreign funds, since we do not have the funds’ ownership. Conversely, the point that we have consistently stressed is that flows belonging to Thai juristic and natural persons i.e. current account flows should not be intervened for the following reasons:

It represents a cross subsidy between the external side and internal side of the economy i.e. exporters gain at the expense of the general population

…correspondingly, it facilitates wealth concentration. Said another way: “Spread the pain and concentrate the gains”

Supports moral hazard as Thai exporters would be discouraged from improving on productivity and quality for gaining a competitive advantage and continue to look to the Bank of Thailand to be competitive based on the price function alone.

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We are scaling back our USD/THB targets: 30.00 for 2Q11 and 29.00 for 4Q11 The new stance expressed by the Bank of Thailand on FX management reflects a more hands on style, being more aggressive in limiting the USD/THB downside and more lenient on the capping the USD/THB upside. This is a significant change from what we saw for the earlier part of 2010. With consideration to these points, we are scaling back our targets for USD/THB and revising them to:

30.00 for 2Q11 29.00 for 4Q11

Fig 5. KBank USD/THB model Fig 6. USD/THB Fibonacci levels

2830323436384042444648

01 02 03 04 05 06 07 08 09 10 11 12

actual model

KBank USD/THB model

28

29

30

31

32

33

34

Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11

USD/THB Min Max 23.6%38.2% 50.0% 61.8% 76.4%


We have not changed our major thesis for the USD/THB. The risk of the USD has been temporarily dismissed from the markets for the time being. Japan’s sovereign downgrade from AA to AA- by Standard & Poor’s is an attestation that countries can not go on forever without fiscal discipline. Greece is a reminder and so as with the rest of the PIIGS in the Eurozone. The Greenback, cyclically constructive…structually destructive The cyclical data points for the US economy seem constructive. The ISM index (the Institute for Supply Management, http://en.wikipedia.org/wiki/Institute_for_Supply_Management ), suggests that both the manufacturing and services continue to expand. A print north of 50 pts indicates that the business sectors anticipate expansions whilst a print south of 50 pts indicates expectations of contractions. Another litmus paper indicator is shown on fig 8. This is a calculation of the top and bottom line of companies listed on the broader S & P 500. The chart shows that both that current revenue and net income levels are about 96% of peak levels leading up to the financial crisis.

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Fig 7. ISM service and manufacturing Fig 8. S&P 500, revenues & net income

30.035.040.045.050.055.060.065.070.0

97 98 99 00 01 02 03 04 05 06 07 08 09 10

ISM Non-Manufacturing (service) ISM Manufacturing

4,000

5,000

6,000

7,000

8,000

9,000

10,000

00 01 02 03 04 05 06 07 08 09 10300

400

500

600

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900

revenue, USD bn (mkt cap / PSR) net income, USD bn (mkt cap / PER)


The previous should provide encouragement that the “I” part of “Y” of GDP (economists would denote Y = C + I + G +(X-M)), is looking better and better. The other and more important facet of final demand is consumption, which no doubt is hinged on prospect of current income, namely wages. January’s employment data points were rather confusing…should be call it heads or tails? Heads was the lower unemployment rate moving from 9.40% to 9.0%. Tails was the lower than expected absolute levels of job creation, namely “non-farm payrolls”, where the shoal of economists was looking for 146k but the reality was only 36k. The optimists blamed the lower reading on snow storms and weather related challenges rather than on the reluctance of US companies to add human resource costs. Fig 10 shows a worrying structural trend which is a continually declining labor participation rate. This is the ratio between the size of the labor force (people working and are looking for work) divided by the size of the total population. The decline can be due to a couple of reasons we can think of:

Americans are discouraged from looking for work since it during the past two years it has proven futile.

The demographic shifts towards an aging population as the baby boomers (Americans born post WWII) entire retirement.

Fig 9. Number of Americans out of work, unemployment rate

Fig 10. US labor participation rate declines

02000400060008000

10000120001400016000

00 01 02 03 04 05 06 07 08 09 10 112%3%4%5%6%7%8%9%10%11%

unemployed, k, left unemployment rate, % , right

5859606162636465666768

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

participation rate, % of total US population


Our concern here is that retirees are not active consumers which do not bode well for the Asian export market from a structural basis. Reconsidering these facts, the US is looking more and more like Japan. The other similarity is the “G” part of GDP. According to the Congressional Budget Office (CBO), the US Federal (excluding state) governments will rack up a USD 1.4 trillion budget deficit or about 9.8% of GDP. The aging population is

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definitely a factor and hence the need for healthcare reforms. But after 2011, the US federal government is still expected to spend money it doesn’t have i.e. more fiscal deficits which means that the mountain of debt will continue to climb… as long as Asian central banks remain naïve to lend on the premise that such debt will not be monetized. Sure, the US federal government will not default…when the debts become matured… Asian central banks will trade in one piece of paper for another piece of paper. Note that the US federal debt to GDP will exceed those severe levels during WWII.

Fig 11. US federal budget deficit to GDP Fig 12. US federal debt to GDP

-12-10

-8-6-4-2024

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017

2020

US budget surplus / deficit as % GDP projected

020406080

100120140160

40 44 48 52 56 60 64 68 72 76 80 84 88 92 96 00 04 08 12 16 20

US Federal Debt to GDP, % calculated, with Congressional Budget Office estimates


Beside the US Federal Government, the growing concern with the US (the United States) is with the state and local governments’ ability to keep themselves afloat amidst mounting debt. The following function in Bloomberg (MIFA <GO>) shows that the likes of California, Texas, New York are experiencing ever larger deficits. This means the Fed is unlikely to shift its ultra accommodative monetary policy anytime soon (please see the annex to the FOMC’s recent statement). More US dollars can eventually only mean lower prices. Table 3. The arguments for and against USD/THB directions

USD/THB positives USD/THB negatives Resumption / escalation of political unrest, which

prompts a more extended outflows of foreign portfolio flows out of Thailand

Increasing probability that the Eurozone breaks up, hence reallocation of foreign currency reserves back to the USD

Service account outflows from SET dividend repayments / Japan fiscal year closing

Increasing perceived political risk of emerging markets as seen in Tunisia, Egypt and the spreading to other parts of the Middle East and possibly Asia

Concerns that Asian central banks are behind the curve in controlling inflation. Inflation is the depreciation rate of money.

Current account surpluses of Thailand, meaning,

exporters outnumber importers. This is a result of irregularities in the Thai political and social landscape which thwarts domestic demand

Expectation of further USD/CNY downside as to supplement the fight against inflation

Continued Fed accommodative monetary policy, meaning more USD, lower USD price

Better economic growth prospects in Asia relative to the West

Political clarity on Constitutional amendments and general elections

Return of Thai portfolio flows e.g. from Korean bonds

Source: KBank

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Fig 13. The USA or USB, the United States of Bankruptcy


Federal Open Market Committee (FOMC) Statement January 26, 2011 Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer term inflation expectations have remained stable, and measures of underlying inflation have been trending downward. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow. To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its

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securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate. Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

Playing “chicken” with inflation? Economics is the study of opportunity costs and hence any decisions taken by economic agents will incur a trade off. The inconsistency in monetary policy of pricing baht with respect to other currencies (FX exchange rates) and with respect to time (interest rates) might be causing more problems than it solves. The riots in Tunisia and Egypt is said to be partly attributable to rising inflation. In layman’s term, inflation simply means that one is getting poorer as to oppose to gaining prosperity. The rise of China in the global economy is proving to more like a double edge sword. On the positive side, it is serving as a large production base as well as becoming a large market for goods and services. On the other hand, it is clear that the planet is being strained to supporting a population with over 1.36 billion with growing wealth of nearly 10% a year. Coupled with more frequent supply shocks from nature i.e. floods, drought, diseases, it is no wonder as to why the prices of commodities, whether it is metals, energy or agriculture have consistently climb. Fig 16 shows that before the fall of Lehman Brothers, there is a high correlation between China’s nominal GDP and the CRB (Commodity Research Bureau) index of 19 commodities including agriculture, energy and metals. Fig 14. China’s nominal GDP & CRB commodity index Fig 15. Not just coincidence

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Fig 16. …neither is this: China’s nominal GDP & Thai CPI

Fig 17. …as well as explaining a lot

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The question is, how can an increase in Thai policy rates control Thai inflation if inflation is more of a function of regional supply and demand rather than just Thai supply and demand? After all, this is by design via all the Free Trade Agreements sign for regional economic integration. Fig 17 shows that size of the Chinese economy has a large influence on Thailand’s inflationary environment. So, it seems that by playing “chicken” with portfolio flows, the central bank is also playing “chicken” with inflation. By allowing the baht to weaken amidst rising commodity prices, the transmission of imported inflation will be much more rapid. The Bank of Thailand’s recent inflation report strongly indicates a fear of rising inflation and that core inflation might get out of hand if interest rates remained low. The following table is the probability distribution for core inflation going forward. With the assumption that the repo remains at 2.25%, there is a 43% probability that core inflation will exceed the 3% upper band in 3Q11 and a 55% probability for 4Q11. Table 4. BOT Inflation Report, Core CPI probability distribution

Ranges: % 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 >3 0% 12% 43% 55% 11% 6% 3% 3%

2.5 3.0 2% 26% 31% 28% 24% 17% 11% 11% 2.0 2.5 22% 34% 19% 13% 32% 31% 25% 26% 1.5 2.0 51% 21% 6% 3% 23% 29% 32% 32% 1.0 1.5 23% 6% 1% 0% 8% 13% 21% 20% 0.5 1.0 2% 1% 0% 0% 2% 3% 7% 6%

<0.5 0% 0% 0% 0% 0% 0% 1% 1%

Source: BOT Inflation Report, Jan 2011

The major source of unease for the central bank is that economic growth has closed the output gap. In layman’s term, fig 20 shows what an output gap is. If the actual growth is above trend (in this figure, it is a simple best fit regression line), it suggests that the output gap has closed, meaning that there is little slack left in the production side. This would then indicate that the pass through of inflation (the depreciation rate of money) would be more readily transmitted. A case in point is our current problem with palm oil. If there is not enough slack on the supply side, there will not be enough goods to go around

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and prices have to rise anyways. Actually price ceilings might exacerbate the problem as black markets form where the price sold is higher than the price ceiling. Fig 18. Output gap has closed Fig 19. KBank BOT repo model

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We have inputted the assumptions suggested by the BOT Inflation Report which we believe that the MPC also believes in these assumptions, after all, BOT scholarships are not cheap and easy to come by. Fig 21 shows our repo model which is a behavioral model. Simply it gauges how the MPC responds to key economic data points (e.g. growth and inflation) as reflected in the repo rate. With the new assumptions, we view that the BOT is likely to take policy rates up to 3.25% by the end of the year, as opposed to our earlier call of 2.75%. The release of the MPC minutes (the first ever) shed a lot of light of their concerns for growing potential financial imbalances.

Minutes of the Monetary Policy Meeting of the Monetary Policy Committee Bank of Thailand 12 January 2011 Publication date: 26 January 2011 Members Present Prasarn Trairatvorakul (Chairman and Governor), Atchana Waiquamdee (Vice Chairman and Deputy Governor, Monetary Stability), Suchada Kirakul (Deputy Governor, Corporate Support Services), Ampon Kittampon, Praipol Koomsup, Siri Ganjarerndee, Krik-krai Jirapaet Financial Markets The Thai baht was volatile, appreciating relative to the US dollar on the back of capital inflows while depreciating in the beginning of 2011 due to sales of equity by foreign investors after better-than expected US economic data. Going forward, investors are expected to give greater weight to recovery in major countries, resulting in greater two-way movement of the baht as opposed to continued appreciation pressure observed in the previous year. In addition, the yield curve shifted slightly upwards following the previous MPC meeting reflecting market pricing of an interest rate hike this meeting. The majority of market participants surveyed expected the current MPC meeting to result in a rise in the policy rate by 0.25 percentage points while some expected an overall rise of 0.50-1.00 percentage points in 2011. International Economic Conditions Risks to global economic growth have fallen. The US economic recovery continued to strengthen. A survey of economists indicated that the majority viewed that the US economy would grow faster than forecasted and that employment would improve although risks from house prices remained. Nevertheless, certain MPC members expressed concerns regarding the

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continually high rate of unemployment. The European economy stabilized although money markets remained volatile due to concerns over sovereign debt. However, core member countries, especially Germany, are projected to become drivers of growth. The Japanese economy still faced deflation while the appreciating yen may impede growth going forward. The Asian economy continued to grow on the back of domestic demand and exports destined to both within the region as well as new markets with high growth potential. Overall, the region is becoming less reliant on the G3 economies. However, the risk to inflation for the region as a whole increased significantly. The uneven growth of advanced economies and emerging markets has led to varied monetary policy responses. Advanced economies pursued accommodative monetary policy to safeguard economic recovery while emerging markets tightened to maintain price stability and are expected to accelerate the pace of interest rate normalization in 2011. As a result, challenges for Asia going forward are likely to come from capital flow volatility and the appropriate pacing of monetary policy tightening. Domestic Economic Conditions Thai economic growth was projected to return to its long-term trend. The Thai economy continued to expand in Q4 of 2010 from the previous quarter in line with domestic and external demand. Going forward, growth will be supported by 1) private consumption expansion on the back of both agricultural and non-agricultural income, increase in the minimum wage, low unemployment and robust consumer confidence and 2) private investment, which despite some slowdown after accelerating in the prior period, should expand going forward due to favorable business confidence, high capacity utilization in many industries, and future investment plans to meet internal and external demand for goods in services and 3) fiscal stimulus from government income support programs for mostly low-income earners and government investment for both large projects and state enterprises which was expected to increase from the previous year. Export growth in the previous year exceeded expectations and was expected to continue its growth trend into 2011 due to Chinese and ASEAN economic expansion as well as the rising trend in advanced orders. In addition, various research houses projected strong export growth in 2011 supported by a rising export prices (except for fisheries where there is low pricing power) which was expected to partly mitigate the adverse effects of baht appreciation. Tourism activity was solid and was expected to expand going forward. In the monetary sector, private credit expanded well together with overall economic growth. The expansion in commercial bank credit was primarily due to demand from households. Corporate loans also increased and were projected to grow continuously in 2011. Commercial banks rapidly raised both deposit and loan rates following the policy rate hikes. In regards to price stability, inflation pressure increased from the previous period. Headline inflation accelerated in line with the rise in wages while core inflation picked up due to the pass-through of production costs into goods prices, especially prepared food and seasonings and condiments. The MPC assessed that inflation pressure going forward has increased due to both cost-push and demand pull factors. Cost-push factors include: 1) upward trend in oil and commodity prices on the back of global economic expansion; 2) increased pass-through from the Production Price Index (PPI) into Consumer Price Index (CPI) as authorities allowed price increases in many product categories; and 3) gradual pass-through of production costs to consumers as producers’ ability to absorb such costs became more limited. Demand-pull factors include: 1) a diminishing

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output gap as output growth neared potential while producers have revised their inflation expectations upwards for some time. These factors would speed up price adjustment going forward. In addition, some MPC members expressed concerns over the possibility that inflation may breach its target this year. Considerations for Monetary Policy. The MPC viewed that the risk to inflation had increased relative to the risk to growth compared to the previous meeting. The global economic recovery strengthened compared to the previous meeting. The risk of a double dip recession in the US declined while Asia faced the challenge of rising prices, particularly those of commodities. The Thai economy continued to return to its long-term growth trend. The MPC viewed that domestic demand would become the principal driver of growth in the coming period. In addition, strong export performance pointed to Thailand’s economic resilience in face of the baht appreciating in the previous period. Inflationary pressure clearly increased due to rising oil and commodity prices, the return of the Thai economy to its long-term growth trend and pent-up pressure from delayed price adjustments. At the same time, increases in the minimum and civil service wages may boost consumption expenditures more than expected and lead to a rise in inflation expectations going forward. Some MPC members were concerned that low real interest rates may foster financial imbalances, depress savings and lead to asset bubbles in the future. MPC members were unanimous in seeing the need to maintain continuity in signaling rate normalization. Robust economic expansion together with significantly increased inflationary pressure led to some members discussing the possibility of a rate hike of 0.5 percentage points. Nevertheless, the majority of MPC members viewed that policy rate adjustment should be gradual while taking into account that the neutral rate depends on changing economic circumstances. The MPC therefore decided unanimously (7 to 0) to raise the policy interest rate by 0.25 percentage points per annum, from 2.00 to 2.25 per cent per annum, effective immediately.

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Pricing in inflation risks

BoT’s message is simple – bring prices under control and correct

the level of real returns to savers

Investors had been reducing portfolio duration of portfolio during past 3 months while the yield curve is pricing in 100bp rate hike

In Asia, monetary tightening likely to be greater in economies that delayed rate actions – a negative for their bond markets

Local near-term inflationary threat looks benign, but Thai people’s consumption basket shows continued increase in food prices have greater impacts on low income and rural households

Yield curve outlook remains one of a bear-flattening

We expect consecutive policy rate hikes during the next three meetings while Q3 may see a further 25bp increase

Local interest rates update

The Bank of Thailand (BoT) had raised its policy rate for the fourth time since July 2010 and signaled that further hikes are in the pipeline to preempt acceleration in actual price levels and expectations. Such expressions were reiterated in its quarterly publication, Inflation Report, released on January 24th. The BoT left forecast of core inflation rate unchanged at 2.0 - 3.0% this year and indicated a high probability (>40%) of them missing policy target in the third and fourth quarters. That is, given the assumption that policy rate remained unchanged at 2.25% for the next 8 quarters. Moreover, the BoT continued to express concerns over negative real deposit rates that could form the basis of imbalances in the economy over the medium-run. The implication is simple - apart from bringing prices under control, there is a need to correct the level of real returns to savers. So far, the adjustments of fixed deposit rates and minimum lending rates had been rapid. At least when compared to the previous policy rate up-cycle. Fig 20. Changes in deposit rates Fig 21. Government bond yields change

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With the repeated signals from the policymaker, local markets are continually pricing in new expectations as well. Interest rates had been on a gradual but steady up-trend

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recently, with substantial liquidity continually keeping bond yields from overshooting the changes in the policy rate. Nevertheless, there had been a series of more aggressive swings in bond yields and swap rates as well. This was especially so about a week prior to the monetary policy decision day as investors adjust portfolios more actively. In particular, investors continued to reduce their portfolio durations in expectation of further interest rate hikes. This could be observed via the trading volume of government bonds during the recent three months. Outright trading volume of bonds that have maturities more than 7 years had declined by 46% from November to January while trading volume of 1-3 year bonds increased by 44% during the same period. At the same time, bonds with maturities 3-7 years saw a less significant change. Table 5. Thai yield movements and curve spread Month-end 1Y (%) Chng (bps) 2Y (%) Chng (bps) 5Y (%) Chng (bps) 10Y (%) Chng (bps) 2-5 spread 2-10 spread

Oct-10 1.98 3 ▼ 2.31 4 ▼ 2.83 27 ▲ 3.18 6 ▲ 52 ▲ 87 ▲ Nov-10 2.11 13 ▲ 2.38 7 ▲ 2.98 15 ▲ 3.59 41 ▲ 60 ▲ 121 ▲ Dec-10 2.38 27 ▲ 2.8 42 ▲ 3.26 28 ▲ 3.77 18 ▲ 46 ▼ 97 ▼ Jan-11 2.54 16 ▲ 2.96 16 ▲ 3.40 14 ▲ 3.85 8 ▲ 44 ▼ 89 ▼

9-Feb-11 2.60 6 ▲ 2.99 3 ▲ 3.49 9 ▲ 3.86 1 ▲ 50 ▲ 87 ▼ Source:Bloomberg and KBank

Fig 22. Outright trade volume of government and BoT bonds by bond maturity

Fig 23. Government bond yields change

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Inflation theme is a dominant theme in the region

Inflation risks and monetary tightening had become more prominent in Asia in recent months. Although most economies exhibit inflation rates below 4%, the up-trend in commodity prices, especially agricultural items, are making central banks nervous. At the same time, high levels of liquidity in the financial markets continued to bolster asset price increase in many of Asian economies. This suggests that central banks would have to stay extra vigilant against economic imbalances for quite some time. The two figures below show three things: headline inflation rates, policy rate change since central banks started hiking in the year 2009, and market’s expectation of 1-year forward change in short-term interest rates. We note that expectation for monetary tightening this year is greater for the economies that were relatively slower in raising policy rate during the past couple of years e.g. Philippines and Indonesia. This does not bode well for the bond market in such economies. In fact, investors had started to unload some of their medium to long-term bond holdings in the Indonesian and Filipino bond markets. Yields of 5-year sovereign bonds saw substantial increase during the first two months of the year relative to regional bond market.

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Fortunately, we think, spikes in yields are less likely to happen in Thailand. The BoT is likely to be ahead of the curve for its policy rate adjustment this time round and there remains ample liquidity in the hands of investors to help absorb impacts of bond yields from higher inflation rates going forward. We do have concerns, however, about the continued price controls in Thailand. Government’s subsidies and regulations are beneficial in the short-run as the public needed time to adjust but prolonged price controls had in the past led to less efficient use of resources and delays in demand adjustment of the people. In other words, inflationary pressure are only postponed and not likely to be reduced in the medium term by exercising more cautious spending.

Fig 24. Market’s expectation of interest rate increase Fig 25. Market expect more hikes from central banks

that moved relatively slower

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A few more reasons to be concerned about inflation

In Thailand, there are indeed concerns with price pressure going forward, especially with food prices. While the 3% headline inflation rate during the past two months seemed benign, compared to the inflation rates during the 2008 oil price crisis, impacts on households and business people may not be much different. Next, we go back to the construction of the consumer price index (CPI) and attempt to obtain a clearer view of what the CPI can tell us on top of change in general price level. At the same time, we compare price changes of each product category to magnify the magnitude of food price inflation and finally show why we are concerned about the lower income and rural households. From the figures below, we could make a few easy observations. The price index of tobacco and alcohol as well as the price index of food and beverages experienced substantial gain since December 2008. Meanwhile, growth rate of transport and communication items had been among the highest as well, but note also that its slump in 2008 had also been large. Comparing current price indices with record high levels, we observed that cost of transportation and communication is the farthest from its record-high level - not that costs are low, but this goes to show that a large change during the past two years was not accompanied with costs breaching new highs. Fig 27. Thailand’s policy rate and inflation Fig 28. Gains in price indices since Dec 2008

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Fig 29. Price indices of individual category of product

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Source: CEIC, KBank

We combine the above findings with the weights of different product category in the CPI basket (see table below). Since the CPI basket is based on actual household expenditure (based on National Statistical Office’s Social and Economic Survey), we can approximate the burden on household expenditure. The top three highest weights, in descending order, are 1) food and beverages, 2) transport and communication, and 3) housing and furniture. From here, we may begin to worry about the rising prices of food and beverages. Indeed, we should be so worried about food prices. The next figure below shows the growth rate of the Food and Agriculture Organization’s (UN) food price index as well as Thailand’s producer price (PPI) and consumer price inflation rates. As we would expect that global prices may take a few months to affect local prices, we pushed forward the FAO food index series by 3 months and found that its growth pattern coincides with Thailand’s PPI and CPI growth. Unfortunately, this also indicates that local prices may rise higher during the next few months.

CPI Type % Share in CPI basket (proxy share of household expenditure)

Food &

Beverages Clothing & Footwear

Housing & Furniture

Health & personal care

Transport & communication

Tobacco & alcohol

Recreation & education

Non-food & beverage

CPI (2000) 36.06 3.40 23.86 6.04 21.99 2.83 5.82 63.94

CPI (2007) 33.01 2.96 23.48 6.87 26.80 1.66 5.21 66.99

Low income CPI 41.21 2.58 24.62 6.11 19.07 2.30 4.10 58.79

Rural area CPI 41.81 3.45 21.35 5.81 22.10 1.75 3.74 58.19 Source: MOC, KBank

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Fig 30. UN FAO food price index and local inflation Fig 31. Inflation: rural areas and low income

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Next, we compare the CPI baskets of different types of household to highlight he probability that price pressure would hit those who least could afford it. First, observe that nationwide inflation rate is substantially below those that belonged to the rural area and low income households. While we have not the in depth analysis of this divergence, the underlying reason should be rather intuitive. The increases of energy and food prices, which are the more volatile items in the CPI basket, should have a greater impact on the consumption power of the rural and lower-income households. (A re-visit to the CPI basket weight in the table above would help) The two categories of goods make up necessary consumption for day-today living and short-term adjustment in overall household expenditure is likely to be difficult. At the same time, there is less flexibility in terms of product substitution for food and energy, unlike items like clothing and furniture where a lower-income household could opt for more affordable choices. Hence, we are likely to continue seeing such price-impact divergence among the different groups of households. This is also another reason why the central bank is concerned about rising inflation and the necessity to curb the pace of price acceleration and inflation expectation.

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Economic Update

Key economic indicators for Dec-10 were mixed. Exports fell, following a sharp gain in the previous month. However,

figures beat the consensus forecast. Business sentiment displayed growing wariness toward rising

production costs, while private investment and consumption eased. The tourism sector showed a broad-based recovery from flooding,

with the number of foreign tourist arrivals hitting a historic high. A base effect kept the Headline CPI stable YoY, but the MoM rate of

increase accelerated on higher prices for fresh foods and energy. Better-than-expected figures in Nov-10 and Dec-10 have led us to

revise our 4Q10 and 2010 GDP upward slightly to 3.5% and 7.8% YoY, respectively.

Although our full-year 2011 GDP forecast remains unchanged at 4.5% YoY in our ‘most-likely’ predictive case (4.0-5.0% range), some components have been revised to better accommodate higher oil price risks, following political turmoil in some Mideast countries.

Table 1. Thailand Key Economic Indicators

Units: YoY %, or indicated otherwise 2009 2010 2010 2011 3Q10 4Q10 Nov Dec Jan

Composite Private Consumption Index -2.5 5.7 4.9 2.9 4.5 3.8 • Sales Volume of Benzine and Gasohol 5.7 -1.4 0.8 2.4 7.6 1.2 • Value-added Tax at 1995 prices -10.2 15.5 13.0 8.3 9.7 10.3 • Imports of Consumer Goods at 1995 prices -6.2 22.6 16.3 13.7 16.9 12.7 • Passenger Car Sales 4.2 54.7 58.6 36.6 40.9 28.5 • Motorcycle Sales -13.0 22.9 21.1 9.5 9.3 18.2

Private Investment Index (PII) -11.2 17.6 20.1 11.0 15.5 11.0 • Sales Volume of Domestic Cement -2.4 4.2 0.8 -3.1 -1.8 -0.3 • Sales Volume of Commercial Cars -19.2 39.2 39.5 31.6 36.3 29.8 • Imports of Capital Goods at 1995 prices -15.9 24.9 27.1 15.3 20.5 13.8 • Value of BOI Applications 47.6 -29.9 -18.6 -51.5 28.7 -74.7

Manufacturing Production Index -7.2 14.5 9.8 2.9 5.7 -2.5 • Industrial Capacity Utilization 56.1 63.4 64.2 63.6 63.6 63.4

Agriculture Production Index -0.3 -3.2 -6.6 -2.9 -5.3 3.1 • Agriculture Price Index -10.5 25.7 30.2 25.8 26.0 22.7

Exports (in $) -14.0 28.5 22.2 21.1 28.7 18.6 • Unit Value 0.3 9.1 7.4 7.3 7.5 6.7 • Volume -14.3 17.7 13.8 12.9 19.6 11.1

Imports (in $) -25.2 36.8 30.7 18.8 35.0 8.8 • Unit Value -2.5 8.1 6.0 6.5 6.1 7.0 • Volume -23.2 26.6 23.3 11.5 27.3 1.6

Trade Balance ($ millions) 19,388 14,031 3,303 4,072 490 1,310 Current Account ($ millions) 21,866 14,784 2,047 5,509 1,019 1,750 Broad Money 6.8 10.9 9.9 10.9 11.2 10.9 Headline CPI -0.9 3.3 3.3 2.8 2.8 3.0 3.0 $/THB (Reference Rate) 34.335 31.727 31.634 29.991 29.886 30.118 30.584 Source: BOT, MOC, OAE, and OIE

Thanyalak Vacharachaisurapol - KResearch [email protected] Kevalin Wangpichayasuk - KResearch [email protected] Kangana Chockpisansin - KResearch [email protected]

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Exports consolidated MoM, after a healthy gain in Nov-10 Although exports for Dec-10 softened MoM to $17.2 billion, down from the $17.6 billion in Nov-10, they managed to beat the expectations of many analysts that thought a more notable correction was likely after the healthy gain in Nov-10. This MoM drop, coupled with a base effect, helped force the growth of exports down to 18.6% YoY, compared to the 28.7% YoY growth seen in Nov-10. Excluding gold, adjusted export growth was also down to 15.7% YoY, compared to the 25.7% YoY recorded in Nov-10. Fig 1. Dec-10 exports consolidated MoM, after a sharp gain was seen in Nov-10

Fig 2. MoM decreases largely concentrated within leading export products

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Gold Vehicles & Parts Computer & PartsPetroleum Products Electrical Appliances RiceIC and Parts Base Metal Products

Source: BOT, MOC, KResearch Source: BOT, CEIC, KResearch

Looking into the details of key export products, apparent MoM decreases were largely seen within leading export product categories – including vehicles, parts and accessories; electrical appliances; jewelry & gold; and petroleum products. However, agricultural products – e.g., rice, rubber and tapioca products – continued to reap MoM gains, due largely to their seasonality, plus extra demand for rice amid food shortages elsewhere. Classified by export market, MoM decreases were seen in ASEAN, the Mideast, U.S. and Japan. However, when compared to the previous year, a base effect contributed to a different picture on exports to Japan and India, where accelerating growth YoY over Nov-10 figures was seen, while exports elsewhere had recorded decelerating growth. For the full year of 2010, more active intra-regional trade per free trade agreements, coupled with relatively healthy economic growth in Asia, resulted in a gradual shift in Thailand’s export structure to a greater dependency on ASEAN, India and China. However, countries with sluggish economic recoveries during 2010 – including in the U.S., and EU – caused drops in exports to those destinations. China thus managed to climb to the top in export recipient rankings (11.0% share, versus 10.6% in 2009), beating Japan (10.5% share, against 10.3% in 2009) and the U.S. (10.3% share, versus 10.9% in 2009).

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Fig 3. Most major export markets, except Japan and India, saw decelerating YoY growth in Dec-10

Fig 4. China has become our top trade partners, beating Japan and the U.S.

(10)

0

10

20

30

40

50

U.S. China Japan EU (27) ASEAN (9) India Middle East

% Y

OY

2Q10 3Q10 Oct-10 Nov-10 Dec-10

10.9

2.1

5.7

21.322.7

11.910.310.6

11.2

4.92.2

10.311.0 10.5

0

5

10

15

20

25

China Japan U.S. India Middle East EU (27) ASEAN (9)

% S

hare

2008 2009 2010

Source: BOT, MOC, KResearch Source: BOT, KResearch

Imports plunged more deeply than exports in Dec-10 to $15.9 billion, down from the $17.1 billion in Nov-10. In addition, a base effect also contributed to a significant slowdown in the YoY growth of imports to 8.8% YoY, compared to the 35.0% YoY in Nov-10. In terms of import classification, major categories all showed broad-based falls MoM and YoY. As imports had plummeted more than exports, the Dec-10 trade surplus widened to $1.3 billion, down from the $490 million in Nov-10, thereby contributing to a higher current account surplus of $1.8 billion, versus the 1.0 billion achieved in Nov-10. This was despite a slightly lower surplus in the service, income and transfer account to $441 million, down from the $529 million in Nov-10, in tandem with higher profit remittances that hazed healthier tourism revenue. The number of foreign tourist arrivals hit a record high in Dec-10 The tourism sector enjoyed continued recovery in Dec-10. In fact, the number of foreign tourist arrivals managed to hit 1.8 million, which was a record high, improving significantly over the 1.5 million in Nov-10 (despite cooling YoY growth in tandem with a base effect). Meanwhile, the hotel occupancy rate surged to 58.2%, compared to the 55.4% in Nov-10, following higher accommodation take-up rates in the North, Northeast and South (which was hurt by flooding in Nov-10). Fig 5. The number of foreign tourist arrivals hit a record high in Dec-10

Fig 6. The hotel occupancy rate improved significantly in Dec-10

0

500

1000

1500

2000

Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10

No.

of F

orei

gn T

ouris

t Arr

ival

s(M

illion

)

-20

-10

0

10

20

30

40

50

Dec-09 Mar-10 Jun-10 Sep-10 Dec-10

Fore

ign

Tour

ist A

rriv

als

(% Y

oY)

33

38

43

48

53

58

63

68

Hot

el O

ccup

ancy

Rat

e (%

)

Foreign Tourist Arrivals (lhs) Hotel Occupancy Rate (rhs)

Source: TAT, BOT, KResearch Source: TAT, BOT, KResearch

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30

Manufacturing production slipped YoY According to data released by the Office of Industrial Economics (OIE), the Manufacturing Production Index (MPI) for Dec-10 had edged slightly upward MoM (seasonally-adjusted), but drifting downward YoY into the contraction zone at 2.5% YoY, versus 5.7% growth YoY in Nov-10, in light of a high base of comparison. When looking into the details, the MPI for exports greater than 60% of their total production went into decline (contracting 8.9% YoY, compared to the 2.2% growth in Nov-10), because many industries – especially hard-disk drive assemblers – had sped up production during the months before. However, the MPI for exports between 30%-60% of their total productions and for exports lower than 30% of their total production were able to retain YoY growth momentum. The OIE’s capacity utilization rate for Dec-10 decelerated slightly to 63.4%, down slightly from the 63.6% in Nov-10.

Fig 7. Manufacturing production cooled, with export-led goods heading the decline

Fig 8. Business sentiment showed growing concern toward rising production costs

-505

101520253035

Dec-09 Mar-10 Jun-10 Sep-10 Dec-10

% Y

oY o

f MPI

5052545658606264666870

% C

apac

ity U

tilizati

on R

ate

% Capacity Utilization (rhs) MPI (lhs)

25.030.035.040.045.050.055.060.0

May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10

BSI

60.0

70.0

80.0

90.0

100.0

110.0

120.0CCI & TISI

BSI BSI (Expected for the next 3 mths) CCI TISI

Source: OIE, KResearch Source: BOT, UTCC, FTI, KResearch

Business sentiment weakened In Dec-10, private sector confidence soared at the business-end, however, the consumer front was still recovering from flooding and there was wariness toward political turmoil, both hitting their confidence in Nov-10. Apparently, the Consumer Confidence Index (CCI) ended the previous two-month losses, by increasing to 80.8 in Dec-10, from 79.0 in Nov-10. The Thai Industries Sentiment Index (TISI) increased to 109.7 in Dec-10, beating the 99.7 in Nov-10, thus reaching ‘expansion’ territory at above the 100-points threshold, in tandem with growing optimism amid relatively healthy orders (during the high spending season), plus higher farm income and friendly political climate. However, concern toward rising production costs became more pronounced for business, which caused the Business Sentiment Index (BSI) to retreat from 52.5 in Nov-10 down to 51.6.

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Fig 9. Private investment and consumption weakened in Dec-10

Fig 10. …Their YoY growth also cooled

-2

-1

0

1

2

3

4

5

Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10

% M

oM, S

.A. o

f PII

and

PCI

Private Consumption Index (PCI) Private Investment Index (PII)

-20-15-10-505

10152025

2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 Oct-10 Nov-10 Dec-10

% Y

oY of

PII a

nd P

CI

Private Consumption Index (PCI) Private Investment Index (PII)

Source: BOT, KResearch Source: BOT, KResearch

Private investment and consumption scaled back Although the flooding had eased, domestic spending remained in the doldrums in Dec-10. Both Private Investment Index (PII) and Private Consumption Index (PCI) had plunged, seasonally-adjusted, with the PII contracting for the third time in 4 months. A YoY comparison suggests a similar pattern, with cooling PII and PCI moving downward to 11.0% and 3.8% YoY, respectively, compared to 15.5% and 4.5% YoY previously. This slowing growth momentum was seen in passenger and commercial car sales, real imports of capital and consumer goods, as well as cement sales. Despite stable YoY growth, Jan-11 inflation continued to gain MoM In Jan-11, the Headline CPI was held steady at 3.0% YoY. However, this was due to a base effect, as the MoM change in the Headline CPI had gained 0.54%, compared to the 0.16% in Dec-10, following higher prices for fresh foods and energy (although diesel fuel prices had barely changed with a government subsidy). It was echoing a global inflation trend that has recently been exacerbated by food shortages in many countries. Excluding the prices of fresh foods and energy, the MoM gain in the Core CPI eased to 0.17%, from 0.35% in Dec-10. However, a base effect contributed to cooling YoY growth in the Core CPI, reaching 1.3% YoY, down slightly from the 1.4% YoY in Dec-10.

Fig 11. Despite stable YoY growth, inflation continued to gain MoM

Fig 12. In addition to higher oil prices, escalating food prices MoM were behind a rising CPI

-0.2-0.10.00.10.20.30.40.50.6

Jan-10 May-10 Sep-10 Jan-11

% M

oM

0.00.51.01.52.02.53.03.54.04.5

% Y

oY

Headline CPI (MoM-lhs) Core CPI (MoM-lhs)Headline CPI (YoY-rhs) Core CPI (YoY-rhs)

9.0%

1.07

-0.60-0.40-0.200.000.200.400.600.801.001.201.401.60

-2.00

0.00

2.00

4.00

6.00

8.00

10.00OIL AND FAT (LHS)FOOD AND BEVERAGES (RHS)

Source: MOC, KResearch Source: MOC, KResearch

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Given a complete set of full-year key indicators, our 4Q10 and 2010 GDP forecast has been revised slightly upward Following some better-than-expected figures seen in Dec-10 (such as exports) and Nov-10, we have thus revisited our forecast on the 4Q10 and 2010 GDP that will be released on February 21, 2011. There seems to be a higher possibility that the 4Q10 economy will be seen to have grown a 3.5% YoY rate, which is better than the 3.0% YoY anticipated previously, implying definite QoQ growth (seasonally-adjusted). To this end, the 2010 GDP could reach 7.8% YoY, compared to our previous projection of 7.6% YoY. Our 2011 GDP forecast stands pat at 4.0-5.0%, with ‘most-likely’ case being 4.5%, but our mix has been revised to better accommodate higher oil price risks During the past month, G3 economies continued to move as expected, especially the U.S. that has gradually shown developments that are more positive in their key economic indicators. However, food shortages that have even reached the level of crisis in some countries – like Egypt – have pressured not only soft commodity prices, but also oil prices through mounting apprehension toward possible disruptions to oil shipments via the Suez Canal. Although the direct impact of the Egyptian turmoil on the Thai economy is expected to be marginal (occupying only 0.4% of our total exports), as long as any domino effect does not work its way over to other countries in the Middle East, or Africa (that command an 8.4% share of our exports); the Thai economy could be affected indirectly through higher oil prices. To this end, we have revised our forecast for the average Brent crude price upward to $95/ bbl., from the $93/bbl. to better accommodate any possibility that Brent crude might temporary drift upward above $100. Consequently, our 2011 import forecast has been revised slightly upward to 15.0% YoY, from 14.0% YoY previously, thereby pressuring our trade and current account surpluses down to $6.5 and $7.5 billion, respectively, from our previous projections of $8.4 billion and $9.4 billion. However, our GDP projection for 2011 remains unchanged within a range of 4.0-5.0% YoY, with the 4.5% growth being noted as our most-likely case. As for the inflation outlook, although we are keeping our existing forecasts for the 2011 Headline CPI and Core CPI figures, a base effect and heightened commodity prices will likely drive the Headline CPI to a peak of around 4.0% YoY in the final months of 2011. This would be despite the fact that the public might see cooling inflation over the next several months, for the same base effect reasons. As for the Core CPI, it could approach the upper-end of the BOT’s Inflation Targeting range in the last several months of 2011, which implies a need for the authorities to tighten their policy rate further.

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33

Fig 13. KResearch’s Quarterly GDP Forecast Table 3. KResearch’s Indicative Forecasts

% YoY 2009 2010F 2011FGDP -2.3 7.8 4.5

Private Consumption -1.1 4.5 3.7

Total Investment -9.2 9.4 8.8

Gov. Budget (% of GDP) -5.6 -3.2 -3.8

Exports -14.0 28.5 10.0

Imports -25.2 36.8 15.0

Current Account (USD bn) 21.9 14.8 7.5

Headline Inflation -0.9 3.3 3.3

Source: KResearch, Preliminary as of February 3, 2010, and NESDB Source: KResearch, Preliminary as of February 3, 2010.

The Outlook for Next Month In Jan-11, export growth could continue to slide downward MoM, possibly bringing over-year growth down to around 17.0% YoY, from the 18.8% YoY seen in Dec-10. In the meantime, due to a base effect, the MPI will likely show growth YoY, compared to the 2.5% contraction YoY in Dec-10; while the Headline CPI for Feb-11 is expected to stay below 3.0% YoY (although higher prices for soft commodities and energy will continue to pressure inflation MoM). Due to possible increases in prices of goods in the Core CPI basket, it is expected to drift upward, reaching around 1.5% YoY, from the 1.3% seen in Jan-11.

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Strategy: Market pace changes to sideways

Investment theme: ► The continued rally we called last month did not happen and the market fell to 950,

also below what we predicted to be the support level at 980. The market psychology has changed and we now no longer expect a sharp directional trade. The SET is shifting pace and will become sideways.

► The Thai economy is entering a later-stage recovery cycle, an environment that is less positive to the stock market. However, the fundamentals in terms of earnings and valuation have changed little, allowing us to maintain our 2011 SET fair level at 1220 but this target is now likely to be hit by 2H11 rather than 1H11 as originally thought.

► In the environment of volatile USD/THB exchange rate, widening Baht and USD short term rates and inflows of maturing FIF bonds, spurts of short-term liquidity will be injected with potential to overflow onto the SET, triggering the index to spike. In the short term, we recommend investors to reduce equity holdings should the SET index crosses over 1055 (its recent high) and to accumulate on weakness at 950.

► While Thailand and developing economies are speeding into an inflationary environment, the developed economies are showing stronger signs of sustainable economic recovery. The divergence of economic cycles calls for sector re-allocation towards ‘Services’ and ‘Commodities’.

► We are Overweight on energy, agricultural, media, hotel, hospital, commerce, contractor and industrial estate.

► Our top picks are BANPU PTT PTTCH KTB STA CPALL MINT MCOT BGH STEC and AMATA. We add MCOT to our top picks to replace TOP.

Diverging economic cycles The SET index has climbed 140% since Mar-09 when the 2-year bull market started. In the last two weeks, the market has corrected by 6% from its recent peak at 1055. Although we thought the party would continue a little longer, driven by widening spreads between Thai Baht and USD short term rates, foreign investors decided to end it soon enough and took profits. Their capital gains were also assisted by an additional 12% gain from the USD/THB appreciation over this period.

We believe the liquidity dynamics have now changed although the fundamentals in terms of earnings and valuation have changed little. We are now entering a different phase of an economic cycle and history shows that the stock market reacts differently to different phases within a cycle. Before explaining our current position, we will explain what are the 4 phases that we see:

1. Early recession. At this stage, sentiments range from fear to terror. Industrial production plunges, interest rate falls rapidly and unemployment begins to rise. The stock market also takes a sharp dive of more than 50% from it peak.

Kavee Chukitkasem - KSecurities [email protected]

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2. Full recession. Gross domestic product tumbles, interest rates keep continue to fall and unemployment rising. The market continues to drop but at a slower rate than in the early recession as investors have more or less absorbed the worst-case scenario.

3. Early recovery. Consumer sentiment improves, industrial production turns up, interest rates hit bottom, inflation remains low and unemployment peaks. The stock market rebounds rapidly.

4. Late recovery. Interest rates rise as the central bank fights to control inflation, consumer sentiment softens and industrial production becomes flat. The stock market starts to move sideways. The length of this stage depends on the success of authorities to regulate growth.

We believe that the Thai economy is approaching the full recovery phase or in the late-stage of recovery as GDP growth trend weakens and inflation accelerates. The current phase of the economic cycle resembles what we experienced in both 2000-2003 and 2004-2007 (figure 1 and 2) when the SET spent most of its time moving sideways but with an uptrend. The good thing about those two previous cycles is that after moving up sideways in 2000-2002 and 2004-2006, the market surged in 2003 and 2007, respectively as GDP growth did not slip back into the negative territory.

We expect the Thai economy and stock market to follow the patterns of those two periods. KResearch expects 1Q11 sequential growth will be flat (only 1.6% growth) with growth expected to gain strength thereafter, 3.8%, 5.7% and 6.8% for 2Q11 to 4Q11 respectively. On the other hand, headline inflation will peak, in 4Q11, at only 4% this year, much lower than that of our regional peers (see Figure 1). We do not think that the economy will follow the path set in 2008. The forward projected CPI and GDP forecasts are presented in figure 2 which show that both CPI and GDP growth are expected trend up consistently from 1Q11 to 4Q11 but inflation is expected to be slower going into 2012. However, we are expecting the Thai Baht policy rate will peak in July-August at 3.25%.

In conclusion, we expect the SET index to trade sideways up but our fair 2011 SET index level of 1220 will likely be met in 2H11 instead of our previous call in 1H11. Inflationary concerns are expected to rule sentiments while the central bank steadily increases its policy rate. But stronger GDP growth expected to pan out in 2H11 will convince investors that economic growth will not sputter and this will provide positive support to market sentiment.

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Figure 1: GDP growth VS inflation over the past 10 years

200

400

600

800

1000

1200

-10.0

-5.0

0.0

5.0

10.0

15.0


GDP (%) CPI (%) SET (RHS)

Source: BOT, KS, KR (dotted lines are based on KR’s forecasts)

Figure 2: 2011 GDP and CPI forecasts (% YoY) Headline CPI GDP growth

Jan 3.0

Feb 2.9

Mar 2.9

1.6

Apr 2.9

May 3.2

Jun 3.1

3.8

Jul 3.2

Aug 3.3

Sep 3.6

5.7

Oct 4.0

Nov 4.0

Dec 4.0

6.8

Source: KR

Sector rotation Besides dictating market direction, different economic phases also provide different environment for different sectors to thrive or disappoint. Over the last two years the SET index soared 140%, but not all sectors performed equally. Some that dramatically outpaced the market include petrochemicals, agriculture, construction materials, auto, commerce, banking and property and others have lagged significantly (figure 3). This is because of sector rotation.

During the early stage of an economic recovery, low inflation and interest rates prevailed. This is a condition that the banking and property sectors perform well. Later, as recovery gains pace, inflation accelerates, cyclical sectors start to outperform. Finally, the service sectors (hospital, hotel and media) begin to do well as economic growth slows and inflation reaches a peak.

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Figure 3: Sector performance relative to SET index since March 09

-200.0% -100.0% 0.0% 100.0% 200.0% 300.0% 400.0%

PROF. SERVICESINFO & COMM TECH

TOUR & LEISUREPAPER & PRINT

FASHIONMINING

PERSONAL & PHARM.MEDIA & PUBLISHING

FINANCEHEALTH CARE SERVICE

HOME & OFFICEINSURANCE

ENERGY & UTILITIESSET INDEX

TRANS & LOGISTFOOD/BEVERAGE

PROP. DEVELOPMENTBANKING

AUTOMOTIVECOMMERCE

ELECTRONICSCONST. MATERIAL

PACKAGINGAGRI-BUSINESS

PETROCHEM

Source: Bloomberg

Figure 4: Sector performance relative to SET index during Feb-2000 to June-2001

-40.0% -20.0% 0.0% 20.0% 40.0% 60.0%

PAPER & PRINTENERGY & UTILITIESPERSONAL & PHARM

FASHIONPACKAGINGINSURANCE

MININGFOOD/BEVERAGETOUR & LEISURE

AUTOMOTIVEPROP. DEVELOPMENT

COMMERCEPROF. SERVICES

CONST. MATERIALAGRI-BUSINESS

FINANCEHEALTH CARE SERVICE

HOME & OFFICESET INDEX

MEDIA & PUBLISHINGTRANS & LOGIST

BANKINGINFO & COMM TECH

ELECTRONICSPETROCHEM

Source: Bloomberg, KS (Entertain includes only BEC, GRAMMY, MAJOR, MCOT, RS and WORK)

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Figure 5: Sector performance relative to SET index during Feb-2004 to Oct-2004

-30.0% -10.0% 10.0% 30.0% 50.0% 70.0%

HEALTH CARE SERVICEPERSONAL & PHARMENERGY & UTILITIES

MEDIA & PUBLISHINGINFO & COMM TECH

TOUR & LEISUREINSURANCE

AGRI-BUSINESSPAPER & PRINT

FOOD/BEVERAGEFASHION

PETROCHEMCOMMERCESET INDEXBANKING

CONST. MATERIALTRANS & LOGIST

PACKAGINGHOME & OFFICE

MININGFINANCE

PROF. SERVICESAUTOMOTIVEELECTRONICS

PROP. DEVELOPMENT

Source: Bloomberg, KS (Entertain comprises only BEC, GRAMMY, MAJOR, MCOT, RS and WORK)

The outperformance of service sector during a late-stage economic cycle can be fundamentally explained by the fact that the sector is relatively unaffected by rising cost pressures from inflation as most of its cost components are fixed in nature. Meanwhile, commerce companies can also relatively easily pass the higher costs from inflation on to the customers. Visitors to hotels and hospitals are also less price sensitive, given the spending nature which is discretionary.

Under the current economic trend, we see downside risks to the banking and cyclical sectors. As shown in figures 4 and 5, the banking sector underperformed the market both in 2000 and 2004.

While Thailand and other developing economies are in the late-recovery phase, the US and EU are in the early-recovery stage. Their dominant size will require that energy prices will be on uptrend as demand rises. KResearch has revised up average Brent price from USD93/bbl to USD98/bbl for 2011. We also like soft commodities which are related to food. Better standard of living in China and India and increasingly severe and unpredictable weather conditions are long term factors that will keep prices of soft commodities on the uptrend.

In line with our theme, we recommend investors use this current consolidation to start accumulating energy, tourism, healthcare, media, commerce and agricultural stocks as we expect them to outperform the market over the next six months. They are ‘overweight’ in our sector allocation.

Energy stocks will benefit from the recovery of developed economies although we do not expect the oil price to climb significantly this year. Currently, brent price is 99.7/ bbl compared to our new brent forecast of USD98/ bbl. Our top pick is PTT.

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Tourism and healthcare have had to deal with lots of bad news over the last two years, particularly local political disturbance which turned away foreign tourists and foreign patients. They are currently trading at deep discounts to their historical PERs. Our top picks are BGH and MINT.

Media is expected to outperform as businesses spend more on advertising. Our top picks are MCOT and GRAMMY.

The commerce sector has shown consistently strong track record in terms of increasing revenue and profit margins. They also provide high ROEs with significant upside. Our top picks are CPALL and HMPRO.

The agriculture sector is expected to benefit from the rising agricultural products prices. We choose TVO and STA as our top picks.

We are Overweight on energy, agricultural, media, hotel, hospital, commerce, contractor and industrial estate. Our top picks are BANPU PTT PTTCH KTB STA CPALL MINT MCOT BGH STEC and AMATA. We add MCOT to our top picks to replace TOP.

Figure 6: KS’s portfolio Sector Current Weight Recom. Top Recommended / Sector Wt. Picks

Banking Neutral 22.2% KTB

Insurance Underweight .0% BLA Food & Agro Overweight 5.5% TVO STA

Automotive Overweight .2% SAT Petrochemical + SCC Neutral 9.8% PTTCH Energy Overweight 41.6% Coal Overweight 4.0% BANPU E&P Neutral 9.3% PTTEP Integrated Overweight 19.7% PTT Refinery Neutral 6.1% TOP Utilities Underweight 2.4% RATCH Construction - SCC Underweight .0% Property Underweight 4.1% PS Contractor Overweight .8% CK Industrial Estate Overweight .9% AMATA Residential Underweight 1.9% PS Commercial Underweight .4% CPN Commerce Overweight 6.4% HMPRO Healthcare Overweight 1.9% BGH Media Overweight 1.9% BEC Securities Overweight .5% KEST Tourism + MINT Overweight 1.1% MINT

Transport & Shipping Underweight .5% Shipping Neutral .5% PSL

Transportation Underweight .0% Electronics Neutral 1.1% SMT IMM Overweight .0% KKC ICT Underweight 3.0% TRUE

Total 100%

Source: SET, KS

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Limited downside of SET index We have toned down our bullish stance but continue to expect the SET index to be sideway-uptrend through 2011 and maintain our fair index level at 1220. There are reasons to expect limited downside risk for the SET index.

The net selling value of over Bt30bn YTD by foreign investors is simply seen as ‘profit-taking’. Compared to the net purchase of Bt81bn in 2010, foreign investors so far have sold about 32% of their net buy in 2010 for Thailand, 17% for Indonesia and 10% in Philippines (figure 7). The extent of profit taking is somewhat consistent with the level of total equity performance in USD terms: 50.4% for Thailand and Indonesia and 42.8% for Philippines.

We highlight the significance of the foreign exchange movement as a major catalyst for profit taking. The surge in volatility of the USD/THB so far this year (figure 8) may have also contributed to the strength of selling Thai equities by foreign investors. We say this as a cause rather than the result because there has been much more active buying into the bond market with combined YTD inflow from both equity and bond at Bt45bn.

The depreciation of USD/THB is so out-of-line in relation to the fall in the equity market that the USD/THB looks ‘over-depreciated’ compared to other regional currencies (figure 9). This is potentially a source of catalyst to bring in new foreign capital, even though for a short term.

Figure 7: Net foreign Buy/Sell YTD compared to 2010 (USDmn)

-32.44%

-17.15%-10.50%

-4.59%2.37%

35.91%

9.42%

34.89%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

-10000

-5000

0

5000

10000

15000

20000

25000

30000

Thai

land

Indo

nesi

a

Phili

ppin

es

Indi

a

Sout

h Ko

rea

Taiw

an

Viet

nam

Japa

n

2010

2011

(%) of last year buy

Source: Bloomberg

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Figure 8: The daily standard deviation of regional exchange rates against USD

0.36

%

0.27

%

0.21

%

0.18

% 0.36

%

0.22

% 0.38

%

0.09

%

0.18

%

0.20

%

0.39

%

0.30

% 0.41

%

0.38

%

0.30

%

0.72

%

0.09

% 0.24

%

0.20

%

0.41

%

0.49

%

0.40

%

0.37

%

0.32

%

0.83

%

0.07

% 0.27

%

0.28

%

0.28

%

0.63

%

0.23

% 0.37

%

0.27

%

0.62

%

0.07

%

0.22

%

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

0.8%

0.9%

THB India Indonesia Malaysia PhilippinesSingapore Korea China Taiwan

YTD From 2010 From 2009 from 2000

Source: Bloomberg, KS

Figure 9: USD/THB is now ‘over-depreciated’ compared to regional currencies Thailand

Malaysia

Indonesia Taiwan

Korea

China

Philippine

India

y = 0.218x + 0.005R² = 0.5642

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

-16.00% -12.00% -8.00% -4.00% 0.00% 4.00%

Index Return

CurrencyDepreciation

Index Return

CurrencyDepreciation (-5.3%, -2.7%)


Comparing the ratio between cumulative foreign net buy on the SET against the region (adjusted for changes in index level) since March-09 (when the last bull market began) with the estimated weight of the SET in the region (figure 10), it appears that foreign investors are underweight Thailand relative to the region. Since Mar-09 to May-10, when the political protests brought Bangkok to a standstill, the two lines moved similarly. However from May-10, the weight of the SET increased by 2% to 6% but foreign holdings on the SET dropped to 5% presently. Foreign investors are underweight.

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Figure 10: Estimated SET weighting

4.00%

4.50%

5.00%

5.50%

6.00%

6.50%

7.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

Mar

-09

Apr-

09

May

-09

Jun-

09

Jul-0

9

Aug-

09

Sep-

09

Oct

-09

Nov

-09

Dec

-09

Jan-

10

Feb-

10

Mar

-10

Apr-

10

May

-10

Jun-

10

Jul-1

0

Aug-

10

Sep-

10

Oct

-10

Nov

-10

Dec

-10

Jan-

11

% Flow as of 17 Mar 09 (Adjusted)

Mkt Cap. Thai to Regional (RHS)


High cash level among local equity funds In Dec-10, investors bought over Bt14bn of local equity funds, nearly doubled the Bt8bn in Dec-09 and Bt6bn in Dec-08. However, local funds activity in the secondary market last December was much slower than other years. We suspect one of the reasons why local fund managers were not active in the secondary market last month was because of the expectation of large LTFs’ redemptions in early 2011. But this has not happened. On the contrary, there was a net primary flows into local funds during Jan-11, although slight. The widening gap between the primary flows and the secondary flows is indicative of cash levels, which is estimated to be high now. This implies a potentially large buying power among local institutions.

Cash from Korea to fly back A large number of Korean funds that Thai investors bought through FIF are maturing. We estimate that Bt170bn (USD5.5bn) of these will mature February to July this year. On top of this, the phasing in of Deposit Insurance Scheme (maximum amount of guaranteed deposit reduces to Bt50mn this August) will supplement local liquidity. Local liquidity surge will help support the SET index and put a limit to downside risk.

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44

Figure 11: Expected maturing Korean bond funds (Btbn)

0

10

20

30

40

50

Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12

Source: Morning Star, KS

Bottom mining In estimating the downside risk, we also look at the 12-month forward P/BV ratio as a conservative tool. Outside the crisis periods, P/BV hit the lowest point level at 1.56x in in 2004. Using the same ratio, we imply SET downside at 950.

We also look at the gap between the SET consensus target and the SET Index. Typically, the SET index trades at an average discount of 17.5% from such target and remains within the upper half of the 1SD band (shaded grey) shown in figure 12. This band provides us a trading range of between 990 and 1138.

Figure 12: SET consensus target and the SET Index

0

100

200

300

400

500

600

700

800

-

200

400

600

800

1,000

1,200


ImpliedSET Index Target

Foreign fund flow

SET Index

-1 SD From avg discount from Implied SET Index Target

+1 SD From avg discount from Implied SET Index Target

4545

45

Source: Bloomberg, SET, KS

Finally, since Mar-09 when the bull market began, there have been 10 healthy consolidation periods with an average correction of 9.3% and the maximum correction of 12.9%. So far, the market is 7.7% lower from the last peak. Using 9.3% correction as a benchmark, the downside of the SET index should be at 958 and at the maximum, 920.

Risks to our call While we expect the market to go side-way up and the downside risk limit to 950, the major risk to our call is politics ie. if the border clash between Thailand and Cambodia gets worse or protestors in Bangkok take advantage of the border problems to stir up more problems. Moreover, the government’s position and its demands to claim compensations against private cellular phone operators could draw questions on Thailand’s policy on foreign direct investment.

Figure 13: KS sector valuations

Source: KS U – Underweight, O – Overweight, N – Neutral As of 10th February 2011

Figure 14: 2011 sector valuation Figure 15: 2011 Consensus earnings changes

Agri&Foods

Banking

Const.MaterialsPetrochemicals

Contractors

Commerce

Commercial

ICT

IMM

Insurance

Electronic

Energy

Media

Healthcare

Tourism

ResidentialIndustrial Estate

Transportation

Shipping

AutomotiveSET - KS

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

5 10 15 20 25 30

PER / EPS Growth

ROE (%)

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Bank Energy Fin & Sec ICT Petrochem Property

-1 M -3 M( % )

Source: KS Source: Bloomberg

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46

Figure 16: 2011 country valuations Figure 17: SET PER discount to region

China 12/20% HongKong 12/16%

India 16/25%

Indonesia 13/27%

Malaysia 13/23%

Philippines 13/11%

Singapore 15/15%

S. Korea 10/17%

Taiwan 14/14%

Thailand 11/19%

-

0.2

0.4

0.6

0.8

1.0

1.2

1.4

9 11 13 15 17 19 21 23

PER / EPS Growth

ROE (%)

0

10

20

30

40

Jan-

07

Apr-

07

Jul-

07

Oct

-07

Jan-

08

Apr-

08

Jul-

08

Oct

-08

Jan-

09

Apr-

09

Jul-

09

Oct

-09

Jan-

10

Apr-

10

Jul-

10

Oct

-10

Jan-

11

SET PER

Regional PER

-60%

-40%

-20%

0%

20%

Jan-

07

Apr

-07

Jul-

07

Oct

-07

Jan-

08

Apr

-08

Jul-

08

Oct

-08

Jan-

09

Apr

-09

Jul-

09

Oct

-09

Jan-

10

Apr

-10

Jul-

10

Oct

-10

Jan-

11

Source: Bloomberg consensus Note: Country PER, EPS Growth, As of10th February 2011

Source: Bloomberg

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47

Disclaimer For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained herein. Further information on the securities referred to herein may be obtained upon request.

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