>Investment Strategy (MERRILL LYNCH)

● Inflation to Deflation: 12 months ago China’s CPI was 8.7% and the PPI 6.6%. Both measures are deflating: China’s CPI is down 1.6% y/y and the PPI down 4.5% y/y in Feb. Consensus forecasts a 10% decline in Asia’s EPS in 2009. Despite tentative signs of macro stability in recent weeks, the weak global backdrop and regional deflation still suggests the consensus is too optimistic.

● Deflation benefits Asia consumer stocks: But margin expansion for some sectors is likely due to lower raw materials costs. Asia consumer stocks faced a huge squeeze when commodity prices surged in 2006-08 (one-on-three saw two consecutive years of margin compression despite strong top-line). This should reverse in 2009 as lower commodity prices shifts EPS momentum from energy to consumer sectors (Chart 1).

To see full report: INVESTMENT STRATEGY