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Broadgate: Weekly Briefing 25/5

25 May 2012

Europe – Markets across Europe set new lows for 2012 on Wednesday after countries were told by Brussels to prepare contingency plans for a Greek exit. The message from European Union (E.U.) officials knocked shares across Europe, with the major markets all posting losses.

The FTSE 100 closed down 2.5%, its lowest finish so far in 2012, while the German Dax lost 2.3%, and the French Cac 40 closed 2.62% down.

The U.S. provided a little stability for investors, with the S&P 500 closing up 0.17%, while the Dow Jones edged down slightly by 0.05%. The Nasdaq rose 0.39%.

Spain – Spain can’t continue much longer with its current high borrowing rates, its prime minister warned on Wednesday as he urged a joint European response to keep the region’s debt problems from getting worse.

Spain’s borrowing rates are high, and rising, because of fears that its government finances might be overwhelmed by the costs of rescuing its ailing banking sector. High borrowing rates are at the heart of Europe’s crisis and have already caused Greece, Ireland and Portugal to need bailouts.

U.K. – The U.K. economy shrank more than initially estimated in the first quarter after construction was revised to show a deeper slump, which may bolster the case for the Bank of England to restart bond purchases.

GDP fell 0.3%, compared with a 0.2% decline estimated last month, the Office for National Statistics said. Construction output fell 4.8%, the most in three years and more than the 3% initially estimated, while services and production were unrevised.

China – China has said it will take measures to boost demand and investment amid fears of a slowdown in its economy. On Wednesday, the government said it will encourage private investment in sectors such as energy, railways and telecommunications.

The move comes as its export sector, one of the biggest drivers of growth, has been hurt by falling global demand.

China’s central bank has cut the reserve ratio requirement, the amount of money that banks need to hold in reserves, three times in the past six months. It is thought that the central bank may further reduce the reserve requirements for banks in the coming months as well as cut interest rates.

East Asia – The eurozone debt crisis could harm the growth of East Asian economies, the World Bank has warned.

The bank said that a “serious disruption” in the eurozone could hurt growth and dent demand for exports from East Asia. It said that East Asian countries need to boost domestic demand to re-balance their economies and sustain growth.

The bank warned that a faster than expected slowdown in China was also a threat to the region’s growth.

“A slowing China, which comprises 80% of developing East Asia’s GDP is a drag on growth across much of the region given China’s growing role as an export destination and source of foreign investment,” the bank said in its latest report.

Japan – Japan’s credit rating has been downgraded by two levels by rating agency Fitch on concerns about the country’s high levels of debt.

Fitch cut Japan’s rating to A+ from AA and warned that further downgrades were possible.

Japan has by far the highest debt to GDP ratio of any major economy, although much of this debt is held by domestic investors.

“[Japan’s] fiscal consolidation plan looks leisurely relative even to other fiscally-challenged high-income countries, and implementation is subject to political risk.” Fitch said.

Companies – Prada Ltd, the Italian fashion company that owns the Miu Miu and Church’s brands, plans to add 260 stores in the next three years to tap demand in emerging markets including Brazil, China and Persian Gulf countries.

Demand for Prada leather goods and other items is rising even as China’s economic growth slows and Europe’s debt crisis weighs on consumer spending. The company is benefiting from increasingly wealthy Chinese tourists who are fuelling growth in Europe as it also targets markets in the Middle East.

“We are expanding in Morocco, Istanbul, Beirut, Dubai and Qatar,” CEO Patrizio Bertelli said. “Brazil is also a big market we’re looking at.”

Commodities – Gold gained for the first time in four days in New York as central banks increased their holdings and the U.S. dollar declined.

Central banks continued to buy bullion in April as Turkey raised its reserves by 29.7 metric tons and Ukraine, Mexico and Kazakhstan also increased their holdings, IMF data shows.

“We regard the central banks as a stabilizing element on the gold market and anticipate increasing buying of gold if its price should fall towards the USD1,500 per ounce mark,” Commerzbank AG said in a report on Thursday.

Spotlight on: Fears of China’s supposed property bubble

The booming Chinese property sector has long been a central point to analysts’ speculation as to whether the second largest global economy is heading for a hard or soft landing, if at all.

As recently as March, China’s property sector was attracting increasingly nervous attention from fund managers, 14% of which cited it as the riskiest sector for asset allocators (according to a Bank of America Merrill Lynch fund manager survey).

Mark Martyrossian, a founding partner at Tiburon Partners (a fund management business offering UCIT compliant funds with an Asian bias), has dismissed these views of the real estate market as “sour grapes”, with western investors voicing discontent more out of sour grapes than calculated honesty.

He says: “I think the western view of Chinese property is misguided. We have messed up our economies in much part by lending too much money to people who can’t pay it back and that has partly been in property, sub-prime [having been] the poster child. I think a lot of people look across at China and they feel we’ve messed it up and I think they are going to mess it up as well.

“Look at the fundamentals; luxury residency is a tiny part of the Chinese property market as a whole, [between 6% and 7%] but it makes better headlines to talk about ten million dollar luxury residentials in Shanghai than it does it to talk about 10m 500sq/f boxes of social housing that is being churned out in China and has been for the last couple of years.”

Martyrossian says the primary difference between a property bubble, such as the sub-prime mortgage crisis or the Japanese real estate collapse in the nineties and the Chinese situation is the presence of debt.

“Do I lose sleep over the Chinese property market posing a systemic risk to the economy as in Japan in the eighties or sub-prime in the late nineties?” he asks.

“No, because it’s not built on debt. Property bubbles are dangerous when they are built on debt. Prices may come down.”

Schroders’ Jim Rehlaender has made a similar case in recent weeks, arguing that markets have “unique structural factors offering it strong support.”

China’s National Bureau of Statistics confirmed that investment in real estate development in the first quarter was over CNY1tn , representing year-on-year growth of 23.5% but four percentage points lower than in 2011.

Rehlaender, who co-manages the GBP596.9m Schroders Global Property Securities with Al Otero, concedes that the Chinese housing market is viewed with “anxiety” but points out that unique structural factors offer it strong support.

However, Rehlaender says: “People also forget when looking at China that it is unlike any market in the world in that the government never relinquishes ownership of the land.

“In the case of a developer who can’t perform, the government takes, or refunds the land premium, and the land could be retained or ‘sold’ later to another developer.”

The manager, who holds 3.5% of his portfolio in emerging markets such as China, also points out that higher-quality property companies, such as China Overseas Land and Investment, have seen “solid” home sales and improving margins.

Rehlaender adds that investors should be prepared to see some bankruptcies by companies among the 85,000 residential developers that cannot complete their projects.

But he concludes: “Although we understand the concerns that have been raised about the Chinese residential market, we believe that we are past the crisis point”.

The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.

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