US quantitative easing throws Asian equities into a tailspin
The Asian equities market is vulnerable to US quantitative easing in the short term, but the market itself is very diverse and the longer-term outlook stronger.
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It might be a long way from downtown Shanghai to the US Federal Open Markets Committee meeting, but it only took a hint from Ben Bernanke about plans to turn off the money tap and Asian equity markets were thrown into a tailspin in July and August.
Both the Indian and Indonesian currencies dropped sharply as talk of US ‘tapering’ of its quantitative easing (QE) policy saw global investors focus on the large current account deficits in both countries. The comments also quickly resulted in spooked investors repatriating assets out of several Asian equity markets.
Despite the concerns, most local experts believe the investor flight out of Asian markets has been overdone and the case for investing there remains strong.
Morningstar fund research analyst Alex Prineas believes nervous Australian investors should calm down a little.
“Investors should look at Asia as a long-term investment, rather than responding to short-term noise.”
Craig Mowll, CEO of Certitude Global Investment, agrees they should not be jumping at every market movement.
“Asia has got some wonderful opportunities to it,” he says.
The megatrends underpinning the Asian growth story are still intact and still make investing there attractive, according to David Bryant, CEO/CIO of Australian Unity Investments. “I am a big believer that levels of income, population growth and income flows are big drivers of economic growth.”
He believes these young economies still offer the best mix of income and population growth and stable government.
“Many Asian economies are coming off a low base in terms of income and wealth and they have lower cost resources to produce their goods,” Bryant says.
Wall Street waves
Despite the strong fundamentals, confidence in Asian equity markets was definitely rocked by concerns about a potential shift in US monetary policy – and there are clear short-term risks for investors.
“QE tapering will lead to less liquidity and we have already seen the Indian rupee down 20 per cent to the US dollar and the Indonesian rupiah 20 per cent down. The Indonesian market has been one of several powerhouses, but it has been hit very hard in recent times,” Prineas says.
Stuart Rae, Hong Kong-based CIO of Pacific Basin Value Equities at Alliance Bernstein, agrees equity markets have felt the impact of US concerns.
“There has been an indiscriminate sell off due to money flowing out following concern about QE,” he says.
“In the short-term, it is clearly a negative for risky assets and Asian equities, as it is assumed they are riskier so they have seen outflows.”
Although hints about the winding back of US liquidity have had ramifications in Asian markets, Bryant expects them to be temporary.
“Currency disruption and liquidity wind-back have had a short-term impact, but this will hasten self-consumption and will not have a long-term impact. It flows through most in the smaller markets,” he says.
Rae believes the US moves may have an upside.
“The US is seeing increased economic stabilisation and that is good for the export-oriented part of Asian markets. It may not be all bad for some sectors and countries,” he says.
In fact, the changes will create opportunities.
“The different impacts in different countries lead to opportunities for managers, as the differences can be exploited,” Rae notes.
Prineas believes the ructions highlight that Asian investments are not for the nervous.
“It underscores the need for a long-term view due to the megatrends supporting Asian economies, such as population growth.”
The current volatility is the other side of the growth equation, Bryant argues.
“Asia as a whole is still more volatile than Western markets, and that is to be expected if you are gearing up an economy and it is priced to grow. If you want return on the upside, then you need to take the volatility that goes with it,” Bryant says.
China chills and Japan warms
If volatility courtesy of US tapering was not enough, investors have also been buffeted by concerns about the slowing in China’s headline growth rate.
Rae sees the slowdown as part of the maturation of the Chinese economy.
“Economic growth in China is half heavy investment and half domestic consumption and this has averaged 12-13 per cent. The slowdown has been in heavy investment, which is now growing more slowly, but consumption is still growing, so growth is now at 7.5 per cent.”
Heavy investment growth rates have gone from mid-teens to mid-single digits, which is more sustainable, he says.
Although some investors are concerned about the Chinese slowdown, Bryant is relaxed.
“You can’t do 10 per cent compound growth forever and 7.5 per cent is not ‘cool’ for economic growth. It is a fantastic growth rate, given the relative size of the economy and a pretty good driver of growth globally. To keep it at that rate is extraordinarily good.”
While China may be slowing, Japan’s economy finally seems to be reawakening courtesy of its new ‘Abe-nomics’ growth policy, which has fuelled a 55 per cent rise in the local equity market over the past 12 months.
“The play out of Abe-nomics will be very interesting, as they will have the largest global saving pool in the history of the world to invest,” Mowll says.
He believes just as investors have closely watched where Chinese investment has gone, there will be similar interest in where Japanese investments occur offshore.
Bryant agrees the economic changes occurring in Japan are highly significant. “China and Japan are the link points between the Asian economy and the West.”
Bear case remains
Despite the strength of most Asian economies, risks still linger for investors.
“The Chinese government is not doing too bad, but some risk remains of it being too heavy handed. The risk is that if you take a huge machine and slow it down, it may seize or collapse,” Rae says.
“There is a valid bear case for China, but the numbers do not support that at the moment.”
To counter concerns about the reliability of the economic numbers coming out of China, Alliance Bernstein also follows some of the second tier statistics.
“The top-line numbers are harder to trust, so we look at physical activities like electricity and cement. When you look at that, it supports growth of 5-10 per cent,” Rae says.
The two main areas of concern regarding the Chinese economy are housing and the finance sector, which has seen rapid growth in alternative financing channels or so-called ‘shadow banking’. However, Rae believes the situation is under control.
“The alternative financing system is not big enough to break the Chinese economy – not like in the US. But it is the rate of growth that worries people,” he says.
The Chinese Government also has monetary tools which are unavailable in most Western economies.
“China can directly control a number of lending rates and the availability of lending. It has more buttons to push than the RBA.”
In fact, Rae sees parts of the Chinese financial sector as attractive.
“The big banks are fairly traditional in their funding model, so we hold big bank stocks,” he says.
Although there is also concern about the Chinese housing market, the current data suggests this is overdone, as there is significant under-reporting of income and over-reporting of housing availability.
“They are trying to get slower growth, not a price collapse in housing. We are seeing 0-1 per cent price growth month-on-month, but wages are growing at 10 per cent per annum,” he says.
Concerns about the economic slowdown in countries like India are also unlikely to cause major problems, as the flow-on to the global economy is limited.
“The Indian economy has a large population base, but it is not as critical a link to external economies as China and Japan,” Bryant explains.
“It is not a major through-put economy, so the consequence outside India is less than with China.”
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