Checkpoint For Asian Equity Rally

Asian equities have outperformed mature markets in 2009 thanks to continuous foreign institutional investor inflows amid diminishing risk-aversion among global investors and relatively resilient macroeconomic fundamentals. Since July, the markets moved further up on the back of better-than-expected corporate earnings reports.

As of August 24 2009, MSCI Asia Pacific gained 25.8% YTD with Indonesia and Sri Lanka as the best performers, Australia and New Zealand as the worst performers. However, following the rally since March, Asian equities are no longer considered to be cheap. The region's price/earnings ratio has risen significantly above its historical average. In addition, downside risks still remain in H2 2009 with revival of any global risk aversion. Economic recovery may be slower-than-expected if stimulus effects fade out and global recession has greater-than-expected impacts on regional economies. Also, corporates may post worse-than-expected earnings reports as Q2's improvements were largely driven by cost-cutting efforts not by recovery in demand. The outperformance of Asia is all the more blatant when you take out Japan, which has been one of the world's worst performer YTD. Comparatively, despite Malaysia's robust run over the past few months, the local index has been among the lesser performers of Asia.

Will Asian Equities Continue to Outperform Mature Markets?


• 2009 MSCI Asia Pacific performance in USD terms: 22.8% YTD as of August 24, up 56.7% during March 9 - August 24
• 2009 MSCI Asia performance in USD terms: 20.5% YTD as of August 24, up 53.3% during March 9 - August 24
• 2009 MSCI Asia (excluding Japan) performance in USD terms: 42.0% YTD as of August 24, up 70.0% during March 9 - August 24
• Best performers (YTD as of August 24, 2009): Indonesia: 75.3% | Sri Lanka: 68.4% | Vietnam: 67.4% | China: 64.4% | India: 62.0% | the Philippines: 52.7% | Taiwan: 48.9% | Singapore: 48.3%
• Worst performers (YTD as of August 24, 2009): Thailand: 45.2% | South Korea: 43.4% | HK: 42.7% | Pakistan: 41.3% | Malaysia: 34.0% | Japan: 19.4% | Australia: 18.9% | New Zealand: 13.0%
• In 2009: Asia's equity market (excluding Japan) have outperformed mature markets, up 46.3% YTD as of August 24 2009, while the S&P 500 Index and the U.S. Dow Jones Industrial Average rose mere 10.1% and 5.3% respectively during the same period.
• Since March 2009, Asian equity markets have witnessed a rally following a surge in U.S. markets and began to benefit from the widening valuation gap on the back of relatively resilient macroeconomic fundamentals. During the March 9- August 24 period, MSCI Asia (excluding Japan) rose by 75.1%, significantly higher than the S&P 500 Index and the Dow Jones Industrial Average which gained 51.6% and 45.2% respectively.
• Capital flows: Continuous FII inflows to Asian equity markets have taken net flows to a positive US$14.4 billion as of June 24 2009, significantly up from US$10.8 billion in H1 and US$9.6 billion in H2 2008. Since end-June, however, fun flows have been volatile, "with inflows and outflows each recoded half of the time". Particularly, during the middle of August, the region saw fund outflows the most in 24 weeks as investors start to cast doubts on Chinese rapid expansion of bank lending, which has helped regional economic recovery and asset market reflation.
• Valuations: New Zealand (356.4) has the highest price/earning ratio in the region as of August 24 2009, followed by Taiwan (94.3). In opposite, valuations of Pakistan (11.2), the Philippines (26.8) and India (18.8) are among the cheapest. In overall, the region's forward price/earning ratio is at 23 times as of mid-July, about 30% above its three-year average. The valuation gap between Asian and western stocks has also widened; the spread between eastern and western P/E rose to 8.6 in mid-July, from its three year average of 4.5 (Asia: 23x, the U.S.:16x, EU: 13x).
  
• 2008 Review: The peak-to-trough decline in Asian equities in 2008 (more than 70% for some markets) surpassed the 60% fall in local currency terms during the 1998 Asian financial crisis. Sustained outflows from offshore Asian funds took total net redemptions in Jan-Oct 2008 to a record high such that all money that flowed in during 2007 flowed out.
  
• Market Integration: There is a noticeable upward trend in the Asia-U.S. correlation with the correlation parameter picking up sharply in H2 2008 (peaking during mid-Oct 2008). However, average correlations for emerging Asian equity markets are generally higher between the region's markets than with U.S. markets.
• Government intervention: Several countries including Taiwan, Pakistan, Vietnam, Thailand intervened in the stock market by narrowing the trading band, introducing stabilization fund to contain volatility, banning short-selling, directing government funds to buy share.

Will the Rally Continue? Or Is a Correction a Real Possibility?

• Upsides: Better-than-expected earnings reports, relatively healthier macroeconomic fundamentals, aggressive fiscal stimulus spending and ample liquidity in the region would have positive impacts. Also, buying into most of the region's equity markets seems a better bet than bonds amid increasing bond issuance.
• Downsides: Worries over the U.S. economy, exit by local investors and also FIIs alarmed at greater-than-expected impact of global slowdown on Asia's growth, exports, fiscal deficits, slowing consumer spending and investment may have negative impacts. High (external) debt exposure of corporate sector in some countries and risks of real estate correction and bank profitability are additional risks.
• Morgan Stanley: "The recovery is real." Asian equity markets will continue to have good momentum and corporate earnings may rise substantially until 2010.
• UOB: Liquidity conditions will support the equity market in the near-term. But authorities may have to limit further monetary and fiscal expansion as inflation may resurface before growth normalizes in the medium- to longer-term. (August 17, 2009)
• Citigroup: Risks remain, driven not by earnings but by still weak real economy. Exports and domestic demand should rebound quickly in H2 2009 to meet the forecasts and to justify V-shaped recovery. (July 24, 2009)
  
• FT: In the past, Asia's stock market performance was highly correlated with that of western counterparts. However, Asian equities may plot a more "independent course" on the back of less leveraged economy, better capitalized banking sector, huge FX reserves and healthier fiscal position. (Lex; July 16, 2009)
• EIU: The recent rally in Asian equity markets might not continue due to still-weak real economic condition in many countries and the region's ultimate reliance on exports to the U.S. and EU, which means that financial-investor sentiment will remain susceptible to economic setbacks in those markets. (July 2, 2009)
• DBS: Prospects for further inflows into Asian equities remain substantial, as global portfolio continue to adjust from relatively underweight positions, and given cheap equity valuations relative to bonds. (June 11, 2009)
  
• Adrian Mowat, Chief Asia Strategist, JP Morgan: Asian stocks have yet to reflect expectations for a powerful, synchronized recovery in the global economy as markets are still bearish on global growth and on emerging markets growth.
  
• ADB: Given decreasing inflationary pressures and relatively healthy fiscal positions, further fiscal and monetary stimulus policies by Asian governments will able to boost the region's equity markets in H2 2009. (April 2009)

Background

• As of end April 2009, market capitalization of Asian Pacific markets (US$10.2 trillion) has come ahead of that of European markets (US$9.3 trillion, including Africa and the Middle East) as Asian stock prices sour at a faster pace than European ones.
  
• Banks remain the single largest sector in Asia. However, its share has been decreased to 20.1% as of June 2009 from 43% in 1975. In opposite, the share of cyclicals has risen to 38.7% (including basic materials, industrials, oil & gas and technology) from 18% (industrials) in 1975.

p/s photos: Sarah Song Hei Leen