BT Editorial: Asian stocks - down but not out

Business Times - 31 Jan 2008

Asian stocks - down but not out

BUFFETED by headwinds from the US sub-prime mortgage crisis, global stock markets are now currently in the grip of a cyclical bear market - on average, the major South-east Asian equity indices are down 12-15 per cent for the year so far.

However, investors suffering from the hard hits of the past 3-4 months can take some comfort: there are plenty of reasons to expect this to be only a cyclical and not secular bear market. It might stretch past the half-year mark, but could well run its course by the third quarter.

The key to equities bouncing back lies with Wall Street. Although many observers predicted at the start of 2007 that Asian markets would decouple from the US because of their exposure to the explosive growth of China and India, the events of the past year have confirmed the old market adage 'when Wall Street sneezes, the rest of the world catches a cold'. However, despite the huge drag on the US economy posed by sub-prime losses and the resulting dent this has created on US consumer spending, there are good reasons to expect the slowdown to be less drastic as some expect, or that it will extend into 2009.

For one, a Fed that was earlier criticised for being too far behind the curve now appears determined to pull out all stops to ensure a soft landing for the economy and the markets. As a result, chairman Ben Bernanke will probably lower the Fed funds funds rate by as much as it takes - to perhaps even as low as one per cent - by the end of the first half, to combat the deflationary forces now at work. Together with a generous fiscal stimulus package announced this week and provided financial institutions manage to strengthen their balance sheets adequately in the aftermath of their sub-prime losses, these moves should provide some relief for beleaguered US consumers and sow the seeds for a recovery later this year.

In addition, although Asian markets have not decoupled from Wall Street, the original premise that Asian economies are now less reliant on the US than before still holds. A US recession will impact Asian growth but this may not be too profound - as US broker Merrill Lynch correctly pointed out in a Jan 23 report, Asia's macro backdrop is a mirror image of the US: Asia is a lender, not a borrower; leverage is low, not excessive; the housing upturn is young, not mature; financial systems have been conservative, not aggressive; and current accounts are in surplus, not deficit.

There will, of course, be plenty of turbulence ahead and there's no denying that risks have increased - for instance, there is a chance that the US might find itself mired in stagflation, or stagnant growth amid rising inflation. Also, it is not clear how badly corporate profits will be affected by the slowdown.

However, the chance that the present cyclical bear market will not degenerate into a secular one rises with each day and investors would do well to look beyond the present turmoil. On a medium term view, those who remain long on Asian stocks may well find themselves reasonably well placed.