Lower trade barriers and increased globalisation are encouraging sector analysis in most asset class...
Lower trade barriers and increased globalisation are encouraging sector analysis in most asset classes. However, in the Far East, the country in which a company operates is still more important than the sector to which it belongs. This is because there are many fundamental differences between the economic, political and regulatory frameworks of Asian countries. As a result, country-based analysis remains the most appropriate way of selecting stocks.
Unlike Europe, the Asia Pacific region does not operate as a single market with a single currency. There are no centralised political and economic institutions and, as a result, there is no region-wide economic policy. So it is hardly surprising that the countries in the region end up in different parts of an economic cycle.
For example, the local currency in Hong Kong is pegged to the US dollar at a fixed rate. While many other Asian currencies have depreciated significantly since 1997 - for example, the Korean won and the Singapore dollar have become cheaper against the US dollar by 30% and 20% respectively - the Hong Kong dollar exchange rate has been maintained at 7.8/US$.
As a result, local prices in Hong Kong have had to adjust downwards to stay competitive with their Asian neighbours. So it is not surprising that Hong Kong is experiencing 4.5% deflation. Hong Kong's interest rate is also tied to that of the US. Hence the Hong Kong economy had a tough time last year when US interest rates began to go up against a background of falling prices. Meanwhile, Korea and Singapore had vintage years in 1999, with their economies growing by 10.7% and 5.4% respectively compared with 2.9% in Hong Kong.
Having lagged behind its regional peers in 1999, the Hong Kong economy is quickly catching up with its neighbours. This is being driven by three factors. US interest rates are peaking, deflationary forces are weakening and its relationship with China, unique in the region, is bearing fruit as China pushes through structural reforms.
Partly driven by the threat of foreign competition which goes hand in hand with entry into the World Trade Organisation (WTO), China is planning to build up national champions in industries such as airlines, power, and petrochemicals by merging key players in each of those industries. Shares in these national champions will be offered to domestic and international investors and proceeds will be used to push through further reforms such as state pensions and banking, as well as replacing inefficient capacity.
As one of the key service hubs for China, particularly in the financial services arena, what is good for China is good for Hong Kong.
These are just a few examples which illustrate the diversity in economic systems and cycles in Asia.
But the economy is not the only area in which differences arise. A number of other country-specific factors, such as politics, can have a dramatic impact on the share prices in any given country.
A recent example can be found in the foundry industry. Foundries manufacture customised electronic chips for third parties such as Sony, Motorola and Ericsson. It is a very specialised industry dominated by three global players, all of which are located in Asia.
One of them is UMC, located in Taiwan. Its share price took a heavy hit in the first quarter this year in the lead up to the national elections, when the political tension between Taiwan and neighbouring China resurfaced. At the same time appetite for technology was very strong globally. The result was that UMC drastically underperformed Chartered Semiconductor, its peer based in Singapore, by 85% in the first quarter.
Political factors also cast a shadow over telecom company Philippine Long Distance Telecom (PLDT). While technology, media and telecom stocks raced away in the first quarter, PLDT fell by 12%. This was due to a widely held view that the Philippines lacks political and economic leadership. Moreover, smaller markets in Asia were not performing well and even good companies in these markets were sold off.
Rules and regulations
In addition, legal and regulatory frameworks also differ significantly in countries in the region. In some, such as Singapore, business laws are set out clearly. The same cannot be said for China where regulations can be ambiguous. As a result, investors attach a 'certainty premium' to Singapore shares.
Regulations can have a dramatic impact on the profitability of some industries, such as utilities.
In Hong Kong, for example, returns for electricity companies are dictated by a formula which is linked to capital investment, so it is relatively easy to forecast profits. By contrast, in Korea tariffs charged by utilities are subject to government approval. If an election is approaching and inflation is running high, for example, the government can prevent companies from raising prices.
But the relevance of regulation extends beyond corporate profitability; it can also have an impact on the robustness of an economy. A clear example of this could be found during the economic crisis three years ago. Poorly regulated banking systems pulled the whole economy down in countries such as Thailand. Thai banks are still struggling with bad debts on their balance sheets.
The problem is that banks perform a crucial function in an economy: they act as intermediaries between borrowers and lenders. When banks are unable to perform that function, the whole economy suffers. Singapore, on the other hand, has extremely good regulation. Consequently Singapore was able to recover much more quickly from the crisis.
All these factors mean that the share prices of Asian companies continue to be influenced far more by the country in which they operate than the industry to which they belong. But this does not mean that sector analysis has no role to play in stock selection in the Asia Pacific region, or that coun
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