A year ago, as Asia was gripped by severe acute respiratory syndrome panic, the region’s stock markets swooned, touching lows not seen since the 1997'98 financial crisis.
Today SARS is a much-diminished threat, and Asian markets are thriving. In 2003 the MSCI emerging-markets Asia index rose 30 percent, reflecting a surge of investor confidence in the region’s fast-growing economies. Thailand’s stock exchange was up an extraordinary 116 percent; Chinese stocks rose 80 percent; and Indonesia gained 70 percent. With few exceptions, the region’s rise has continued in 2004. Asian markets were up 10 percent through early April, compared with a 2 percent gain for the MSCI world index.
Will these traditionally volatile markets sustain their gains, or are they about to revert to their more typical pattern and pull a fast fade? Many money managers believe Asia’s good times have only just begun. Michael Watt, who oversees $600 million in the region as the manager of the Henderson TR Pacific and Henderson Far East Income investment trusts, finds current valuations attractive. “If you compare the stock markets with their peaks in the mid-1990s, there is still a long way to go,” he says.
Even the bulls, however, can’t help but harbor some misgivings. “I am always wary when the consensus is so overwhelmingly positive,” says Jason McCay, who manages more than $1 billion in the region as head of Asia and global emerging markets at Edinburgh, Scotlandbased Martin Currie.
The optimists’ case begins with one compelling statistic: Although Asia supplies 27 percent of the world’s GDP, it has only 19 percent of global market capitalization. That gap will surely narrow, says Edmund Harriss, who manages $200 million in Asian equity funds for London-based boutique Guinness Atkinson Asset Management. “These markets are playing catch-up. There is a large valuation gap both with the true productive base of Asia and the prices of developed stock markets,” Harriss says.
The bulls note that the region’s econ-omies are at the start of an expansionary phase in the credit cycle. Following the 1997'98 financial crisis, Asian companies paid down debt and shored up their balance sheets. Central banks rebuilt their foreign exchange reserves, which they can use to prop up their own currencies if necessary. They now have more than $2 trillion, mostly in U.S. dollars, with China alone holding $415 billion. In March 1999, China’s foreign exchange reserves stood at just $146 billion.
As the dollar has declined, Asia’s central bankers have pumped liquidity into the system in a mostly successful effort to stop their own currencies from dramatically appreciating. (No Asian country wants a strong currency that might undermine its already difficult competitive position vis-à-vis China in sectors like manufacturing.) If the dollar remains weak, many money managers believe, Asian stock markets should thrive.
Though some investors fret about excess credit in the system, the bulls point to the fact that the ratio of loans to deposits at Asian banks is currently about 80 percent, well below the mid-1990s peak of 115 percent.
And although stock multiples have risen in the past year, they’re still a long way from their apex, when stocks traded at three times book value. Valuations vary widely by country, from 1.3 times book in South Korea to 2.2 times in Thailand; the region as a whole currently trades at 1.8 times book value. That’s a 25 percent discount to world markets.
Says Henderson’s Watt: “South Korea, Taiwan and China are still at about only 50 percent of their historic highs. Indonesia and Thailand are way behind -- about 30 percent and 27 percent, respectively.”
Many money managers also see a nascent expansion of consumer credit as a positive sign for Asian stocks. With the exception of such developed markets as Singapore and Hong Kong, consumer credit was virtually unheard of in most Asian countries only a few years ago. But as companies have cleaned up their balance sheets and demand for loans has declined, banks have aggressively courted consumers, offering more mortgages and credit cards. The number of credit cards in use in Thailand, for example, grew by 30 percent last year, to 4.3 million.
Though generally seen as a healthy development that helps local economies diversify, consumer lending recently got out of hand in some countries. The South Korean government began offering tax breaks in 1999 but took away the benefit in 2002. That sparked a rash of credit card delinquencies, which peaked at 13 percent last year. The government was forced to bail out several credit card companies.
That hasn’t deterred G. Paul Matthews, founder of $2 billion-in-assets Matthews International Capital Management in San Francisco, who is seeking beneficiaries of Asia’s consumer spending boom. He owns a sizable stake in Hong Konglisted Giordano International, the region’s biggest clothing retailer. The stock recently traded at HK$4.35 ($0.56), up from HK$2.50 a year ago.
Nowhere is the boom in consumer spending potentially more explosive than in China. “The Chinese economy has profoundly changed,” says Guinness Atkinson’s Harriss. “We used to think of the Chinese as consumers of TVs and refrigerators. Now they’re also consumers of big-ticket items like cars.” Indeed, China’s car market is now the fourth biggest in the world, up from seventh in 2001. Sales of passenger vehicles grew by 75 percent last year, to 1.97 million.
Martin Currie’s McCay likes Hong Konglisted Denway Motors as a play on Chinese consumer spending. Denway has a 47.5 percent stake in Guangzhou Honda Automobile Co., which built 117,000 cars in 2003 and expects to increase production 71 percent, to 200,000, in 2004. The company’s stock jumped from HK$2.50 to HK$8.95 in the 12 months ended in early April.
Still, Asian economies, especially that of China, remain critically dependent on export revenues. Chinese exports, which increased by 30 percent in 2003, to $380 billion, represent nearly a third of GDP. The country’s share of global exports has grown from 3.9 percent to 6 percent since 2000; in 2003 the U.S. posted a $100 billion trade deficit with China. This year Chinese exports to the U.S. are expected to overtake Mexico’s, making China the U.S.'s second-biggest trading partner after Canada.
“Asian economies are less dependent on the U.S. than in the past, but any weakness here will still have a big knock-on effect in Asia,” says Matthews International’s Matthews.
Even if exports remain strong and Asian economies continue to grow, both Matthews and McCay are mindful that Asian equity values could experience a midcycle correction.
“It’s a tactical view that does not alter my long-term bullishness,” says McCay. “There are signs of inflation in the region, and monetary tightening in China or a rise in U.S. bond yields could prompt a sell-off.”
Experienced investors in the region recall the market’s extreme swings during the past decade. One result: Asian emerging markets have returned a paltry 1.7 percent annualized over the past ten years. “You have to be wary of saying things have definitely changed,” says Henderson’s Watt. “Though at a country and a company level, things are far better than in 1997.”
McCay has already made some adjustments to his portfolio to lock in gains in certain markets. He has cut back overweight positions in last year’s stellar performers, Thailand (down from 10 percent to 3 percent) and China (down from 18 percent to 15 percent). The newly available money is being put to work in South Korea (up from 14 percent to 19.5 percent) and Taiwan (up from 9.5 percent to 11 percent).
Harriss says his country allocations have remained broadly the same; he is maintaining his 32 percent weighting in China and Hong Kong despite some analysts’ concerns about an overheated economy. An avid buyer of Taiwanese technology companies, Harriss likes MediaTek, which designs integrated circuits for the DVD market, and PC giant Acer. He also has a modest position in Taiwan Semiconductor Manufacturing Co., which paid a cash dividend earlier this year for the first time since it went public in 1994.
McCay continues to pursue Asian consumer spending plays. He cites PT Astra International, which manufactures cars for Toyota Motor Corp. and is also Indonesia’s largest automobile distributor, as both a recovery play and a beneficiary of car sales that are increasing by 40 percent a year in its home market. “Astra is trading at seven times 2004 earnings and has a 5 percent dividend yield, and its balance sheet will have no debt by next year,” says McCay. “Before the Asian crisis it traded at 18 times earnings, and it is a far better run company now.”
