Regional economies remain robust, but investors are unnerved about the impact on exports of a slowdown in the U.S. economy
It's the gift that keeps on giving. Back in late February, a near-10% decline in Chinese stock markets whipped up a miasma of selling that spread to Wall Street, Europe, and other parts of Asia. That was followed by a stretch of relatively stable markets globally—that stretch has ended. As evidence gathers that U.S. growth could be crimped by default worries in the subprime mortgage market, some serious wealth is getting vaporized again.
On Mar. 14 major regional markets in Asia took a nasty hit a day after a broad, roughly 2%, decline in the Dow Jones Industrial Average (see BusinessWeek.com, 3/13/07, "Stocks Tumble On Mortgage Worries").
The closely watched Morgan Stanley Capital International Asia-Pacific Index lost 2.4% on concerns about the possible impact of a significant slowdown in the U.S.—an all-important export destination market for Japan, China, South Korean, and assorted Southeast Asian economies.
The Correction Continues
In Japan the Nikkei 225 index closed down 501 points to 16,676, a fall of 2.9%. Markets in Hong Kong, Shanghai, Seoul, Kuala Lumpur, and Manila posted losses in the 2% to 3% range. In India, the Bombay Stock Exchange Sensitive Index ended down 3.49%.
What's more, with investors getting extremely edgy, there could be additional dips to come. "When a market corrects like it did two weeks ago, it normally takes a period of one or two months before it bottoms out," says Garry Evans, pan-Asian equity strategist with HSBC (HBC) in Hong Kong. "I expect the correction to continue a bit longer."
Back in Japan, the worst-hit stocks were big exporters with large exposure to the U.S. Toyota (TM), which sees about 60% of its earnings in North America, fell 3.2% to $65, while automaker Honda (HMC) slipped 3.5% to $35. In the electronics sector, Canon (CAJ) and Sony (SNE) also endured selling pressure, closing down 2.6% and 4.1%, respectively.
Risk Aversion Increasing
Appreciation of the yen vs. the dollar—always bad news for the price-competitiveness of exporters—didn't help matters. At the end of currency trading in Tokyo, the yen had appreciated to a one-week high of 116 against the greenback.
Indian stocks were hit particularly hard on the theory that the rising interest rate trend in the U.S., Europe, Japan, and much of Asia will mean less money available to invest in more risky emerging market stocks. "Liquidity is becoming expensive around the world and there is an increasing aversion to risk in India," says Rasesh Shah, managing director of Mumbai-based Edelweiss Capital.
Yet for all the gnashing of teeth, the current stock volatility is largely at odds with the strong, long-term, economic fundamentals across much of Asia—though it may take some time for that to sink in with investors. With Japan recovering, and India and China growing rapidly, few expect the recent selling wave to be prolonged over many months.
The Danger: Contagion in the U.S.
"It is important to remember that both corporate and economic fundamentals have not been this strong in Asia since the start of the 1990's," says Spencer White, Head of Asia Pacific Equity Strategy at Merrill Lynch (MER) in Hong Kong. However at the moment the danger is that credit market woes in the U.S. will encourage global investors to pull out of risky assets overseas. "What we are dealing with is risk appetite and the potential for contagion from subprime mortgage market to other asset classes," he adds.
Japan—the region's biggest economy—is in the midst of its longest postwar economic expansion and its revised fourth-quarter gross domestic product was an annualized 5.5%. Consumer spending, often blamed for Japan's slow recovery from years of deflation, also shows signs of improving. Average household spending grew 0.6% year on year in January, marking the first increase in 13 months.
"Today's losses are not caused by Japan's economic fundamentals, but investors' negative mentality," says Seiichi Suzuki, a market analyst at Tokyo Tokai Securities. He adds that recent volatility in global equity markets is spooking investors. "There's a negative impact on investor psychology."
Most Remain Bullish
It's a similar tale elsewhere. In Korea, for example, analysts say stock prices are bound to be affected by global trends given that foreign investors own around 40% of the market. An unwinding of the exchange-rate-sensitive yen carry trade (whereby investors borrow in Japan, and invest in higher yielding-assets denominated in other currencies) is another risk (see BusinessWeek.com, 3/2/07, "Stocks: Why Japan is More Worrisome than China").
Yet most remain bullish on stocks. "Barring unlikely catastrophes in the global financial markets, Korean shares are expected to do relatively well this year," says Kang Shin Woo, chief investment officer at fund manager Korea Investment Trust Management.
One big reason: The Seoul bourse's average price-earnings ratio is just over 10, while in other emerging markets—with the notable exception of Thailand—they are hovering at 15 to 17 multiples. Kang adds he also expects the Fed to cut rates if the trouble in U.S. subprime mortgage loan market shows signs of spreading to the overall economy.
In some markets, such as Bombay, Shanghai, and Shenzhen, a cooling off period is actually somewhat welcome, given the torrid runup in share prices last year and in January. Says Edelweiss's Shah, "The Indian markets have had a great run and this is part of a realistic consolidation phase."
Recession's a Long Shot
Chinese markets were due for a pause, regardless of what's happening elsewhere in the world economy. The speculative excesses among Chinese investors have been obvious for some time (see BusinessWeek.com, 3/8/07, "Market Mania in China").
Still, it's hard to make a long-term bearish case against the high-speed Chinese economy, unless it overheats in the coming months. China remains on course to grow 10% or so this year and likely will overtake Germany as world's third biggest economy in the same period. Nor does anyone really expect overseas fund managers to suddenly pull up stakes and stop investing in China because a much-needed correction in Chinese stocks finally took place (see BusinessWeek.com, 2/28/07, "Bourse Blowout Shouldn't Brake China").
Of course, no economy in the region would be completely insulated from a serious recession in the U.S., which still seems a long shot at this point. Despite the market instability in recent weeks, there is no sign that U.S. consumers at large have lost their appetite for Toyota sedans, Samsung LCD TVs, or Chinese-made sneakers. With any luck, that will be true at year-end as well.