Far Eastern equities started off 2001 with a bang in January, only to give back their gains and more...
Far Eastern equities started off 2001 with a bang in January, only to give back their gains and more in February and March. Expressed in dollar terms, Morgan Stanley Capital International's All Country Far East Free Ex-Japan Index fell 4.0% in the first quarter of 2001.
Nonetheless, we see good reasons to believe that there is considerable upside in the future. The bottom line is that the main positives in the environment are more than sufficient to offset the short to medium-term challenges that lie ahead.
The liquidity environment is becoming more supportive both globally and locally. The global picture takes its cue from the US, where the Fed is cutting interest rates to revive the flagging pace of macroeconomic growth. Historically, major Far Eastern markets have fared well during periods in which nominal US rates fall.
Within the region, domestic interest rates have already begun to decline and we expect this to continue.
Equity valuations across Far Eastern countries and industry sectors are also compellingly attractive when compared to asset values, historically and relative to global peers. Our sense is that the present could well turn out to be an especially good entry point for investors seeking healthy long-term returns.
The implied risk premium Ã the extra that investors pay for relatively risky assets Ã for Far Eastern equities has risen to levels comparable to those last seen in global crisis periods like 1997 and 1998. We believe this is unjustifiably high and expect the generalised risk premium to fall in the next few months.
In our view, the broad restructuring among Far Eastern companies and industries in the last couple of years represents a secular trend and not a temporary one. Key restructuring steps such as debt reduction, divestment of non-core assets and greater focus on cost of capital and returns on invested capital, bode well for corporate profitability and long-term equity returns.
We recognise the current global environment also includes significant challenges that may cause periodic market volatility. The depth and duration of the US slowdown are unclear, for example, which is problematic for the rest of the world.
Many smaller Far Eastern companies also continue to feel the pain of the region's 1997-98 financial crisis via their inability to generate enough cash either to meet their debt obligations or expand.
Falling earnings growth and lower capital spending on technology and telecommunications infrastructure have spelled disaster for tech and telecom stocks worldwide. Given the fact that Far Eastern technology and telecom companies account for around one-third of the region's total market capitalisation, a meaningful portion of aggregate Far Eastern markets could remain volatile.
Robert B Hrabchak is manager of the Credit Suisse Orient Fund
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