Business Times Singapore Investment
Roundtable
Asian stock markets outlook
William R. Thomson
Nov 5, 2007
OVERVIEW
As one bubble deflates, so
another forms - or so it would appear as Asian stock markets
surge to lifetime highs even while the US mortgage-driven asset
bubble collapses. Does this mean that Asian markets (including
Australia's commodity-fuelled bourse) are dangerous places to
invest just now? At first sight it seems so, but experts gathered
together by The Business Times for an Investment Roundtable discussion thought otherwise. This bull market has
further to run, even if it stumbles occasionally, they suggested.
They are not alone in this
view. The Institute of International Finance in Washington has
predicted that external flows into emerging equity markets, Asia's
included, will reach record levels this year.
And, as Asia has been relatively
unaffected (so far) by the turmoil and financial losses being
suffered in the United States and Europe, the region is being
viewed as a safe haven by many investors.
Even as markets marked the
20th anniversary last week of the 1987 'Black Monday' when leading
stock markets crashed and with Wall Street again looking shaky
now, Asian markets were clocking up record highs. Hong Kong's
Hang Seng Index punched through 30,000 - a lifetime high - and
the Bombay Stock Exchange Sensex index hit another record high
and is approaching the 20,000 level, despite the imposition of
new regulations on foreign portfolio investment in India.
The story is the same in most
other Asian stock markets, China especially, but with the singular
exception of Tokyo, where the Nikkei 225 average refuses stubbornly
to push above 17,000 (less than half its 1990 peak) as Japanese
money continues to join that from the US and Europe in flooding
into other Asian markets. How long can it go on was the question
we put to a panel of experts, and their responses were mostly
upbeat.
DISCUSSION
Anthony: Asian stock markets seem to be in
a state of what former US Federal Reserve chairman Alan Greenspan
might have called 'irrational exuberance'. There are fears of
a US recession, financial markets are in turmoil and oil has
shot to an inflation-threatening level of US$92 a barrel. What
is behind the Asia euphoria, and can these markets go higher,
or even sustain their current levels in the short to medium term?
William, you are a veteran of Asian markets. What is your view?
William: Asian markets have been undervalued
as a group for the past decade ever since the onset of the Asian
crisis. Not very long ago, good companies were selling at giveaway
prices, low single-digit price/earnings multiples and paying
dividends that were well above money market rates. In the meantime,
the economic story in the region has been strengthening - something
which is becoming clear even to Europe and North America with
their ageing, overindulged and welfare-cosseted societies. So,
it is hardly surprising that markets have woken up to the disparity
in value that has existed for too long.
That said the current pace
of change, powered by both Western and Chinese monies, does give
pause for reflection. The confidence that now exists that the
region can shrug off a US recession still has to be tested. I
am confident the region will suffer only a modest slowdown in
its superheated growth rates but, at the very least, markets
are likely to become very much more volatile.
Robert: The main factors behind the Asian market boom,
especially China and India, are domestic liquidity and confidence.
I have never, in 30 years of following Asia, seen the same level
of conviction about corporate earnings and accelerating GNP growth
in both countries (that we are seeing now).
I do believe that these markets
can go higher, although I think China is probably into the 'mania'
stage. There are certainly strong parallels with 1985-89, when
'Zaitech' or financial operations were one of the driving forces
of corporate profits (in Japan). Once again, in Shanghai today,
these may account for up to 50 per cent of earnings.
Christopher: The re-rating of Hong Kong-listed
China shares has been the key factor driving the re-rating of
the overall Asia (ex-Japan) equity universe. A real US slowdown
and further related credit convulsions will raise the threat
of short-term corrections for Asian equities. But Asia remains
in a secular bull market, led by China and India.
Anthony: Which of the Asian markets in particular
has the best prospects for investors, and why? And are there
any sectors in particular that you favour?
Robert: I think India still leads the Asian markets
in terms of two to three-year prospects of corporate profits
growth. Some other markets are interesting - that is, Indonesia,
Thailand and the Philippines. Hong Kong, of course, is a special
case in the catch-up phase with China.
Christopher: India is the quality equity story
in Asia, driven by a powerful investment cycle, while China is
in a liquidity-driven bull market, which is likely to evolve
into a full-scale bubble. Domestic demand and asset-reflation
plays in the region, such as HK property, are my preferred choice.
William: I believe the South-east Asian markets
that have barely recovered their 1997 highs in local currency
terms are very interesting and have further to run. Thailand,
for good and bad reasons, is selling for half its 1994 high in
baht terms, which is about a 70 per cent discount in US dollar
terms and considerably more in terms of euros. The Philippines,
which is having its best economic run since the 1960s, is selling
at almost a 40 per cent discount. In US dollar terms, it is at
its all-time high. Malaysia and Singapore both look very reasonably
valued. Taiwan is interesting as (part of) a Greater China that
is only now beginning to move.
Anthony: Which of the markets do you feel
is most vulnerable to a correction, and why?
Robert: I would have to say that China is most vulnerable
to a correction because of stratospheric price-to-earnings ratios
(P/Es) and the bubble-like characteristics of the market. This
again is like Taiwan in the late 1980s and is 90 per cent driven
by retail investors buying stocks without any attention to fundamentals.
Christopher: China and India because they have
gone up the most recently.
William: Obviously, the values in the closed
Chinese markets are high by any standards, and companies (there)
sell at large premiums to the same companies in Hong Kong and
elsewhere.
As China relaxes its capital
controls, it would seem inevitable these values are normalised.
Markets can be driven for a longish period by weight of money
arguments but eventually there is some factor that brings them
back to normality. India has also come a long way in a short
time and we have seen how vulnerable that can be when there is
a growth or liquidity scare.
Anthony: What external events are most likely
to influence the course of Asian stock markets? First, in terms
of financial flows such as the continuance of yen 'carry trades'
and of abundant liquidity in US markets, and second, in terms
of external macro-economic developments, such as a slowdown in
the US economy or rise of protectionist sentiment in the US or
Europe?
Christopher: The biggest tactical risk facing
all Asian stock markets remains the US consumer. More of a US
growth scare is still expected. But the present cycle of Fed
easing will provide a following wind in Asia to accelerate the
asset reflation cycle in the region. The liquidity flows emerging
out of the renewed cycle of Fed easing will be drawn towards
Asia and emerging markets as the new global asset classes of
choice.
Robert: External events would probably be in the US
- financial shock, economic slowdown, an attack on Iran, or a
collapse in the dollar. But I don't believe that the yen carry
trade is nearly as important as the press says. Japanese savers
are still hungry for yield and are still pushing billions of
dollars overseas. If the yen strengthens significantly, of course
that flow would slow down, but I do not believe it would stop.
In terms of liquidity, if over 50 per cent of trading volume
is coming from hedge funds now, I imagine that a setback in that
area could be serious.
William: I do not believe the banking problems
related to housing, derivatives and structured finance in the
US and Europe is over by any means. Future disruptions could
come from there. A disorderly decline in the dollar is also possible,
and that could be related to geopolitical events. The yen is
the most undervalued major currency in the world by a mile. It
is inevitable that the yen carry trade will unwind at some time
since yen interest rates must be normalised eventually and there
is likely to be pressure to lower dollar rates further.
Anthony: Are most Asian stock markets fully
valued, do you think, on price/earnings, yield basis, etc?
Christopher: Asian valuations, though no longer
cheap, remain quite reasonable in the context of the overall
global equity universe, given the growth story.
The present bubble is likely
to climax with Asian P/E ratios trading at twice the level of
US P/E ratios. Asia has managed to maintain high ROEs and a healthy
corporate balance sheet. Asia also continues to have some defensive
qualities in terms of dividend support.
Robert: Asian stock markets are within their historic
range on a P/E and yield basis and are not overvalued in our
view.
William: As I mentioned earlier, many of them
have been undervalued for a long time. That is likely to be followed
by a period of full to over valuation. China is the one glaring
example of an overvalued market and India is getting fully valued,
but when corrections set in, all markets tend to be affected
together.
Anthony: I can't close a discussion on Asian
stock markets without asking you all whether you have any views
about prospects for Japanese equities.
Robert: It is difficult to get very excited about the
Japanese political, economic or corporate outlook. Nevertheless,
the market is very oversold, small caps are on price-to- book
of one time, large caps are internationally competitive and also
at 10-year lows in terms of P/B, P/E, yield, etc. The problem
is, as I see it, that domestic investors are not interested in
their own market, and any move is coming from foreign investors.
Until there is a trigger for getting Japanese investors back
into the market - that is, some exciting IPOs, technology sector
recovery, a stronger yen - I don't think Japan will outperform.
On the other hand, it has least downside of any market and I
would continue to be fully invested there on a purely contrarian
view.
Christopher: The story for Japan continues to
be about the stock market moving to discount the end of a decade-long
deflation. A move out of such a long-term deflation is a very
big deal in terms of reigniting risk tolerance. A structurally
bullish view is maintained. Global-dedicated equity investors
should remain structurally overweight Japan with the underweight
being financed by remaining short Western financials.
William: I believe the retail investor is
advised to play the Japanese market through funds, especially
Exchange Traded Funds.
Anthony: And, with that, we have to close.
Thank you, gentlemen, for your very interesting and perceptive
contributions.
Participants in the roundtable
Moderator: Anthony Rowley,
Tokyo Correspondent, The Business Times
Panellists:
Robert Lloyd George, chairman of Lloyd George Management,
a London-based investment management group specialising in emerging
markets
Christopher Wood, managing director and equity strategist
at CLSA Asia-Pacific Markets in Hong Kong
William R Thomson, chairman of Private Capital Ltd and
a Senior Advisor to Franklin Templeton International Hong Kong
and Axiom Alternative Investments in London.
Business Times Singapore
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