Oddbox 26

Week Ending 17th May, 2009

End Demand Falters

China’s April trade figures were every bit as bad as was predicted in last
week’s Oddbox. Exports retreated rather than expanded, with movements to
Japan and the EU under-performing movements to the USA. China’s
exports, rather like Taiwan’s, seem to be flattening out at a plateau rather
than rising toward a recovery.

China’s economy seems, therefore, to be doing the splits with domestic

demand resuming growth and external demand stagnating.

News out of Japan points to a weakening of consumer demand in April as

companies aim to restructure their businesses to about 70% or 80% of last
year’s capacity. With the exception of a couple of sectors, there seems to be
more scope for disappointing announcements in the next couple of months.

In the tech supply chain, aside from what seems to be a building of

inventory in Europe, the P/C, mobile handset and LCD supply chains remain
buoyant. There is even talk of component shortages holding back
production.

However, the rise in the oil price against a background of falling demand
and near record inventories seems speculative and the result of loose money.

Japan

Japan’s imports from China during Q109 slumped to US$46.07bn, a drastic

decrease of -23.8% yoy. This fall was much bigger than the comparative
falls for the EU (-19.8% yoy) and the USA (-15.7% yoy). With China’s
exports weakening further in April (see the next section on China for
discussion), it seems that Japan’s demand for mainland goods will remain
well down for the rest of the second quarter.

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Indeed, the overall level of consumption in Japan looks to be in doubt for
months to come. Nikkei Inc.'s Consumption Forecasting Indicator dropped
to its second-lowest level ever in April since polling began in 1980 after
back-to-back months of improvement. The index projects discretionary
spending changes in about six months' time, and dropped 5 points from
March to 69.6 in April, the lowest reading ever save January's. This sudden
setback appears to be the result of deteriorating job and income conditions
as the major companies restructure to cope with demand levels down -20%
or more from last year.

Hitachi announced that it lost JPY787.3bn for FY2008 through March. This
is the second-largest loss of any company in Japanese corporate history after
the JPY834.6bn loss reported by Nippon Telegraph and Telephone in their
fiscal year ending March 2002. Hitachi’s guidance for the coming year was
more cautious than analysts expected, with management projecting a net
loss of JPY270bn in FY2009 against JP Morgan’s forecast of a loss of
JPY130.2bn.

Toyota announced that it will halt three of the 11 production lines at its
largest engine plant in Aichi Prefecture by the middle of this year. This is in
line with its domestic production plan for 2009 to build 2.70mn vehicles,
down -33% yoy or 1.31 million units from 2008, a huge cut.

Nissan Motor announced its decision to shift the entire production of its
popular March subcompact from Japan to Thailand next spring when a fully
remodelled March is to be rolled out. This will result in costs being cut by
30%. The Japanese government has refused to provide support to allow
Nissan to keep the production of the March at home, whereas the Thai
government has introduced a policy incentive for carmakers to build plants
for the manufacture of vehicles with engine capacities of 1.2 litres or less.
This is the first time that a Japanese carmaker has shifted the entire
production of a major model overseas, and it is expected that Nissan will
reposition the car as a strategic product aimed mainly at emerging markets.

Japanese companies seem to be willing to sacrifice market share and to

undergo radical restructuring to ensure cash flow and profitability in this
time of high currency.

Machine tool orders plunged -80.4% yoy to JPY25.1bn in April with

domestic orders falling -77.5% yoy to JPY12.2bn, down for the fifteenth
month in a row, and overseas orders down -82.6% yoy to JPY12.9bn.

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Total domestic lending by Japanese banks rose +3.6% yoy in April, the same
as in March, providing confirmation again that companies are still having
trouble raising funds in the bond market.

Undermined by a political funding scandal, Ichiro Ozawa announced on

Monday evening that he would step down as president of the Democratic
Party of Japan, the nation's leading opposition party. This places sitting
Prime Minister Aso in a stronger position for elections expected to be called
in July.

The number of domestic cases of the new H1N1 flu hit 92 on Sunday after a
total of 84 high school and college students as well as teachers fell ill in
Osaka and Hyogo prefectures. This cluster may indicate that community-
level transmission has begun in Japan and could lead the WHO to raise its
new global flu pandemic alert to the highest level of 6 from the current 5.
The prefectural government has decided to suspend around 570 educational
facilities in Osaka and Hyogo prefectures for certain periods to prevent or
slow the progress of the disease.

Japanese firms have been urged by the government to avoid over-reliance on

China as a market during the visit of Prime Minister Putin of Russia to
Tokyo. Japan and Russia agreed to a significant expansion of mutual
economic ties in areas ranging from telecommunications to automobile
production and agriculture.

Japan signed a pact with Russia as the world's leading enricher of uranium
under which Russia would provide Japan with access to a stable supply of
nuclear fuel. Toshiba announced that it will begin negotiating with Russian
state-run JSC Atomenergoprom to set up a joint uranium enrichment
programme and the construction of a storage facility. Mitsui & Co. is in
talks with Rosatom, a Russian state-run nuclear energy firm, on co-
developing a uranium mine in Siberia.

Japanese state oil exploration company, JOGMEC, signed an agreement

with Irkutsk Oil Co to develop two oil fields in the central part of the
Russian region of Irkutsk thought to hold combined reserves of up to several
hundred million barrels.

Overseas investors were net buyers of Japanese stocks in the month of April
for the first time since Lehman Brothers declared bankruptcy in September.
Net buying by foreigners totalled JPY410bn from March 30th to May 1st, the
first inflow in eight months. However, foreign investors accounted for just
51.7% of the total trading value in April, the lowest since April 2006.

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China

China announced its trade figures for April and they were every bit as bad as
was proposed in last week’s Oddbox. Exports fell -22.6% yoy to
US$91.94bn and imports fell -23% yoy to US$78.8bn. The trade surplus
was US$13.14bn.

One point to note was that exports in the four months to April totalled
US$337.42bn, down -20.5% yoy. In other words, April’s slowdown in
exports was worse than the average for the previous four month period. This
prompts two questions, is demand for China’s exports weakening? And how
is trade to China’s main export destinations faring?

In answer we find that the weakest trade or the greatest slowdown in exports
was with Japan, the EU and the USA in that order. The bilateral trade
volume between China and Japan dropped -23.8% yoy in the first quarter to
US$46.07bn, between China and the European Union by -19.8% yoy to
US$75.19bn and between China and the USA by -15.7% yoy to
US$62.08bn. Thus, the worst of the slowdown is actually being felt by
Japan and the EU, not the USA.

As we look at the graphs of

export and import
performance on the left,
there is no formation of a
clear bottom in exports. If
anything, May’s figure
could challenge February’s
fall. However, imports
clearly bottomed in January.
As we will see, the bounce
back in imports was due to
the government increasing
stock piles of metals and
oil, rather than an increase
in components for assembly
and onward export.

A breakdown of sectors in April’s export figures give reason to suggest that

consumption in the major economies of the EU, Japan and the USA is
weakening. Exports of garments and clothing fell -12.8% mom, of textiles
by -6.6% mom, of footwear by -5.0% mom and of toys by -4.0% mom. It
therefore seems unlikely that the export trend in these sectors will turn
positive before H209.

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As for April’s imports, China imported the highest monthly level on record
of copper (399,800 tons) and aluminum (440,000 tons), partly reflecting
stocking by China’s State Bureau of Reserves.

China's industrial output grew +7.3% yoy in April, slower than the +8.3%
yoy in March. The average figure for January-April was +5.5% yoy. This
pull-back suggests that inventories have been rebuilt, and industrial
conditions going forward remain questionable.

However, further evidence of a pull-back in activity was given by power

consumption which dropped -3.5% yoy to 271.29bn kWh in April.
Interpretation of this figure is not easy. How do you account for a rise in
industrial production of +7.3% yoy accompanied by a decline in power
consumption? Whilst the government has mandated that energy usage per
unit of GDP should fall 4% per annum in the current Five-Year plan, the
disparity is too great to be accounted for purely by efficiency gains.

Industrial use of electricity declined -8.21% yoy, and, with exports falling,
electricity use in the manufacturing and export hubs of Guangdong and
Zhejiang provinces was “below the national average”. There seems to be a
disparity of use of energy by the export and domestic manufacturing sectors.

Domestic demand seems robust. China's retail sales grew +14.8% yoy in
April. JP Morgan reports that companies are saying that domestic retail sales
gained pace in April and accelerated into early May. Output of the textile
industry overall was up +7.8% yoy, suggesting considerable demand growth
onshore against the fall in export demand, and that of the auto sector was up
+9.6% yoy, in line with the rise in auto sales.

Strong sales of real estate continued in April, up +22% mom and +125%
yoy. Combined sales volume in the top seven major cities reached a record
10.3mn sq mtr, surpassing the previous monthly peak of 9.9mn sq m
achieved in August 2007. Furthermore, the strong sales were achieved due
to the government’s policy measures rather than a price cut. The residential
property market could therefore be viewed as having fully recovered.

All of the above gives the sense of a two tier economy for domestic and
export production with each economy having differing energy intensity
requirements.

As expected, Bank of America sold 6% of its 16.6% stake in China

Construction Bank, raising US$7.3bn. The shares were sold to a select group
of predominantly mainland investors including China Life Insurance and
China's Hopu Investment Management, and to Temasek of Singapore. The

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private placement reduced BofA's stake in CCB to 10.6%. All the remaining
shares owned by BofA are subject to a lock-up until Q311.

Reporting of foreign direct

investment (FDI) showed a
sharp year-on-year decline
in April. April’s FDI was
US$5.89bn, down -22.51%
yoy, sharper than in March,
when it fell -9.5% yoy.
However, it is to be
remembered that in April
2008 actual FDI surged
+70% yoy on the back of
hot money trying to profit
from the expected
appreciation of the Yuan against the US Dollar. So the fall is against an
artificially high base of comparison.

Investors were surprised when China Mobile suspended trading of its stock
on Tuesday. The reason for this request was that red chip shares would
become subject to the same 10% withholding tax on dividends that
dividends for H-share companies already were. Thus, the HK Stock
Exchange had adjusted its ex-dividend share price incorrectly. Investors
dumped China Mobile shares as it worked to delay its book-closure period
to accommodate the withholding tax.

The market has known about the dividend tax for H-share companies since
at least September 2008. But not the extension to red chips. The guidance
note for the extension of this dividend tax was issued by China's State
Administration of Taxation on April 27th. It is probable that some foreign
funds will similarly dump other red chips, portending a period of temporary
weakness in red chip share prices.

The memoirs of China's former communist leader, Zhao Ziyang, who was
sacked after the Tiananmen protests, were published this past week. The
book called, Prisoner of the State: The Secret Journal of Premier Zhao
Ziyang, seeks to lift the lid on discussions within the party in the days before
the crushing of the protest movement in Tiananmen Square in June 1989.
The 20th anniversary of this event will occur on 4th June this year, and so we
should expect further revelations and discussion of this highly sensitive
moment in China’s history.

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On Friday, the topic of 1989’s events in Tiananmen Square spilled over into
a meeting of the Legislative Council in Hong Kong. The reply by Chief
Executive Donald Tsang to a direct question on the subject was deemed
inappropriate, prompting 20 pan-democrat lawmakers to walk out of the
session.

The State-owned Assets Supervision and Administration Commission

(SASAC) injected a further 2bn Yuan of capital into China Eastern Airlines,
in addition to the 7bn Yuan injected at the end of last year. It is rumoured
that the new injection will be used to facilitate China Eastern's merger with
Shanghai Airlines within 2009. The restructuring will be completed before
2010 when Shanghai hosts the World Expo. Nevertheless, the major state
carriers remain weakened by low capacity utilisation.

Transparent government reporting on the H1N1 flu has prompted mainland

tourists to reconsider their holiday travel arrangements. Tours to almost all
overseas destinations have seen a big drop in reservations according to
travel agents. For instance, the number of mainlanders signing up for tours
to Hong Kong in the first two weeks of May is reported to have fallen by
80%. China is the largest source of outbound travellers in Asia, and a
slowdown of such scale would negatively affect airlines and hotels in the
region.

Tuesday saw the first anniversary of the 12th May Sichuan earthquake.
President Hu and several top leaders held a memorial service at the
epicentre of the earthquake. In his speech, President Hu brought forward the
target date for the completion of post-quake reconstruction to just two years
from the original three years.

Big Brother, Little Brothers

The news on the relationship between mainland China and Taiwan remains
incrementally positive.

President Hu Jintao, in his capacity as general secretary of the Communist

Party of China (CPC) Central Committee, has invited Wu Poh-hsiung,
Chairman of the Kuomintang, to meet him in Beijing on 28th May on the
anniversary of the death of Dr. Sun Yat-sen, one of the founders of the
Kuomintang. This will be their third meeting. Hu and Wu first met in
Beijing on May 28th last year, just days after the Kuomintang's Ma Ying-jeou
was inaugurated as leader of Taiwan, and they met again in August when
Wu was invited to attend the opening ceremony of the Beijing Olympic
Games.

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The Chinese mainland has agreed to open a further five ports for direct
shipping service with Taiwan, bringing the total number of such ports on the
mainland to 68. Under the earlier agreement, the mainland agreed to open
63 ports to Taiwan ships while Taiwan will open 11 to ships from the
mainland.

Regional Technology

The news in the technology sector is mixed, and ties back as a coincident
indicator to China’s April trade figures.

Hon Hai Precision, the world’s largest contract manufacturer, announced its
sales in April were down -8.23% mom and -8.22% yoy. This announcement
was a disappointment as it represented a sharp step back from the improving
sales trend of the previous three months. Hon Hai had reported sales that
contracted -24.36% mom in January and rose progressively to +24% mom
in March. The slowdown in April’s sales is in line with the pull back in
China’s exports. Hon Hai also forecast that its sales for the rest of Q209
would be flat. This is another example of the lack of hope for recovery in the
global economy in the near future.

North American consumers have continued their love affair with flat panel
TVs according to DisplaySearch. LCD TV shipments in the first quarter
surged +23% yoy to 7.2mn units. Vizio, a company that predominantly sells
value priced products to discount retail channels, returned to the number-one
ranking in LCD TVs for the first time since the second quarter of 2007,
improving their unit share from 13% to 19%. Funai, another company that
predominantly sells value priced products to discount retail channels, also
saw their market share improve from the fourth quarter of 2008 to the first
quarter of 2009. Premium brands like Samsung and Sony lost share as
consumers became more price-sensitive.

Leading laptop maker, Acer, has seen demand in Europe weaken, leaving the
company with high inventory. Acer has therefore reduced its orders to its
main suppliers, Quanta Computer and Compal Electronics.

These companies in turn have lowered their second-quarter notebook

shipment targets by 5% after seeing April sales drop. However, the lower
forecasts are not just based on slow sales in Europe but also include several
factors such as a shortage of certain components like keyboard controller
ICs, panels and PCBs being reported across the supply chain.

The major semiconductor packaging firm, ASE, has reported during their
Q1 investors conference that sales generated from PC applications will

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outperform those from the communications and consumer electronics
segments based on its order flow. Whilst reporting sales up +10.1% mom in
April and up +5% mom in May, packaging sales are still down -20% yoy.

Politics – India and Sri Lanka

The general election in India ended on Sunday with the Congress party
taking 206 of the 543 seats, and its UPA coalition partners adding 54 more.
This places the coalition in a good place to promote growth positive policies
unhindered by the left-wing parties.

Down South in Sri Lanka, the civil war between the government and the
Liberation Tamil Tigers of Eelam (LTTE) drew to a close over the weekend
with the Tigers making a last stand. Let us hope that the government works
successfully to heal the rifts with the minority communities and establish the
country on the path to reconciliation and prosperity.

Energy

The price of oil has cut back up through US$60 despite there being record
inventories.

Given the outlook for global consumption based on China’s, Korea’s and
Taiwan’s recent trade figures, such optimism looks speculative.

Opec has just cut its 2009 demand forecast for the ninth straight month,
lowering its estimate for global demand in 2009 by a further 150,000 barrels
per day to 84.03 million bpd. Opec believes that demand will contract by
1.57mn bpd this year, or -1.8%, from last year’s level. World consumption
shrank by a record 2.4mn bpd in the first quarter of 2009 compared with the
same period last year.

The International Energy Agency (IEA) said in its monthly report that it
expects demand will contract by 2.56mn bpd this year. The IEA said that oil
inventories in developed countries had risen again and, at the end of March,
equalled 62.4 days of forward demand, a measure closely watched by Opec
which considers around 52 days of inventory a comfortable level.

The price rise against such forecasts appears speculative, and could perhaps
be a sign of the extraordinarily lax liquidity meant to support the banks
being misapplied.

Conclusion

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So as we look back at last week, we see:-

• Japan’s imports from China slumped -23.8% yoy in Q109, worse than
the slump experienced by the EU and the USA
• A retracement by the Nikkei Consumption Forecasting Indicator
suggests that consumption in Japan will weaken further in coming
months
• Hitachi announced the second biggest loss in Japan’s corporate
history
• Toyota is taking measures to scale back domestic production by one
third
• Nissan will become the first Japanese carmaker to shift production of
a major model line overseas when it transfers production of the
March/Micra to Thailand next Spring. Nissan expects to reap a 30%
cost saving
• Machine tool orders remain moribund
• An outbreak of H1N1 flu in the Osaka region appears to be the first
community-level transmission of the disease in the world. Local
authorities have closed 570 schools and colleges
• Japan signed a series of agreements with Russia in respect of oil and
uranium exploration
• China’s April trade figures were disappointing with monthly exports
falling back below the four month average rate of decline
• A breakdown of exports by sector shows a sharp month-on-month
decline in garments and clothing and other key soft exports,
suggesting a stalling of demand in Japan, the EU and the USA
• China’s industrial output rose at a slower pace in April and power
consumption was weak
• Retail sales remained robust at +14.8% yoy
• FDI appeared weak, but this was due to a high base of comparison
• Sales of residential real estate based on floor area in April hit an all-
time high
• The dividend tax previously applied to just H-shares has been
extended to red chips, causing China Mobile to halt trading in its
shares whilst the new ex-dividend price was calculated
• The 20th anniversary of events in Tiananmen Square is due on 4th
June. The publication of Zhao Ziyang’s memoirs and a walk out by
Legco members in Hong Kong are evidence that this sensitive subject
will be upper in people’s minds for the next few weeks
• The SASAC recapitalised China Eastern Airlines for a second time in
six months

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 • China marked the first anniversary of the 12th May Sichuan
earthquake by bringing forward the target date for the completion of
post-quake reconstruction by one year
• President Hu has invited the Chairman of the Kuomintang to meet
him in Beijing on 28th May
• Various major tech companies such as Hon Hai and Acer have
indicated that they are seeing a flattening of sales in Q209 after
inventory build up in Europe
• Politics in India and Sri Lanka are positive for growth in South Asia
• The rise in the oil price seems to be based on liquidity rather than
fundamentals. The question is will such price rises spread out to other
energy and raw materials sectors, or will the central banks begin to
pull in liquidity?

All in all, the statistics this week give cause to question if end demand in the
major economies of the USA, the EU and Japan is faltering.

(RH 17.May.09)

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