Improved corporate governance and governments tackling weak banking sectors mean the region is in a good position to benefit from a pick-up in demand from the US
To say that 2002 was a difficult year for financial markets would be an understatement. Apart from a liquidity-driven rally in the first quarter, it was mainly downhill for economies globally.
Weakening economic conditions provided the backdrop for the sharp falls in stock prices. The pace of the decline increased over the summer, coinciding with rising risk aversion, which benefited bonds and safe-haven commodities like gold. External uncertainties including the prospect of a war in Iraq, tensions in North Korea and the Bali bomb blasts also cast a shadow.
Against this less-than-favourable backdrop, Asian markets suffered, but to a lesser extent than their more developed peers. This was all the more impressive given that the US, the region's biggest export destination, continued to suffer.
Economic growth was relatively steady, due in part to a recovering private consumption story. Indeed, the best growth stories were found in Asia, where both investment spending and private consumption recovered. Evidence of this was strongest in Korea and Thailand.
In Korea, a strong cyclical recovery and booming credit story were the primary growth catalysts. Thailand's recovery momentum was fuelled by the availability of easier credit, which helped spark a surge in demand for cars and houses. Encouragingly, exports and foreign direct investments helped support the economy despite the external uncertainties.
Other healthy performers were China and, to a lesser extent, Malaysia and Indonesia. Chinese GDP grew by around 8%, boosted by strong FDI inflows, exports and continued fiscal stimulus. In Malaysia, the government continued to support the economy through traditional pump-priming measures. Another stimulus package is expected during the first quarter of 2003 to prevent the economy decelerating.
Japan's economy remained in slumber mode throughout most of 2002 amid continued deflationary woes, weak consumer confidence, rising unemployment and a distressed banking system. This had a dire effect on the domestic equity market, with the Nikkei index flirting with 20-year lows on various occasions during the year.
While part of Japan's economic problems can be attributed to the global slowdown that gathered pace over the course of the year, prompting the US Fed to cut rates aggressively and increasing fears of war in the Persian Gulf, the faults lie mainly at home.
Uncertainty about the future has been the biggest problem. Three years of deflation in Japan has derailed confidence, with consumers showing less willingness to spend due to heightened concerns over job security and retrenchment as companies move to restructure and repair their balance sheets in line with government initiatives to clean up the sector. Even the Bank of Japan's adoption of a zero interest rate policy failed to coax the public into spending.
Exports continued to be one of the few bright spots for the otherwise distressed Japanese economy and were a principal contributor to the 0.7% quarter-on-quarter rise in gross domestic product during the July-September period.
Going forward, however, gains in export growth are not expected to be enough to offset the persistent falls in personal consumption levels. Consequently, GDP is predicted to decline in the October-December quarter.
At the company level, Asia has shown a marked improvement, reflecting a turnaround in the region's financial health since the crisis of 1997-1998. This was due in part to the proactive stance taken by regional governments to effect corporate restructuring and banking sector reform. Consequently, companies are in better shape, their profitability is improving and they are working hard to create value for shareholders.
Going forward, Asian economies appear poised to benefit from any upturn in growth due to their export dependency. A rebound is predicted on expectations of a turnaround in the US by the second half of the year but a large contributor to the cautious optimism is improving domestic demand across the region.
This is already evident in countries such as Korea, Thailand and Indonesia, which are our markets of choice. China's emergence as a major player in regional trade flows is another development to watch, especially as Japan is no longer the economic engine it once was.
So, although markets have been disappointing in absolute terms, they have provided plenty of opportunities. There is a widespread perception within the region that Asian companies have been doing all the right things in terms of restructuring, paying down debt and refocusing on core competencies. In addition, many governments have been taking the initiative in promoting a better climate of transparency ' enacting new codes on reporting and disclosure, for example.
Of course, not all companies have embraced change and the gap between rules and practice persists. Furthermore, government protection of core sectors often entrenches bad habits, while confirming unfair commercial advantage ' although, admittedly, some de facto monopolies are excellently run.
While these circumstances can limit the availability of good stocks, we have persisted in our disciplined bottom-up stock selection, only investing in well-run companies that trade on reasonable valuations.
Generally, the region's underlying fundamentals remain solid and a committed push to spur domestic demand is likely to become increasingly important in future. There are signs of a policy shift in several countries as lending practices are liberalised and younger central bankers assume charge.
Certain structural weaknesses persist, however, and, depending on where one looks, non-performing loans remain a potential drag on growth. That said, opportunities for credit expansion are limited by lack of demand for funds. Asian companies have learnt the lesson of over-borrowing that leads to excess supply ' a lesson the West is only just confronting as it looks for the scapegoats of deflation.
On balance, we believe neglected Southeast Asian markets offer the best value regionally, especially in the domestic-oriented consumer sector but also in select financial stocks. However, a recovery in capital spending remains critical. It is likely the best growth stories will once again be found in countries where both investment spending and private consumption show sustainable growth.
Companies benefiting from government-led restructuring of banking sector.
Upturn in growth likely due to expected increase in demand in the US later in the year.
Structural weaknesses persist and non-performing loans remain a potential drag on growth.
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