Is This Rally Too Much?

Is this rally or bear market rally or recovery rally just a tad too much, ... too much hot air, too exuberant, too optimistic? Is the market running way ahead of itself. I found the following chart from dshort.com which places where we are in the recovery process, compared to the most severe crises of the past. The current path is marked in BLUE. The current recovery is already more "exuberant" than the recovery path taken by the internet/tech implosion in 2000. However, it is still within fairly safe territory when compared to the recovery path taken following the nasty oil crisis in the early 70s. Bottom line, its not too exuberant ... (yet).

While many were jumping up and down that we are headed for the Depression again, well the gray line tells us what hell they went through in the 30s.

Our economic and financial crisis will always be there and will haunt us every few years, but the recovery process in the present days will ensure that the recovery process will be relatively quick because: we have a much better understanding of the usage and effects of monetary and fiscal policies; we have a more transparent decision making process by most governments, and whose decisions will be critiqued and deliberated instantly via the net and media - urgency and clarity; and we have most governments being more proactive and willing to attack economic and financial crises together.

[via dshort]

p/s photos: Haruna Yabuki

Deciphering Hot & Hotter Emerging Markets

Trying to further decipher whether the flow of funds into emerging markets' equity is broad based or selective, is an important question. If it is broad based, then it is primarily a big picture capital flows trend. Generally, when we get the big picture correctly, the smarter money would further drill down to specific markets. Not all markets are created equal. At any point in time, some markets will be more attractive than others based on the prevailing interest rates, growth rates assumptions, equity valuations and other lesser investing factors.

I have managed to come across a great chart by the highly respected Bank Credit Analyst, which basically explains which markets would "see the most action" in this current rally. Anyone could plot a valuation chart based on the country's prevailing interest rates and match that with the country stocks' forward or trailing PER. That would be quite one dimensional. The BCA's chrat is a lot more persuasive in that it is based on forward and de-trended (I don't even want to attempt to know what that word meant, but it sounded so sophisticated) trailing PERs, price to book ratio, and dividend yields shown relative to the average of 18 countries".

Hence it is a peer-to-peer analysis. There is one major shortcoming in that tabulation, in that it does not take into account the historical average valuation of each specific market say over the past 5 years. The BCA chart only looks at how each country is faring in valuation terms relative to one another. For example, if Malaysia's historical PER forward valuation was 18x, and HK's historical PER forward valuation figure is 15x - naturally if we just look at PER, HK will always look cheap relative to Malaysia. However if the current forward PER for Malaysia and HK are 14x and 13x respectively - HK would still be cheaper on a straight out valuation but in actual fact, we should look at its PER now compared to the historical valuation for a more nuanced and value-add commentary, whereby Malaysia's market would be the 'cheaper' one.

Besides that caveat the BCA chart looks very good indeed.

From the BCA chart, the most attractive markets NOW:
1) Czech and Thailand - these are "false favourtites" in a horse race. On valuation matric, they are the most attractive and cheapest, but their valuations have been skewed because of extreme financial distress (in Czech Rep) and heavy political uncertainty in Thailand. Hence we need to take these two out or at least regard them with a lot of conservatism.

2) HK - Its looking really good, tus explaining the surge in hot money there. Shanghai and Shenzhen are not so open to foreign funds, hence much of the hot money has been diverted to HK as proxy.

3) Poland - Cheap on valuations.

4) Malaysia - You wouldn't get many houses recommending Malaysia, but the BCA thesis puts Malaysia as highly attractive. Bank Negara's recent decision to leave rates unchanged makes things hotter still till the next BN meeting.

5) South Africa & Hungary - These are attractive but have very high rates, which indicates that money might be flowing out of these two countries. In an effort to retain capital flows, these rates are kept high. In instances like these, foreign funds regard these as tricky markets as your equity gains could be erased by a weak local currency in the end.

China is very hot even though its not the most attractive on valuations, it is a relatively closed market and the surge in bank lending (i.e. liquidity) over the past 6 months has ensured a most vibrant market.

Singapore unfortunately may be trailing the rest of the emerging markets as valuations wise, it is not that attractive. Still, trailing it may be, it will still enjoy some partying albeit much less enthusiasm.

Asian Equities Vs Developed Markets Outlook

• 2009 MSCI Asia (ex Japan) performance in USD terms: 11.0% ytd as of Apr 24, 2009. MSCI AXJ Index rose by 34.4% during the March 2-April 24 period
• Best performers: China: 32.1%| Pakistan: 25.2%| Taiwan: 24.3%| Sri Lanka: 20.6%| Korea: 19.2%| India: 17.9%| Indonesia: 16.3%| Malaysia: 11.8%| Philippines: 11.4%
• Worst performers: Thailand: 5.6%| Singapore: 3.2% | HK: 3.1%| Vietnam: -0.6%
• In 2009: Asia's equity market (ex Japan) have outperformed mature markets, up 11.0% ytd as of Apr 24 2009, while the U.S. Dow Jones Industrial Average and S&P 500 Index fell by 10.6% and 7.0% respectively during the same period. With the exception of Viet Nam, all Asian equity markets rose since the beginning of 2009
• From 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
• Valuations: Asian equities are now reaching the lows seen during the 2001-2002 recession. Taiwan (26.3x) and China (22.1x for A-shares) are valued most exceeding 20 times reported earnings, whereas Indonesia (9.9x), Pakistan (9.4x) and Singapore (9.3x) are cheapest when compared to their regional peers. Given China's aggressive fiscal and monetary policies to stimulate domestic economy, A-shares are valued more than B-shares (15.8x)
• 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
  
• 2009 Outlook: Asia markets will need to offer more attractive growth and valuations than the rest of the world in order to attract fund flows into the region. Asia valuations, however cheap by its own historical standards and cheaper than the U..S, are still more expensive than the 8.6x median of 46 countries (DBS). Nonetheless, given decreasing inflationary pressures and relatively healthy fiscal positions, further fiscal and monetary stimulus policies by Asian govts will able to boost the region's equity markets in H2 2009
• Upsides: AXJ region is now attractively valued, and buying into most of the region's equity markets seems a better bet than bonds amid increasing bond issuance. continuous FII inflows to Asian equity markets since early March have taken ytd net flows to a positive US$1.6bn in mid-April 2009, with 4-week average as strong as those experienced in 2006 and 2007
  
• Downsides: gloomy earnings forecasts, 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. Investors may move money to bond markets from equity markets in an anticipation of slower global economy's recovery due to the spread of swine flu. High (external) debt exposure of corporate sector in some countries and risks of real estate correction and bank profitability are additional risks
• 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 the US 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 govt funds to buy shares

p/s photos: Han Ga In

The New Asian Financial Crisis, But Its In Central & Eastern Europe

We all in Asia know how bad the Asian financial crisis was. The biggest problem was Asia's dependence on foreign investments or foreign funding, and when that exited, the economies had no legs to stand on. There is a similar new Asian financial crisis but this time its in Central & Eastern Europe (CEE). The only difference is they are in a much bigger pot of doo-doo than us now, hence the dire consequences they are facing now and will be facing for the next couple of years at least will be a lot worse than what Asia went through.

The ones in the biggest trouble are Estonia, Latvia and Lithuania. Hungary and Romania are not far behind, but will see bigger aftershocks because their economies are larger. Bulgaria's problems are different as it has more to do with their current account deficit.

While Asia has bulked up their foreign reserves, Asia has gone back to exports to revive growth over the last 5 years. Asia is now hit because of the slackening demand for exports. Either way, you get hit, be it dependence on foreign funding or relying on exports for growth - but I rather be reliant for exports and get whacked in a global downturn than to be dependent on foreign funds inflow as the latter is usually short term in nature and does not build up the economies structurally (unlike long term foreign investments).

p/s photos: Kathy Chow Hoi Mei

The Asian Response

• 10 ASEAN nations planning for a crisis fund to tap from if they face severe liquidity crunch due to global financial crisis; Fund can also be used to purchase bad assets, recapitalize troubled financial institutions and private companies; ASEAN+3, ADB, IMF will contribute to the fund while World Bank has contributed $10bn; also include plans for stand-by liquidity facilities
• In spite of limited exposure to US bank losses, risks from external funding crunch, higher borrowing costs, bank panics and deposit withdrawals are growing for banks and corporates in Korea, HK and Taiwan
• Asian central banks had been injecting liquidity into banking system and cutting rates (discount/policy rate) and/or bank reserve requirements to ease liquidity squeeze and spike in short-term rates (swap, overnight, inter-bank rates and spreads) since Sep; Some banned short-selling, guaranteeing deposits, considering fiscal stimulus; following global central bank intervention, these rates have somewhat eased in recent days
  
• Australia: $7.3bn stimulus for pensioners, middle and low-income groups, first-time home buyers; additional stimulus may follow; deposit guarantees; cut overnight cash rate to 6% from 7%, offering 6-mo/1-yr repos; Term Deposit lending facility, expanded types of collateral, loan maturity under bank lending facility as difference b/w inter-bank and overnight indexed swap rate surged; doubled swap agreement with Fed from $10bn to $20bn; banned short selling; to purchase $3.2 bn in residential-backed mortgage securities to help small lenders offer home loans
• Japan: supplementary budget for fiscal stimulus; providing unlimited dollar funds to banks at a fixed rate against pooled collateral until Jan-09 under swap agreement with Fed; eased rates under lending facility, expanded range of bonds under repos, suspended program of selling bank shares; Injecting liquidity amid spike in Yen overnight LIBOR; banks' exposure to Lehman had led to decline in stock prices and short halt in trading on Sep 15
• India: Raised cap and credit cost on external borrowing of firms; cut interest rate 100pbs to 8%; conducting 14 day Repos to help banks provide credit to MFs; allowed banks to lend to MFs against CDs; Allowed Savings bond holders to borrow from banks against govt paper; to infuse capital into commercial banks to raise CAR up to 12%; cut bank reserve ratio thrice in Oct from 9% to 6.5% (first time in 5 yrs); raised FII limit in corporate bonds; raised interest rate on non-resident deposits by 50bps following similar move in Sep; eased limits on banks to raise foreign capital, restrictions on FII equity investment; eased Liquidity Adjustment Facility; continues to sell FX reserves
• HK: to use forex reserves to guarantee bank deposits, set up a fund for banks to access capital; Cut base rate by 150bps to 2% twice in Oct to contain jump in HIBOR; providing additional liquidity to banks via 3-mo repo window, expanded acceptable collateral
• Korea: cut 7-day repo rate 75bps to 4.25% and lowered the base rate 75bps on loans to SMEs amid high commercial paper and loan refinancing costs, household debt; up to $100 bn to guarantee maturing foreign currency debt; to use forex reserves to inject $30 bn liquidity in won-dollar swap market after an initial $10bn; might buy govt bonds from the market to reduce USD shortage; temporary ban on short selling
• Taiwan: Guaranteed bank deposits; Cut discount rate on 10-day loans to 3.25% on Oct 9 (second time in 2 weeks following first cut since 2003), cut reserve ratio (first time in 8 yrs) and ratio for passbook deposits; injecting liquidity into foreign-currency interbank market; lending via repos to insurance companies w/ extended maturity up to 180 days; banned short selling; instructed 4 major funds and state-owned banks to buy shares after stock market fell to 3-yr low on Sep 15
• Indonesia: allowed commercial banks to use central bank debt and govt bonds as secondary reserves; extended FX Swap tenor to 1 month; passage of foreign currency via banks for firms; abolished limit of daily balance position; eased foreign currency min reserve req; Cut bank reserve ratio 1.58bps to 7.5%; exempted banks from mark-to-market rule, eased rules/cap for firms to buy back shares; Suspended trading on Oct 8/9 following 10% slide in stock market; banned short selling for Oct; injected over 3bn via 6-day repo; lowered overnight repo rate, adjusted rate of liquidity facility; might increase infrastructure spending, fiscal stimulus for exporting firms, households
• New Zealand: overnight Cash Rate cut 100bps to 6.5%; introduced opt-in deposit guarantee scheme; accepting (longer term) bank paper in daily market operations, ABSs from local banks for swapping foreign cash into NZ dollars
• China: Chinese banks reluctant to extend loans to foreign banks in the interbank market; reduced 1-yr lending rate (second time in 3 weeks, first since 2002) by 27bp to 6.93% and 10yr deposit rate to 3.87% and cut bank reserve requirements by 50bp to 17%; eliminated stamp duty on stock purchases with plans to buy shares in state-owned banks; to introduce short selling and margin trading to ease pressure on share prices
• Singapore: guaranteed deposits; Injecting liquidity via market operations; prepared to provide further liquidity if necessary and also to individual banks amid spike in 1-mo and 3-mo SIBOR, BEA bank run, CDS also rising; but rates have eased somewhat following central bank measures
• Malaysia: guaranteed deposits; Might inject liquidity, move interest rates if necessary; planning for an economic stabilization stimulus
  
• Pakistan: declining capital inflows/outflows in inter-bank and open market causing currency depreciation; central bank injected $100-200 bn, raised limit on investment bonds and term finance certificates under banks' statutory requirement
• Easing commodity prices, peaking of inflation, growing risks to exports, economic growth might also shift central banks' bias towards monetary easing; Taiwan, Pakistan, Vietnam had earlier intervened in stock market by narrowing trading band, introducing stabilization fund to contain volatility; India, S.Korea, Thailand, Philippines, Indonesian intervening in forex market to contain downward pressure on currency (led by capital outflows, decline in external balances)

Comments: Malaysia and Singapore are still the last to act. Hinting that their fundamentals are more solid than the rest. Safe to say that there is "no attack" on the currency so far. The difference is that Singapore was adamant in defending the strength of the Sing dollar - which could very well bite them in the back as their property side is headed for a substantive fall.

p/s photos: Haruna Yabuki

Risk-Reward Ratio Improving

Let's look at valuations. Asia's valuations have reached 1.2x P/BV. That figure is all of Asia minus Japan as Japan is a weird animal on its own. Earlier this year the valuations went as high as 3x P/BV, thus Asia as a whole has corrected severely. The question is whether it can go down some more. Well yes of course it can go down some more, there is always 0.00 to that P/BV figure.

The biggest crises for the past 40 years in Asia had been in 1982 and 1998 and during those times the P/BV went as low as 0.9x. Will we get there? I don't think so. I think we are pretty close to the bottom give or take 10%.

Its interesting to also look at what the Asian investment banks are weighting Asia as a whole with the "new clearance prices". Most are putting just 4 countries in the Overweight category, in order of attractiveness and weightage: Korea, Taiwan, HK and Malaysia. The countries getting the biggest Underweighting are: China, India and Singapore. As for sectors, most analysts prefer to look for bargains in: telecommunications, then banks followed by information technology. The ones that should be the LAST on anyone's buy list should be: construction materials, consumers, real estate and energy related counters.

Just how big is the financial mess we are in and why it is so prevasive. Much of Asia did not even touch those bloody CDS or CDOs, why are we like a pinyata in a Mexican party full of drunks. According to some estimates, this crisis is about twice as big as the Japan financial crisis back in the 90s and 3 x bigger than the US savings and loans bailout. Fair enough but it should not wipe out so much from Asian markets, should they? If Asia was part of the culprits dabbling in those instruments, then yes. Because then you would be seeing a significant amount of "capital being decimated" and wealth being destroyed overnight. The capital and wealth destruction were mainly in the US and Europe.

Some countries which may not be part of that mania but had problems of their own, including Russia, Iceland, Pakistan and Korea, may collapse as well under the distressing scenario. As for the rest, the flight to safety and confidence crisis are not "solid enough reasons" to whack the rest of the world with. We still have our domestic economy. Yes, our exports will be affected and property values will drop but surely it cannot be anything like the 1997-2000 financial implosion for us as then we were directly responsible, and we saw huge amounts of wealth and capital being depleted.

As for Malaysia our markets is trading at 1.5x P/BV now, which sticks out like a sore thumb when compared to the 1.2x P/BV for Asia (ex-Japan). We should remember that we were the hardest hit during the Asian financial crisis where we went as low as 0.7x P/BV briefly. During the internet collapse in the US the Malaysian market dipped to 1.4x P/BV. The problematic SARS period saw the local bourse going to a low of 1.5x P/BV. Hence technically speaking the local bourse is holding up very well. We have to also acknowledge that the country's balance sheet is a lot better today than in 2000 or 2003.

p/s photos: Linda Chung Kar Yan