Update On Asian Equities

Overview: Asian equities have outperformed mature markets in 2009 thanks to continuous foreign institutional investor (FII) inflows amid diminishing risk-aversion among global investors and relatively resilient macroeconomic fundamentals. In September, markets continue to march upwards after seeing some volatility in August, driven by concerns that the Chinese government is tightening the credit.

As of MSCI Asia Pacific has gained 30.5% YTD as of September 16, with Sri Lanka and Indonesia as the best performers, Japan and New Zealand as the worst performers. In terms of valuations, Asian equities are no longer considered to be cheap, following the rally since March. The region's price/earnings ratio has risen significantly above its historical average. In addition, downside risks still remain in H2 2009 with revival of any global risk aversion. Economic recovery may be slower-than-expected if stimulus effects fade out and the current global recession has greater-than-expected impacts on regional economies. Also, corporates may post worse-than-expected earnings reports as Q2's improvements were largely driven by cost-cutting efforts not by a recovery in demand.

Will Asian Equities Continue to Outperform Mature Markets?

2009 MSCI Asia Pacific performance in USD terms: 30.5% YTD as of September 16, up 66.6% during March 9 - September 162009 MSCI Asia performance in USD terms: 26.7% YTD as of September 16, up 61.2% during March 9 - September 162009 MSCI Asia (excluding Japan) performance in USD terms: 54.8% YTD as of September 16, up 85.4% during March 9 - September 16Best performers (YTD as of September 16, 2009): Sri Lanka: 91.9% | Indonesia: 80.0% | Vietnam: 76.5% | India: 72.9% | China: 64.8% | Taiwan: 62.1% | Thailand: 57.9% | Pakistan: 55.8% Worst performers(YTD as of September 16, 2009): Singapore: 51.8% | South Korea: 49.7% | HK: 48.8% | the Philippines: 47.8% | Malaysia: 38.4% | Australia: 24.9% | Japan: 15.9% | New Zealand: 15.4%

In 2009: Asia's equity market (excluding Japan) have outperformed mature markets, up 54.8% YTD as of September 16 2009, while the S&P 500 Index and the U.S. Dow Jones Industrial Average rose mere 14.7% and 8.4% respectively during the same period.

Since March 2009, Asian equity markets have witnessed a rally following a surge in U.S. markets and began to benefit from the widening valuation gap on the back of relatively resilient macroeconomic fundamentals. During the March 9- September 16 period, MSCI Asia (excluding Japan) rose by 85.4%, significantly higher than the S&P 500 Index and the Dow Jones Industrial Average which gained 58.0% and 49.6% respectively.

Capital flows: Continuous FII inflows to Asian equity markets have taken net flows to a positive US$14.4 billion as of June 24 2009, significantly up from US$10.8 billion in H1 and US$9.6 billion in H2 2008. Since end-June, however, fun flows have been volatile, with inflows and outflows each recoded half of the time. In the middle of August, the region saw fund outflows the most in 24 weeks as investors start to cast doubts on Chinese rapid expansion of bank lending, which has helped regional economic recovery and asset market reflation.

Valuations: Taiwan (122.8) has the highest price/earning ratio in the region as of September 9 2009, followed by Australia (83.9). In opposite, valuations of Pakistan (12.4) and the Philippines (15.1) are among the cheapest. The P/E ratio of 32 for Asia (excluding Japan, unweighted) is significantly higher than that of U.S. equities, 19.1 for the S&P 500 and 13.7 for the Dow Jones Industrial Average.

2008 Review: The peak-to-trough decline in Asian equities in 2008 (more than 70% for some markets) surpassed the 60% fall in local currency terms during the 1998 Asian financial crisis. Sustained outflows from offshore Asian funds took total net redemptions in Jan-Oct 2008 to a record high such that all money that flowed in during 2007 flowed out.

Market Integration: There is a noticeable upward trend in the Asia-U.S. correlation with the correlation parameter picking up sharply in H2 2008 (peaking during mid-Oct 2008). However, average correlations for emerging Asian equity markets are generally higher between the region's markets than with U.S. markets.

Government intervention: Several countries including Taiwan, Pakistan, Vietnam, Thailand intervened in the stock market by narrowing the trading band, introducing stabilization fund to contain volatility, banning short-selling, directing government funds to buy share.

Will the Rally Continue? Or Will a Correction Follow?
Upsides: Better-than-expected earnings reports, relatively healthier macroeconomic fundamentals, aggressive fiscal stimulus spending and ample liquidity in the region would have positive impacts. Also, buying into most of the region's equity markets seems a better bet than bonds amid increasing bond issuance.

Downsides: Worries over the U.S. economy, exit by local investors and also FIIs alarmed at greater-than-expected impact of global slowdown on Asia's growth, exports, fiscal deficits, slowing consumer spending and investment may have negative impacts. High (external) debt exposure of corporate sector in some countries and risks of real estate correction and bank profitability are additional risks.

Global portfolio rebalancing toward U.S. equities, expecting "a U.S. growth spurt," will pose risks to Asian (exculding Japan) equities. U.S. equities have gained much less than Asian (excluding Japan) equities and have lower valuations.

The recovery is real. Asian equity markets will continue to have good momentum and corporate earnings may rise substantially until 2010. Liquidity conditions will support the equity market in the near-term. But authorities may have to limit further monetary and fiscal expansion as inflation may resurface before growth normalizes in the medium- to longer-term.

Risks remain, driven not by earnings but by still weak real economy. Exports and domestic demand should rebound quickly in H2 2009 to meet the forecasts and to justify V-shaped recovery. In the past, Asia's stock market performance was highly correlated with that of western counterparts. However, Asian equities may plot a more "independent course" backed by less leveraged economy, better capitalized banking sector, huge FX reserves and healthier fiscal position.

Prospects for further inflows into Asian equities remain substantial, as global portfolio continue to adjust from relatively underweight positions, and given cheap equity valuations relative to bonds.

Adrian Mowat, Chief Asia Strategist, JP Morgan: Asian stocks have yet to reflect expectations for a powerful, synchronized recovery in the global economy as markets are still bearish on global growth and on emerging markets growth.

As of end April 2009, market capitalization of Asian Pacific markets (US$10.2 trillion) has come ahead of that of European markets (US$9.3 trillion, including Africa and the Middle East) as Asian stock prices sour at a faster pace than European ones.

Banks remain the single largest sector in Asia. However, its share has been decreased to 20.1% as of June 2009 from 43% in 1975. In opposite, the share of cyclicals has risen to 38.7% (including basic materials, industrials, oil & gas and technology) from 18% (industrials) in 1975.


p/s photos: Olivia Ong

Asia Showing A V-Shaped Recovery

Some emerging Asian economies posted robust growth in Q2 2009 after contracting or slowing sharply in Q4 2008 and Q1 2009. Aggressive fiscal and monetary stimulus, improving credit market conditions and positive wealth effects from rising asset markets have revived domestic demand. Lower leverage and better macroeconomic fundamentals are also a plus.

• China and India grew 7.9% y/y and 6.1% y/y respectively in Q2 2009, accelerated from 6.1% and 5.8% respectively in Q1 2009.
• Both Singapore and Taiwan grew over 20% q/q (seasonally adjusted). South Korea and HK grew 2.3% and 3.3% (sa) respectively. However, all tiger economies saw GDP contractions on a y/y basis.
• ASEAN: Indonesia's growth decelerated to 4.0% y/y in Q2 2009 from 4.4% in Q1, while Vietnam's growth accelerated to 4.5% y/y in Q2 2009 from 3.1% in Q1. Both Thailand and Malaysia posted positive quarterly growth in Q2 2009, with GDP contraction easing to 4.9% y/y and 3.9% y/y respectively from 7.1% and 6.2% respectively in Q1.
• Backed by aggressive fiscal and monetary easing policies, China and Indonesia have led the region's recovery, whereas Malaysia and Vietnam have lagged. While China introduced the most aggressive stimulus package, South Korea, Singapore, Malaysia, Taiwan and Thailand implemented fiscal stimulus packages that are at lease 4% of GDP. South Korea, India, Indonesia and China will lead the region in policy tightening in H1 2009.
  
• In February and March 2009, the pace of export contraction eased. But since Q2 2009, the pace of export contraction has been volatile, first accelerating and then decelerating in most countries. Demand from Chinese fiscal stimulus has not been strong enough to offset weak demand from G3 countries (though commodity exporters have enjoyed some benefits), but exports to the G3 have started to turn the corner. Export contraction is still sharp in most countries in the region, exceeding 20% y/y as of June 2009. Singapore and Hong Kong have shown some stabilizing indications, with exports now falling in single digits.
  
• Since March 2009, manufacturing activity has rebounded sharply, with the purchasing managers' index (PMI) rising above 50 for China, India and Singapore. In Q2 2009, industrial production surged 40% annualized and has recovered 65% of the ground lost since late 2008. Nonetheless, as of June 2009, industrial production was still falling about 10% y/y in Singapore, South Korea and Taiwan. Industrial production for Vietnam grew at an accelerating pace in Q2.
• Foreign direct investment (FDI) inflows are contracting. China and India have experienced over 20% y/y contraction in Q1 2009. Cutbacks in capex will hit economies highly dependent on FDI inflows, including Singapore, Malaysia, Thailand and Vietnam. In Q1, gross fixed capital formation contracted sharply in Singapore, Taiwan, Thailand and the Philippines, while that in Indonesia grew, though at a decelerating pace.
• Domestic consumption is weak due to strong ties of exports to investment and consumer spending. Aggressive fiscal spending is a plus, but increasing job losses, slowing income growth and negative wealth effects from 2008's asset market correction will weigh on the region's consumption. Starting in Q2 2009, private consumption has picked up in China, India, Indonesia and Vietnam, while it continues to contract in Hong Kong and Singapore.
• Though the pace of job losses has slowed in Asia in Q1 2009, the unemployment rate is likely to increase further to 5.1%-5.9% in 2009, up from 4.6% in 2007. The unemployment rates for Indonesia and the Philippines are among the highest in the region. Youth unemployment is a significant concern in Thailand and South Korea. China and Vietnam face the risk of social unrest from job losses among migrant and factory workers.
  
• The decline in resource utilization, increased excess capacity and lower oil and commodity prices compared to 2008 have caused deflationary pressures in the region. Consumer prices are falling in China, Malaysia, HK, Singapore, Taiwan and Thailand. But 2008's base effects might start fading in Q3 2009, leading to slower deflation or even inflation risks, which are emerging in China, India and South Korea. Capital inflows and asset market rallies might be fueling asset inflation.
• Commodity exporters like Malaysia, Indonesia and Vietnam have been hit by commodity correction, while the Asian Tigers and India have benefited. Rising oil and commodity prices since since February 2009 might be a risk for some countries.

Will Asian Asset Markets Continue to Rally?

• Domestic liquidity, capital inflows and diminished risk-aversion have boosted Asian equity markets since March 2009. However, the impact of slower sales on corporate earnings and external factors might pose risks to capital inflows.
  
• In 2009, Asian equity markets (excluding Japan's) have outperformed mature markets and are up 47.7% year to date as of August 6, 2009. Valuations and improving growth prospects are pluses for some countries, while capital inflows and market rallies might be making valuations expensive in some countries.
• Since March 2009, all major Asian currencies have been on an appreciation path, buoyed by capital inflows, improving trade balances, firmer signs of the bottoming of the industrial cycle and an overall bearish market view on the U.S. dollar.
  

Will Asia Continue to Show Robust Recovery?


• To achieve potential long term growth, export-dependent Asia needs a revival of external demand in G3 countries. Also, the drivers of growth need to come more from domestic demand by boosting private consumption and investment. Strengthening social safety nets and encouraging more labor-intensive services are necessary.
  
• The sharp contraction in Asian exports has moderated, helped by easy macro policies. Sound fundamentals are attracting large capital inflows. However, the recovery is still fragile due to high unemployment and overcapacity and risks of a double-dip in advanced economies and an exodus of foreign capital.
• The drop in both industrial production and exports was due more to 'one-off' and other temporary factors, and...the upturn is mainly a result of those factors fading from the picture. Asia's supply side is surging back in V-shaped fashion, and the region's exports are climbing strongly, thanks to improved demand from China.
• ASEAN countries, especially Indonesia and Vietnam, that can serve China's domestic demand for commodities will likely see a swifter cyclical recovery.

p/s photos: Fiona Sit Hoi Kei