It was hard to ignore Asian equity markets in 1998 because they kept falling for much of the year an...
It was hard to ignore Asian equity markets in 1998 because they kept falling for much of the year and helped trigger the summer's global meltdown. It is still hard to ignore them so far in 1999 because they have soared upwards, fuelled by signs of recovery and investor expectations that recovery will continue.
But markets have a habit of overreaching themselves when trying to restore some level of equilibrium. In the past couple of weeks, in fact, sentiment began to emerge that Asia's economies and stocks were doing so well that local central banks would have to raise interest rates just to keep control.
This was most painful to South Korea, whose economy and market had been among the fastest to recover.
The Korean market absorbed the largest single-day decline (in terms of index points) in its history on 23 July, when investor fears of rising rates and a possible default by Daewoo sent share prices tumbling. By the time trading ended, Asian equity markets collectively had experienced their worst week of the year.
Therefore it is quite natural for investors to question whether the Asian bull still has room to run. We think it does, for the following reasons.
The liquidity environment is supportive and should remain so. Interest rates across the region have plunged in the past year, balances for nations' trade accounts and current accounts are strongly in surplus, inflation is low and unlikely to rise much, and credit conditions should improve in the next year or so.
Earnings should surprise on the upside. We believe that most analysts are underestimating the pace at which many Asian companies are positioning themselves, through restructuring and cutting costs, to benefit as the region's economies recover. As a result, corporate earnings growth should exceed expectations, suggesting plenty of potential appreciation for stocks.
Valuations are not unreasonable. Unlike previous rallies in 1994 and 1987, Asian equity valuations are fair rather than excessive. This indicates additional upside for valuations, as they adjust to reflect the positive earnings surprises that we expect.
Foreign capital flows should increase. The inflow of foreign capital into Asia in terms of portfolio flows, direct investment and commercial lending has not yet returned to pre-1997 levels and we believe that it will.
Global economic recovery should benefit Asian exports. If, as we expect, the world's economies start to grow in sync next year, Asia's key export sector should be a major beneficiary. This should positively impact not only earnings and pricing power for exporters, but also the macroeconomic environment.
There are three main risks. Asian interest rates may rise faster than economic conditions suggest is appropriate; the large quantity of new equity being issued to reconfigure debt-laden capital structures may prove more than markets can handle; and corporate restructuring activity will slow as soon as economies recover. In each case, we think prospects are unlikely.
In the near term, we expect Asian equity markets to experience some consolidation. Given their extraordinary period of sustained appreciation since the last quarter of 1998, recent selling is most likely part of a reasonable pause as investors seek to realise gains.
Our outlook for medium and long-term investment horizons is solidly optimistic.
Robert Hrabchak is chief investment officer Asia at Credit Suisse Asset Management.
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