Is Asia's Rally For Real?

Stock markets are jumping, but economic revival is still far off

After more than a year of grim news, the mood in Asia's equity trading pits is finally improving. Buoyed by falling global interest rates, Asia's most devastated market, Jakarta, is up a handsome 58% in U.S. dollar terms since early October, while Seoul is up 40% and Hong Kong, 31%. Even in recession-gripped Japan, the Nikkei stock average has rallied 13%, to around 14,500, amid signs the country is moving to fix its banking mess.

But the recent gains from what Mark Holowesko of the Templeton Worldwide global equity group calls "ridiculous levels" may not signal an Asian economic recovery. Although some overseas fund managers are moving back into the region, most bourses are still trading well below their all-time highs. And many pros are unwilling to concede that this is anything more than a classic bear market rally. "Don't be fooled," says Hong Kong-based hedge fund manager William S. Kaye. "Economies have not bottomed anywhere."

Indeed, just about every Asian economy is expected to contract this year and next. Reflecting that, earnings are still under pressure, and wages, employment, housing starts, and retail sales are continuing to fall. The cumulative effect, experts predict, is that Asia's stock markets will continue to bounce along the bottom for at least the next year.

Much of the recent buying across Asia has been concentrated in select blue chips with strong cash flows. In South Korea, for example, four companies have largely driven much of the market's recent gains: Pohang Iron & Steel (POSCO), Samsung Electronics, Korea Electric Power, and SK Telecom. Across Asia, the revival of the blue chips is a reversal of the situation only a few months back, when investors were selling solid companies along with the dross. But even after their recent gains, many blue chips still trade at far less than their net asset value.

Take Singapore. It is just beginning to feel the brunt of the Asian crisis, with its economy contracting by 1.5% between the second and third quarter. Political unrest in Malaysia and Indonesia is also weighing heavily on Singapore. Yet the Singapore market rose 27.9% in October, partially fueled by the buying of such high-quality companies as Singapore Airlines Ltd. "I don't like Singapore, but I love Singapore Airlines," says Holowesko, who notes the company's market capitalization was 30% less than the liquidation value of its fleet at its low point in August. "It has the best balance sheet of any airline in the world," he says. "And it's the only airline in the world that can write a check for a new plane," he says.

THIN TRADING. It's not only lower interest rates that are pulling stocks back up. Trading volumes on Asian markets remain thin, so even small trades have had a disproportionately large effect. In Hong Kong, where the "free float," or number of shares available to the public, is only half of the $240 billion market capitalization, the government took an additional $15 billion worth of equities out of circulation when it started buying in August to support the crashing stock market. With the already small float further reduced, prices shot up after the U.S. Federal Reserve started cutting interest rates.

In Japan, the Nikkei gained 4.1% on Nov. 4, after Morgan Stanley Dean Witter global strategist Barton Biggs urged clients to increase their exposure to the country. True, price-earnings ratios for major listed companies are running at about 74 times estimated 1999 earnings. That's high by international standards. But it's down sharply from recent years and not bad for Japan, where investors have long tolerated high p-e's as huge chunks of stock are locked up in cross-shareholdings between banks and their keiretsu, or corporate partners.

Still, even the reduced p-e's could turn out to be no bargain if earnings continue to crater. Profits are expected to fall about 30% in the fiscal year ending in March. Already, some blue chips such as Hitachi Ltd. and Toshiba Corp. have posted first-half losses for the first time since World War II. And a lot of economists see the recession that started in 1997 extending into early 2000 despite government efforts to bail out banks and boost spending. Meanwhile, Japan's cross-shareholdings are unraveling as cash-strapped banks and companies try to cut their losses. That may put enormous pressure on the Nikkei, which some pundits say could fall as low as 10,000 before Japan's decade-long bear market turns a corner.

"FALSE DAWN." Profit prospects in other Asian countries are also open to question. After the big runups of recent weeks, Asian companies with good fundamentals are already hard to find. "There was value six weeks ago, but now, things are beginning to look expensive," says Ian MacFarlane, Paribas Asia Equity's chief emerging-markets strategist. Back in late summer, average price-earnings ratios in Hong Kong, for example, were around 9, compared with 23 in the U.S. Now, Hong Kong p-e's are closer to 16, a level many pros say is too high.

Hong Kong's Sun Hung Kai Properties Ltd. is a clear example. Its shares nearly doubled during October, driving up its p-e from a low in July of 4.8 to 18.2. Is that excessive? "Hong Kong should command a risk premium" because of fears that China may devalue the yuan and that Hong Kong may delink its currency from the dollar, says Eugene K. Galbraith, managing director at ABN-AMRO Asia.

Amid doubts over earnings and economic growth, many big investors remain skeptical despite the recent onrush of foreign buying. They prefer to observe, rather than participate in, the current rally. "This is a bit of a false dawn," maintains Robert Sassoon, research director at SG Asia in Hong Kong. "The fundamentals have not changed." You'd never know it from all the excitement lately.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE