By M H Ahsan & Yuang Chow Yo
Asia's stock markets are on a roller-coaster ride, last week dipping drastically on financial contagion fears about the faltering US subprime-mortgage market, and on Monday recovering strongly after the US Federal Reserve in a surprise move cut a key benchmark interest rate by 50 basis points. But are market forces reacting rationally to Asia's underlying profit and loss prospects?
Asian markets tumbled in near-unison last week, with some bourses notching single-day losses not seen since the September 11, 2001, terror attacks against the United States. On Friday, Japan's stock exchange recorded its largest one-day loss in more than seven years, shedding 5.5% of its value. The South Korean bourse recorded its worst performance ever last week over any given three-day period, shedding more than 200 points. On Friday, financial hub Hong Kong's exchange lost more than 6.5% of its total value, while Singapore's stock market dropped 6% on Friday.
Malaysia recorded its largest one-day loss ever, 5.3%, also on Friday. Thailand, Indonesia and the Philippines were similarly all hit hard last week, falling respectively by 6%, 13.5% and 12%. On Monday, regional markets bounced back to varying degrees, propelled up by Friday's sudden US interest-rate cut. Japanese stocks jumped 3%, Seoul's bourse was up 5.7%, and Hong Kong was up 3.6% in late trade. Singapore was up 5%, and other Southeast Asian markets also gained. So what happens next? Some financial analysts argue that the equity-market recovery is a knee-jerk reaction to the gains witnessed in the US on Friday, where the Federal Reserve's announcement drove up the Dow Jones main index by 1.8%.
The stock-market recovery, they say, also prices in widespread expectations of another 50-basis-point cut at the Federal Reserve's next monetary-policy meeting, scheduled for September. Yet if the US subprime-mortgage market continues its decline and begins to transmit financial contagion through the broad US housing market, where median prices appear to outpace widely individual borrowers' underlying earning power, the US economy could in a worst-case scenario slip into recession. Speculation is rife that the global financial order, now through financial liberalization measures more integrated than ever, could be on the brink of a crisis as big as or larger than that witnessed in the 1980s US savings-and-loan meltdown and the bursting of the technology bubble in 2001.
Significantly, last week's contagion effect on Asia's stock markets was driven more by panic selling than any new critical revelations about the region's economic and financial fundamentals. Until last week, Asia's stock markets and currencies had in general this year performed strongly. Apart from Singapore and pockets of China, Asian real estate is frothy but has not experienced the runaway price-inflation rates witnessed in US property markets. Relative to US and European banks and investment funds, regional financial institutions are believed to hold only small amounts of the derivative products that contain securitized subprime US housing loans.
Last week's financial turbulence in Asia was driven more by revised downward expectations that a slowing US economy would consume considerably less of the region's exports. All of Asia's major economies run big trade surpluses with the US. Southeast Asia's major trade-geared economies, including Thailand, Malaysia and Singapore, which export huge amounts of consumer electronics and their component parts to the US, are all exposed to shifts in US consumer sentiment. However, some regional economists argue that that basic analysis is simplistic.
Frederic Neumann, a Hong Kong-based economist at HSBC, argues in a recent research report that "the region has decoupled to a surprising degree from US demand conditions, and that even if the American economy were to slow down further, Asia could be only mildly affected". He argues that the region's "growth drivers" have become more balanced in recent years, with China and the European Union becoming more prominent, and that a deceleration in US economic growth will have a "less severe" impact on Asian than in the past. Recent HSBC sensitivity analysis shows that a 1% decline in US gross domestic product would have an equal or greater impact on only three Asian economies, namely Hong Kong, Singapore and Taiwan. The negative effect on China was surprisingly only 0.2% for each 1% decline in US growth.
At the same time, Asia's financial fundamentals are much improved from the last time financial contagion pummeled the region in 1997-98, hedging substantially the risk of a repeat broad-based economic meltdown. Central banks across the region have stockpiled unprecedented amounts of foreign-currency reserves to defend both their currencies and their banks from speculative offshore attacks. Although not universally, several countries in the region have also substantially improved their debt management, with governments reining in their public-debt profiles and corporations trimming the debt-to-equity ratios that left many of them vulnerable to the sudden shift in foreign-investor sentiment in 1997-98.
Many Asian governments are now in a financial position to prime the fiscal pumps of their economies if US growth and demand tail off significantly. While foreign money last week rushed out of regional bourses to cover subprime-mortgage-hit financial positions in the US, last week's capital flight could be a short-term phenomenon - even if the US slips into recession. Faced with tanking economic growth in the US, institutional money will inevitably seek out higher returns overseas. Asia's comparatively strong fundamentals and, in many business sectors, low price-to-equity ratios represent a natural counter-cyclical hedge against slowing US growth.
Representatives of big US-based hedge funds who before last week's turmoil met with Asia Times Online had been trolling Southeast Asia for undervalued stocks exposed to local consumption rather than global exports. To be sure, there are countervailing concerns that Asia's recent large balance-of-payments surpluses and subsequent buildup of foreign reserves have resulted in buoyant domestic money supplies. Regional central banks have to varying degrees of success attempted to sterilize those capital inflows to avoid a more rapid appreciation of their already rising currencies. Over the past year, domestic monetary aggregates, commonly known as M1 and M2, have soared across the region.
There are at least theoretical risks that, if mismanaged, sterilization of capital inflows could cause new inflationary pressures and asset price bubbles. Economists say that to date, neither is statistically apparent across most of Asia, nor were foreign-investor concerns over recent monetary interventions apparently a contributing factor to last week's financial turmoil. Indeed, HSBC's Neumann notes that in Asia over the past 15 years, there has been a weak empirical link between broad money-supply growth and stock prices. In Thailand and Japan, the relationship has historically been negative, while in Singapore, Malaysia and Pakistan the correlation is stronger but not significant. Neumann notes that in all major Asian markets, money-supply growth historically tends to lag rather than lead asset-price gains.
A recent Asian Development Bank report shows instead that the recent rise in Asian asset prices was driven more by capital inflows than domestic liquidity. Investor risk perceptions, however, are often more subjective than empirical, and herd behavior is still clearly the rule rather than the exception. As such, Asia could still be dragged down in tandem with a US slowdown, whether from underlying financial and economic measures the region deserves to be or not.
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