The more anemic that the Western recovery turns out to be, the longer it will take for Western interest rates to normalise, increasing the likelihood of Asia entering an asset bubble, says Christopher Wood of CLSA

Christopher Wood says that neither US consumption nor US employment recovery will be healthy and that this should become apparent by the first half of 2011. "This also seems to be the message from the US government-bond market, which has remained relatively well bid, despite the ongoing rally in the S&P500 amid rising optimism. The US bond market continues to send an entirely different message from the US stock market," Mr Wood writes in a global strategy piece in CLSA's Asia Themes 2011 report.



US bond prices have been falling from early November while yields have been rising. According to a Bloomberg News survey of the Fed's 18 primary dealers, investors buying benchmark 10-year notes will gain about 1% in 2011 once interest payments are re-invested, as the yield rises to 3.65% after averaging 3.2% in 2010. US treasuries have given a positive return in 2010 versus negative returns in 2009. But the best year was 2008, when US government debt was in great demand, as investors sought it as a refuge from the financial crisis.

Wood predicts that Western policy will remain 'super easy' due to the lackluster outlook for consumption and employment in the American economy and Europe's sovereign debt crisis. This will create an asset bubble in Asia, where China will be the epicenter. Asian governments are likely to progressively tighten their monetary policies, but this will be mainly to curb inflation. Over the longer term, this asset bubble will eventually give way to a deflationary bust says Wood.

In this same report CLSA's Eric Fishwick says, "QE2 will drive down the cost of capital globally and thus Asia is likely to see credit growth and accelerating domestic consumption and construction activity in 2011."

About India, the report says that "while the market looks vulnerable to a tactical correction on a continued commodity rally, the fragile state of some of the largest global economies raises question on the sustainability of high commodity prices. We would thus be less worried about the likelihood of a lasting impact on the market or economy."

Even so, the report warns of inflation fears, the hardening price of crude (India being particularly vulnerable), and the rising fiscal deficit raising the risk perception of the country. Also, higher commodity prices will put margins of Indian companies under pressure.

Despite these warnings, the broker expects investment upturn to further strengthen in 2011-12 due to the combined effect of higher infrastructure spending and an increase in private-sector capex. The firm urges investors to put their money in "best-managed Indian firms that leverage rising commodity prices" such as Hindalco, Tata Steel and Cairn India. One of CLSA's top long-term picks is Maruti Suzuki, but it is hesitant about it near-term, mainly because of the price wars with Toyota. The firm is overweight on the Indian banking sector.

Consumer plays are also big on its list-China, India and Indonesia's consumer sectors should exhibit J-curve hyper-growth over the next 5-10 years on rising incomes and propensity to consume and take risks. Even in the face of slower global growth, their consumers remain upbeat and will benefit from strong liquidity inflows and wage inflation in 2011.

The report also says that Australia presents a good investment opportunity, since it provides Asian exposure without the emerging market risk. "China and other emerging markets are driving demand for energy and materials, of which Australian companies are among the leading providers. A range of secondary beneficiaries will also see topline growth. The key risk is labour- cost inflation." — Munira Dongre