Business Times Singapore Investment Roundtable: Asian Stock Markets Outlook
Participants in the roundtable.
Moderator: Anthony Rowley, Tokyo Correspondent, The Business Times
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.
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.
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.