Asia: Cash Is King in Uncertain Times

Lehman investment strategist Paul Schulte thinks Corporate Asia's strong balance sheets and cash stockpiles will help insulate it from U.S. credit market troubles

Asia hasn't escaped completely unscathed from the U.S. housing bust and the resulting shock waves that have reverberated throughout global credit markets. Regional financial players such as Australia's Macquarie Bank (MQBKY), Shinsei Bank (SKLKF) in Tokyo, and several Taiwanese insurers with exposure to high-risk mortgage-backed securities have taken hits. And Wall Street's big price swings in recent weeks have driven down Asian stock prices to near two-month lows.

The burning question now for regional economists and stock strategists is whether a full-blown credit squeeze emanating from troubles in the world's biggest economy, and the crucial export destination for Asian companies, would inflict deeper pain. Lehman Brothers (LEH) Chief Regional Equity Strategist for Asia ex-Japan Paul Schulte, a consummate money pro with deep knowledge of the region, is optimistic it won't come to that—unless, of course, the U.S. housing bust unexpectedly tips the U.S. into a recession.

Yet few economists see that outcome, at least for now. On July 18, U.S. Federal Reserve Chairman Ben Bernanke, in testimony to the House Financial Services Committee, disclosed that the Fed was slightly lowering its forecast for 2007 growth from what it had said back in February. The "central tendency" is for the economy to expand 2.25% to 2.5% from the fourth quarter of 2006 through the fourth quarter of 2007, he said. That's down from a forecast of 2.5% to 3% in February. He said the Fed was lowering its 2008 forecast by a quarter-point, to 2.5% to 2.75%.

"Terrific Balance Sheets"

Standard & Poor's Chief Economist David Wyss expects gross domestic product growth of 2.5% for the second half of the year and 2.1% for the full year and improving into 2008. (S&P, like BusinessWeek, is a unit of The McGraw Hill Companies (MHP).) He also calculates that the housing decline has clipped about one percentage point of growth from U.S. gross domestic product this year and doesn't expect housing prices to bottom out until spring 2008.

Assuming these forecasts hold true, Lehman's Schulte likes the prospects for Asian regional economies and stock markets over the long term. The reason is the tremendous stockpile of cash and retained earnings on the balance sheets of big listed companies in the region. "You have terrific balance sheets and a huge amount of cash," says Schulte, who was appointed to his new role at Lehman on July 11 after serving as a portfolio manager and head of research for Big Sky Capital, a hedge fund based in California and part of the U.S.-based Wynn Family funds.

Schulte, who has covered emerging and Asian markets for 15 years and once served as an economic adviser to Indonesia's Ministry of Finance, has seen a broad transformation in business practices take root since the Asian financial crisis hit currency and stock markets throughout much of the region a decade ago. "There is a hatred of debt since the Asia financial crisis," he points out.

That idea is certainly backed up by a Lehman report that Schulte co-authored with colleague and research analyst Justin Lau which assessed the financial strength of 615 listed companies across the region, excluding Japan. Listed companies in the region have made huge improvements in balance-sheet management, and today boast some $350 billion in cash and $423 billion in retained earnings in the most recent fiscal year examined.

Regional Stocks: Buy Opportunities?

On top of that, most regional governments have lowered debt levels (especially short-term debt denominated in foreign currencies) and eliminated current-account deficits that set the stage for the region's collective economic nervous breakdown a decade ago. Then there is the $2.5 trillion or so in foreign currency reserves held by major central banks in the region. "There is much more room for loosening," says Schulte. Another sign of strength: Asian bonds have been the best-performing asset class during the recent global credit market upheavals.

That hasn't been the case in most regional stock markets, but Schulte thinks there may be a bit of "self-reinforcing selling" by fund managers and the public. Regional companies with loads of cash, clean balance sheets, and strong fundamentals could represent buy opportunities if their stocks have experienced punishing declines in recent weeks.

Among the more well-heeled regional players (in terms of cash on hand) are China Mobile (CHL) with nearly $20 billion in cash, followed by Samsung Electronics (SSNKF) with $10.5 billion, and Hong Kong-based ports, telecommunications, and property conglomerate Hutchison Whampoa (HUWHY) with an $8.2 billion hoard.

If anything, the worry is that the regional companies probably have more money than they know what to do with. "You are in a region that is overcapitalized, and returns on capital become a problem," says Schulte. Still, excess cash is what some might call a "quality problem"—especially in a global market environment of uncertainty and wild swings in equity prices.