Credit Suisse - Asia Equity Strategy: Leading Indicator Watch

US mortgage applications have fallen sharply over the past month

While most of the nine global leading indicators that we watch continue to surprise on the upside (US ISM new orders rising above 50 in May, only a 0.4pp fall in the China PMI in May), the one that has weakened considerably over the past month has
been US mortgage applications and in particular refinancing.

While US mortgage applications are still up 60% from the October lows, they are down 38% over the past one month (first week of June versus first week of May). This fall has been driven entirely by the 50% fall in US mortgage refinancing (see Figure 1), as purchases are up 2% over this period. With the further spike in US bond yields last night to almost 4% (and, with it, mortgage rates), this weakness in mortgage applications looks likely to intensify further.

As long as the job picture improves, we think this is unlikely to derail the US recovery. However, we note that the two most overvalued cyclicals within Asia are Taiwan tech (82% premium) and Chinese materials (88% premium,). We reiterate our call to switch to cheaper cyclicals.

US mortgage applications fell sharply over the past month While most of the nine global leading indicators that we watch continue to surprise on the upside (US ISM new orders rising above 50 in May, only a 0.4 p.p. fall in the China PMI in May), the one that has weakened considerably over the past month has been US mortgage applications and, in particular, refinancing.

While US mortgage applications are still up 60% from the October lows, they are down 38% over the past one month (first week of June versus first week of May). This fall has been driven entirely by the 50% fall in US mortgage refinancing, as purchases are up 2% over this period.

With the further spike in US bond yields last night to almost 4% (and, with it, mortgage rates), this weakness in mortgage applications looks likely to intensify further. As long as the job picture improves, we think this is unlikely to derail the US recovery.

But we note that the two most overvalued cyclicals within Asia are Taiwan tech and Chinese materials. Taiwan tech trades at an 82% premium on our P/B versus ROE valuation model. For the premium to go to zero, ROE needs to rise from the current 4.4% to 13%. Taiwan tech’s ROE has averaged 12% since 2002.

The premium on Chinese metals has risen to 89%, which is the highest since our data started in 2002. The previous high was 85% in September 2007. For the 88% premium to go to zero, we estimate that ROE needs to recover from the current 5.4% to 15%.

In contrast, we are still finding substantial discounts in Indonesian coal (142%), Indonesian palm oil (66%), regional steel (35%), Korean industrials (33%) and Chinese oil (30%).