Michael Chiu, senior investment manager at ING Investment Management, has China Mobile as its biggest holding, and is overweight the banks as it plays down the potential impact of NPLs.

Many investment portfolios are not positioned for the major shifts in consumption that will occur in the next 10 years, according to Anatole Kaletsky, chief economist and co-founder of GaveKal Research.

At the recent G20 meeting in Pittsburgh there was growing support for the idea that the world had to rebalance its out-of-kilter economy, with the surplus countries in emerging markets needing to spend and the deficit countries in developed markets needing to save. But even if your portfolio has a large allocation to Asian equities, you’re probably holding the wrong stocks, argues Kaletsky.

This is because fund managers have tended to focus on the big manufacturing exporters in Asia, rather than domestic demand-oriented stocks such as retailers and food and beverage companies.

“We will see a dramatic decrease in consumption in the UK, US, and Southern European countries like Spain and Italy, offset by a dramatic increase in consumption in countries running a surplus, otherwise we could face a decade or more of extreme global deflation,” Kaletsky said at a London seminar for investment firm Ashburton last week.

Kaletsky said the Chinese had accepted they could not continue to rely on exporters to achieve the desired 8 percent growth in GDP per annum and therefore domestic demand would have to pick up the baton. Conversely, he sees the US economy being export-led for the next five years, meaning that US portfolios tilted towards the big consumer stocks will underperform. “Very few portfolios are positioned for this shift,” he said.

Is latte at Starbucks in China overpriced or is the local currency, the yuan, unexpectedly overvalued? The former is certainly more plausible, but it might be equally true that the yuan, if not overvalued, is at least not as undervalued as other measures suggest.

This conclusion would come from my proposed Grande Latte index, the caffeinated equivalent of The Economist's Big Mac index. The Grande Latte index, like its burger brother, is a light-hearted attempt to find a basket of goods that can be compared across countries to assess purchasing power parity (PPP) and, by extension, fair currency value. There are serious flaws, but I will save these for, ahem, the bottom of this blog.

The cross-country cost comparison of grande (i.e. medium in Starbucks-speak) lattes shows that the Seattle-based coffee chain's brew is rather dear in China. A grande latte costs $3.75 in the United States but $4.10 in China in dollar terms. It is even more expensive in Japan. The conclusion, that the yen is currently overvalued by 23 percent, accords well with the views of many analysts. But the idea that the yuan might be overvalued by 9 percent flies in the face of pretty much all conventional wisdom. It is also a drastically different perspective than that of the Big Mac index, which in its latest edition showed the yuan to be 49 percent undervalued.

The Grande Latte index is certainly not the gospel truth, though nor is burgernomics. The truth, as ever, probably lies somewhere in between the two extremes -- i.e. the yuan is undervalued, but not to the tune of 49 percent. One thing is clear. Arguing that the yuan is undervalued is easy enough, but the actual degree of undervaluation is a matter for serious debate. With Beijing not about to let the exchange rate float freely, the market may have to wait a few years more before getting a chance to deliver its own verdict.

As for questions about the price of Starbucks, there is no shortage of coffee shops in China, from international chains to local cafes, and their prices are all about the same. Here, in any event, is what a Starbucks spokeswoman in Shanghai said:
"Setting the price for coffee is quite complicated. We have to consider the costs. We import the coffee from the U.S. and there are customs taxes. There is the labour cost, the store rental cost and the drink cost, so there are many factors to consider. Different markets have different conditions, so you cannot do a direct comparison with the United States. As far as we understand, our customers do have some price sensitivity. But this is not their only deciding factor. They think the service we provide and the values that Starbucks represents are more important."

 
Grande Latte index

Local currency / Dollars / Implied PPP / Actual dollar  / Valuation / Big Mac %
                                         of dollar      exch. rate        vs dlr %     

USA       3.75       3.75

Britain    2.35       3.76            1.60             1.60                  ~             +3

Canada   3.75       3.45            1.00            1.08                -7.5             -6

Japan      420        4.63            112               91              +23.1            -3   

China        28        4.10            7.47            6.83               +9.4           -49

 
The most glaring flaws in the Grande Latte index are that: (1) a key input, coffee, is not locally produced in most countries, and (2) in places like China, coffee is a niche product that is consumed by a subsection of well-heeled urbanites.

But, in defence of the index, coffee beans are a relatively small input in every latte, with water, milk, labour, rent, advertising and packaging making up the bulk -- all are reflections of local costs, hence fair measures of purchasing power parity. As for catering to well-heeled urbanites, this is true, but these are the very people with international experience, who should know the fair price of a latte, and hence should insist on proper application of the law of one price in China.

All the talk of addressing the global imbalances throws a spotlight on contrasting demographic trends in the world’s two most populous nations — China and India.

Prior to the financial crisis, India’s annual growth rate of about 9 percent seemed positively moribund next to China’s double-digit economic expansion. But purely on demographics, the dimming power of the US consumer could give India an edge over its neighbour in the longer run.

That’s what India’s trade minister Anand Sharma seemed to suggest last week when he reminded the audience at a London conference that the country had “20 percent of the world’s children”:

We know that when we talk about emerging countries the consumption patterns are different. Most of China’s production is meant for (markets) abroad. India consumes two-thirds of what India produces.

Indeed, Goldman Sachs projects that India’s middle class will outstrip China’s by 2045. This is some 15 years after half of China’s population becomes either too old or too young to be part of the workforce.

Beijing’s mandarins are taking note of this monumental shift in dependency ratios. After decades of enforcing a ‘one-child’ policy in the face of an human rights outcry, China appears to be relaxing its stance on population control. Family-planning officials in Shanghai have begun to urge eligible couples to have two children.

BlackRock Asian equities portfolio manager Jing Ning says it’s useful for investors to start thinking about this demographic shift. Healthcare providers, for instance, will look increasingly attractive investments.

“For the next 20 years, it will be critical for the government to reform its social welfare system,” she said.

It's becoming increasingly common to blame Chinese stocks for recent volatility in global markets.

In some places, numbers do back up why China and other markets are increasingly moving in tandem.

According to Brown Brothers Harriman, the correlation based on percentage change between Shanghai stocks and the S&P 500 index has risen to 18 percent in the last three months. This compares with year-to-date correlation of 9 percent and 4.5 percent in the past two years.

The correlation between the front month copper futures and the Shanghai composite has risen to above 30 percent in the past three months from 27.4 percent since January and 16.5 percent over the past two years.

Over the two past years, the correlation between the euro/dollar exchange rate and the Shanghai Composite is 12 percent, same as the year to date. In the most recent 3 months the correlation has risen to just above 21 percent, its highest since Q2 2007. The highest over the past decade was recorded in Aug 2005 with a correlation of about 40 percent.

The yen's correlation with the Chinese equity market is not statistically significant. Over the past two years, the correlation is about 4 percent and year to date it has fallen to a little more than 2 percent, but in the past three months has risen to about 5.5 percent.

Five things to think about this week:

CENTRAL BANKERS IN A HOLE
– The global economy and financial system appear on the road to recovery but that is in large part due to unprecedented official stimulus that will have to be withdrawn at some point - the questions investors want answered are when, and how.  Central bankers no longer appear to be quite as shoulder to shoulder with one another on coordinated policy as they were last year in the aftermath of Lehman’s collapse.
 

CHINA STOCK WATCHING
–  It is August, liquidity has dried up with the summer holiday season in full swing, and investors are palpably more cautious about the economic outlook now than they have been for months. It is against this backdrop that that the Chinese stock market is emerging as the focal point and driver of all other asset markets. The Shanghai Composite technically slipped into bear market territory earlier last week, shedding 20 percent in the two weeks from Aug. 4 to Aug. 19 on profit taking from the 90 percent surge this year. There is no major Chinese economic data scheduled for release this week, leaving thin markets at the whim of sentiment in what is a notoriously volatile stock market.
 

GROWTH FOUNDATIONS
– The United States, Britain and Germany unveil revised estimates of Q2 economic growth. Revised GDP figures rarely garner much attention but with initial estimates from Germany, France and Japan earlier this month all showing that these countries exited recession in the last quarter, investors will be looking for further evidence the world economy has turned the corner. The hard data is stronger now than it has been for some time but is the global economy building a solid base for recovery, or is it more likely to buckle were authorities to begin withdrawing the massive fiscal and monetary stimulus?
 

ABNORMALLY NORMAL MONEY MARKETS
– A veil of normality continues to cloak interbank money markets, with Libor at record lows and some closely-watched measures of money market health like Libor/OIS spreads and the TED spread almost back to levels seen before August, 2007. But that is only thanks to authorities’ liquidity injections, guarantees and asset purchases worth trillions.  Banks have hoovered up this free or ultra-cheap money but still are not feeding it into the real economy, with lending to business and households still patchy at best. Euro zone M3 money supply figures for July are expected to show another slowdown in the rate of growth, to 3.3 percent on the year from 3.5 percent in June.
 
SAFE AS HOUSES?
– Figures will show how the U.S. housing market, the epicentre of the global financial crisis, is faring four and a half years on from its peak. The Case/Shiller house price index is expected to show the annual pace of price declines slowed again in June, fuelling the belief that the market has bottomed.  But the number of foreclosures is high as the U.S. labour market remains weak, and the national housing market stock remains high by historical standards. Economists say there will be no sustainable recovery of the financial system and economy without a durable recovery in the US housing market.

It may be a fertile market, but Caterpillar and Navistar are hardly breaking new ground with plans to set up a joint venture in the People's Republic. A source tells us the two U.S. machine makers are teaming up with China's Jianghuai Automobile to set up a truck venture, a source said, hoping to gain a foothold in China's 150 billion yuan ($22 billion) heavy truck market. But while the market may be fertile, it is a crowded space for foreign firms, with Daimler, MAN and others already tied-up with local partners.

Heavy truck sales in China rose 11.75 percent to 541,256 units in 2008, more than double the level in 2003, according to Nomura Securities, and are set to rise in the coming years on state pump-priming and infrastructure development.

While the money might be there, demand might not be for bourgeois trucks. "Foreign truck makers face a much bigger challenge in China comparatively because an Audi is a status symbol, while a Volvo truck can only push up trucking firms operating cost," said Chen Qiaoning, an industry analyst with ABN AMRO TEDA Fund Management.

Five things to think about this week:

APPETITE TO CHASE? 
- Equity bulls have managed to retain the upper hand so far and the MSCI world index is up almost 50 percent from its March lows. However, earnings may need to show signs of rebounding for the rally’s momentum to be sustained. Even those looking for further equity gains think the rise in stock prices will lag that in earnings once the earnings recovery gets underway, as was the case in past cycles. The symmetry/asymmetry of market reaction to data this week — as much from China as from the major developed economies — will show how much appetite there is to keep chasing the rally higher. 

TAKING CONSUMERS’ PULSE 
- A better picture of the health of the consumer will emerge this week as U.S. retailers’ earnings coincides with the release of U.S. July retail sales data and the UK BRC retail survey comes out on the other side of the Atlantic. With joblessness still rising, the reports will show how willing households are to spend and whether deep discounts, which eat into retailers’ profit margins, are the only thing that will tempt them to shop — both key issues for the macroeconomic and corporate outlook. 

CENTRAL BANK WATCH 
- After last week’s Bank of England surprise, all eyes turn to what sort of signals the U.S. Federal Reserve and Bank of Japan will send on the outlook for their respective economies and QE programmes. After the BOE’s expansion of its QE programme the short sterling strip repriced how soon UK rates would rise. But the broader trend recently in the U.S., euro zone and the UK has been to discount rate rises in 2010 — and possibly as soon as this year in Australia. Benchmark interbank euro rates have risen for the first time in two months, and central bankers everywhere, including China, face the delicate balancing act of managing monetary tightening expectations in the months ahead. 

PRICE PROTECTION
-This week’s inflation data (from Germany, France, Italy, euro zone, U.S.) is unlikely to contain any nasty surprises. But the U.S. Treasury’s willingness to consider bringing back the 30-year TIPS suggests that enough investors and reserve managers are looking beyond current subdued price data to future inflation risks from QE programmes, etc. That will ensure a close eye is kept on breakevens and whether the main issuers of inflation-linked products in the euro zone are inclined to increase issuance of such products.

TRADE 
- Official resistance to currency appreciation has been evident in some developed countries (Switzerland, RBA, RBNZ, among others) and there are suspicions that some Asian central banks may also be inclined to check such trends given the fierce competition among the world’s exporters to grab what orders there are. Trade data this week will show how trade flows are faringand the extent to which Chinese economic activity is driving them.

Five things to think about this week:

GOOD RUN 
-  Stocks have managed to extend their rally but potential hurdles, such as this week’s U.S. non-farm payrolls, could prove increasingly hard to leap given valuations — European stocks are trading at their highest multiples of earnings since May 2008 while the multiple for the S&P is the highest since mid-September 2008. If investors are to boost equity holdings — which Reuters polls show already back to pre-Lehman levels — it may require more concrete evidence of economic expansion, rather than just economic stabilisation, and signs that profit margins will be supported by revenue growth, rather than cost cutting. 

BOE - HANGING IN THE BALANCE
- The Bank of England will have to decide this week whether to end its asset-buying programme or extend it. Concern about potential longer-term inflation implications will have to be weighed against the signs of economic weakness still manifest in recent Q2 GDP data. With economists split on the outcome, markets look set for volatility, not least as the MPC’s decision is likely to be viewed as a indication of when other central banks could start to halt/unwind their credit easing strategy. 

SQUARING CIRCLES
- The dexterity with which China can manage surging lending and potential price pressures without unsettling markets with any rapid reversal of stimulative policy is increasingly in focus and will have financial market and macroeconomic repercussions well beyond its borders and Asia, as last week showed. Australia, which felt the spillover effect of the China jitters, has its own policy dilemma as the RBA is trying to push back against its currency’s appreciation while giving markets another reason to buy A$ by its more upbeat view on the domestic economic outlook. The RBA policy meeting this week will give the central bank a chance to show how it squares this circle. 

INVENTORIES AND EXPORTS 
- Detailed PMI data and UK, Italy industrial output reports will be scanned for signs of whether the inventory decline that accompanied a rise in Japanese industrial output is being seen elsewhere, with the inventory-shipments, inventory-orders ratios remaining firmly in focus as key signals for the outlook for production. The extent to which Asian economic activity is helping trade flows will also be flagged by German and French June trade data (all the more interesting given May exports rose in both countries, despite their differing export specialisations.

LOAN PROVISIONS 
- European banks reporting this week will be closely watched for the extent to which they follow in Deutsche Bank’s footsteps by making higher loan loss provisions. The ECB’s latest lending survey shows euro zone banks’ expect to continue to tighten credit conditions in the coming months, albeit at a slower pace; heftier loan provisions will make this all but guaranteed.

Investment guru Burton Malkiel, author of A Random Walk Down Wall Street, has revealed at a briefing that Chinese equities form the largest part of his personal satellite portfolio, although the core remains in low-cost index funds.

Malkiel, in town to beat the drum for Vanguard’s index funds, argued that China will be the biggest economy in the world in 20 years’ time, but most investors are underweight the emerging giant. “I’m a real expert on China - I’ve been there five times,” he joked, but made the serious point that most investors have a home bias.

“In general, people are inadequately diversified,” he said. “When people ask me how much international diversification they should have, I say: A lot more!” He conceded that asset class diversification had not been much help last year when markets collapsed in a great unwinding, but added that gold and US Treasuries had provided some relief.

Malkiel believes investors would do much better if they didn’t try to time the market - because they invariably get it wrong.

Over 15 years, between 1994 and 2008, those who stayed the course enjoyed an average annual return of 6.5 percent, whilst those who missed the best 30 days were down 3.7 percent per annum. If you stayed out longer and missed the best 90 days, you’d be down 14.6 percent per annum on average.

Similarly, those investors who save regularly, putting money into markets every month through good times and bad, benefit from dollar cost averaging, essentially buying more units for the same monthly sum when prices have fallen, and then enjoying any subsequent appreciation.

It’s a victory for the tortoise, not the hare.