Churchouse Letter
January 2015          by Peter Churchouse

Burning Tigers, Hidden Dragons

Or How to Make 40 times Your Money or More....
Things are looking ugly in some major Emerging Markets.
...but I’ve seen this all before…. And as things get worse, we’ll have an opportunity to make 40-100 times our money.
Right now, we have a couple of attractive EM plays, but the big breaks are yet to come.
Back in 1996, I was on a business trip to Bangkok. Looking out my hotel window, I could see 75 construction cranes. Then there was the forest of cranes that I couldn’t see.

The view would have been similar if I had been in Jakarta, Manila or Kuala Lumpur. So I sat down at my desk and did a quick tally. The way the numbers worked, the new supply of office buildings that would complete construction in Bangkok in the next 18 months amounted to more than seven times the average annual office takeup at the time. There was no way all those offices were going to be occupied.

So I took a trip down to the leading banks in Bangkok. I wanted to get a hold on how much exposure they had to the property sector. Real-estate lending, they said, amounted to only 12 to 13 percent of all loans.

I knew this wasn’t true. It couldn’t be. Real estate is a capital-intensive business, and the funding had to be coming from some-where. I sent our bank analyst to dig a little deeper. She got the same reply.

Then I figured it out. A lot of the development was on the books of big conglomerates that had veered into property as a profitable sideline. So the banks could handily classify those loans as industrial, or “general corporate lending.”

Two years later, just after bonus season, I took a quick look at two of the companies I covered at the time.

Land & Houses (LH TB) was the largest listed property company in Thailand. At its peak it had a market capitalisation of around US$4.2 billion.

At the end of 1998, its market cap had fallen to less than US$48 million. That is a fall of nearly 99%.

Today its market cap is just over US$3 billion. That’s a 65-fold increase since the depths of the financial crisis.

Another company I covered in those days was called Property Perfect (PF TB). The name was unfortunate. Its market cap fell from US$627 million to US$641,000.

Yes, a little more than half a million bucks in total market cap, or a fall of 99.9 percent! It is now worth just over US$200 million

I walked into the dealing room of my investment bank and joked with the sales force that we should club together and buy all the shares of Property Perfect. It would have taken the help of only a few of my colleagues. Would that we had. Those shares are now up more than 300 times since its low.

I want to show how we can use those lessons learned to set ourselves up to make similar huge returns today.

A lot of what I read these days tells me we are on the edge of doom. And if markets melt down, we want to be ready for it. We want to be ready to identify opportunities that can give us 40 to 100 times our money.

Does that sound impossible?

Well, as my trips to Bangkok back in the day show, it has happened after previous financial meltdowns.

It will happen again, and maybe it already is happening in some countries. I want to be ready.

Look at global financial markets today, and it’s déjà vu all over again. I’ve seen this movie before. And last time, the ending was a particularly sad one. Not for everyone around the world. But for folks in Asia, I promise you it was a tragedy.

This isn’t a re-run. It’s a sequel, made some 17 years later. Hollywood likes nothing better than rebooting an old franchise.

Part Two has some of the same actors, but a much more diverse cast than the original. The same old themes have been given a new twist. Just like every blockbuster nowadays has actors from China, Japan, all over, to guarantee worldwide sales, the new version will have a much broader reach.

But the script of the original movie tells us how we can avoid a sad ending this time around. It also points to the potential for making huge gains on the back end, as they say in showbiz.

The fallout from any near-term shock is going to be very widespread, but it will likely be reasonably short. Any near-term shakeout will be a big opportunity in disguise.

The original movie could have been titled “Burning Tigers, Hidden Dragons.” It was released with a much duller title, the Asian Financial Crisis, but the events were far from dull, let me assure you. Anyone who lived through it will remember it well.

That movie took several years to make, and it premièred on July 2, 1997 in Thailand. It was the culmination of a series of plot points acted out over the previous three or four years.

I was a bit player in some of those scenes.

The ensuing turmoil enveloped all countries and companies in Asia. Hundreds of millions of people were affected, mostly for the worse.

It produced massive currency devaluations, defaults, bankruptcies, layoffs, recessions, and crippling deflation that took years to escape.

Hundreds of stocks in markets such as Thailand and Indonesia fell by more than 90 percent in U.S. dollar terms.

That is wealth destruction on a grand scale.

Take a look at Figure 1. This chart shows the maximum drawdown experienced by a range of benchmark Asian equity indices through this period in U.S. dollar terms. Thailand and Indonesia fell by more than 90 percent. Malaysia fell by nearly 90 percent, Korea by 85 percent and Singapore by 70 percent.

Drawdown of Asian Equity Indices in US$ Terms 1996-1999: Thailand Indonesia Malaysia Singapore & Korea
But once the dust settled, brave investors made anywhere from 50 to 100 times their money in a lot of stocks I followed before and after the Asian financial crisis.

If a serious shakeout does occur in global markets in the near term, we can probably count on similar gains to follow for smart investors.

Thanks to better “distribution” by globalized markets, the impact of any sequel will be widespread, especially in emerging markets. But few countries will be spared entirely. Developed countries will also be screening it this time around.

Looking back on the events of 1997 and its aftermath in Asia, I identify the themes of that script as “The Four Cs”.

¨ Current accounts
¨ Currencies
¨ Credit
¨ Carry trades

These themes are all present today in the high-risk countries around the world. They were the factors that fuelled the firestorm in Asian economies and their stock markets. Even the stable, well-run economies in the region got singed.

Let me explain.

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