The dice are rolling in Asia
Once again last year, the Asian region provided some of the most rewarding returns for foreign investors. And if 2001 was an important year for Asia, with China and Taiwan entering the World Trade Organisation (WTO) and the markets of South Korea, Taiwan and Thailand giving investors a boost, then 2002 should be a year of further progress. This scenario is not without its downside, of course, with much depending on the fate of Japan and the US, but Asia has shown an ability to shrug off the global malaise and tackle issues it is able to deal with domestically.
For example, Korean companies have done much to improve their efficiency, and while issues of effective corporate governance remain, there is real hope for that market. The market rallied strongly in 2001, on the back of a re-rating of bank shares and stronger DRAM prices which supported shares such as Samsung Electronic. Brokerage stocks also rose strongly with the higher trading activity in a relatively buoyant market. Fund managers have bought Korea and Taiwan, not because they want the second- or third-tier tech stocks, but because the market rating of these stocks was at odds with their potential value. Despite the recent strong run, this remains the case for many of them. Analysts have focused on the improvements in ROE and sales growth over capex. It is useful to look at stocks such as Samsung and to realise that their debt to equity is better than that of Phillips.
Korea is always a good market to own in a cyclical upturn. The risk now is that this country has had its run, but the consensus view is that Korean companies have made bigger strides than their Hong Kong counterparts. For domestic investors, the relative attraction of equities over fixed income is becoming clear. The recent run-up in the market has been driven by foreign buying. The liquidity conditions exist for domestic buyers to provide the next leg.
Morgan Stanley is “maximum bullish” about Asia and has advised clients not to miss the opportunity regional markets are providing, according to chief strategist Ajay Kapur. He says Asia is showing good signs of recovery, with regional markets at record lows compared with the US. Large-cap Asian stocks, for example, are about 34% undervalued. Asia corporations were generally in good shape with low leverage, while capital expenditure over sales was down to global levels. Kapur expects Asian markets to deliver solid returns of 30% in 2002.
Investors might want to remember that Morgan Stanley’s chief global strategist, Barton Biggs, famously stated he was “overfed and maximum bullish” about China back in 1993. This was to prove a comment that came back to haunt him and those who followed his words, in the subsequent collapse of sentiment at that time.
So the question remains, are Asian countries doing enough to survive? Broadly, the situation is one of gradual change in the face of a more hostile global operating environment. Hong Kong is yet to emerge from a period of gloom, brought on by fear of being undermined by the growing influence of China’s mainland centres. Growth forecasts are being revised downwards and the deflationary spiral is entrenched.
In South East Asia, Singapore’s re-elected government is reviewing policy towards addressing the current recession and introducing measures to improve the country’s competitiveness. As a geared play on the electronics cycle, Singapore trails Korea and Taiwan. It also has to contend with the often self-destructive nature of its immediate neighbours, while struggling to find its niche with regard to China.
Malaysia is likely to continue to be a lagging market, on the basis of its low technology exposure and uncertainty despite some progress on the corporate and political fronts. Indonesia has been unsettled, as indicated by the downgrading by Standard & Poor’s. Of the Asean markets, Thailand remains a favourite with fund managers. A reversal of monetary policy, away from the tightening stance, may help to give the Thai market a lift in the first quarter.
Though there appear to be several fundamental downside risk factors in the near term, professional investors in Asia feel this does not alter the overall positive outlook from an improving global backdrop in the second half of 2002. Figures from the manufacturing sectors suggest that the worst may be over. Subject to US consumption not suddenly going into a tailspin, the outlook for Asian production and exports is expected to steadily improve.
For many, the greatest worry remains over Japan. Madhav Bhatkuly of Arisaig Partners, a Singapore-based investment house, says: “We sympathise with hapless prime minister Koizumi. His failure to deliver on much anticipated structural reform is not surprising. The task is simply too great and the problems too intractable, especially against a backdrop of global recession. We believe the end-game will be a US-endorsed drastic weakening of the yen.”
If this were to transpire, a nasty domino effect devaluation of currencies across the region would be unavoidable, especially in competitor countries in North Asia. And this does not bode well for investors in the region. Arisaig has taken the unusual step of hedging part of its Korean won and Taiwanese dollar exposure on a 12-month forward contract, which is a relatively inexpensive exercise. Hedging Asean currencies is still prohibitively expensive.
In terms of portfolio tilts, managers such as Credit Agricole like the economies where the consumer sector has been the strongest, notably Korea and China. Credit Agricole believes that Korean equities, even after their good run, will continue to perform well. China’s economy will also be positively impacted by improvements in the external environment. However, a note of caution is sounded following its WTO accession, that foreign investors’ expectations may be disappointed.
China is obviously going to be the focus of increased scrutiny by foreign investors. The levels of FDI to China increased by almost 50% in 2001 and there are a great many positive news flow scenarios that will aid the liquidity flow. The only concern here is that, once again, foreign money will be flowing in just as valuations are looking stretched. The quality of the majority of listed sectors, including the financial sector, continues to raise questions.