Risk-takers beware
Written by changthai11 on Saturday, September 20th, 2008
ASIA FOCUS
Risk-takers beware
While Asia may look healthy, export dependence could lead to more pain, reports Umesh Pandey
As global equity markets take a turn for the worse, fund managers are warning those with an appetite for risk that they should look twice at Asia’s heavy reliance on exports before they take the plunge into regional equities, saying a lot of pain is yet to come.
“What we see is just 50% or less of the pain that may unravel over the next couple of months as the crisis in the financial markets is concentrated in what we call the Grade A category of firms,” said a fund manger based in Shanghai.
“Imagine if this is the Grade A category, then what would be the status of the others?”
Other fund managers agree, saying that although fundamental valuations in Asia look attractive, the likelihood that they would get cheaper going forward is relatively high.
“Look at Asia - there is a group of people who say that the markets are attractive and I don’t disagree with them, but the point is that Asia is not immune to the events across the world,” said another Singapore-based manager of close to $20 billion in investments across Asia.
The latest global panic has taken the Asian markets, which had been considered immune to the crisis in the United States, by surprise. Equity markets have been falling daily since Lehman Brothers filed for bankruptcy, and the Fed had to pump $85 billion into American International Group (AIG) to stop the world’s largest insurer, with nearly $1 trillion on its balance sheet, from going belly-up.
“Nobody knows which is the next financial institution to go next,” says the fund manager based in Shanghai who specialises in China, Hong Kong and Thailand.
China, India and the growing regional economies, he says, may offer long-haul growth but these economies are not immune to the crisis in the world’s largest consumer market, United States.
The United States accounts for nearly a quarter of the world’s consumption and that demand has for a large part underpinned the rapid ascent of China, India and other regional economies over the past decade.
China, which has recorded double-digit annual growth over the past decade, got so scared that a day after the collapse of Lehman Brothers the country cut its interest rates to shore up businesses and consumption.
The People’s Bank of China (PBOC) announced that commercial banks’ benchmark lending rate would be cut by 27 basis points (bps) from Sept 16, while deposit rates would remain unchanged. In addition, medium and small financial institutions will have their reserve requirements lowered by 100 bps from Sept 25.
“We think the rate cuts sent a clear signal to the market that the [Beijing] government is concerned about the growth outlook and weak market sentiment, which could have been weighed down even more by bad news from Wall Street,” wrote Tao Wang, an analyst at UBS Securities.
Andy Rothman of CLSA Securities says the biggest indicator of a slowdown in China comes from power-generation data, which indicate that the Chinese economy is slowing sharply, with year-on-year generation growth contracting from 16.6% in March to 8.1% in July and 5.1% in August.
He says there has been some softening of industrial power demand, consistent with the mild slowdown in macroeconomic growth. As well, administrative measures designed to promote restructuring have had a disproportionate impact on production of energy-intensive goods, but this is largely the result of raw-material supply constraints and a margin squeeze, not significantly slower demand for final goods.
His views are sending shivers down the spines of fund managers and investors who have been witnessing daily declines of their net worth.
“It is inevitable that China’s economy would show a significant slowdown following the footsteps of the US as China is an export-oriented economy,” he says.
This is the reason why a lot of the funds have been withdrawing their investments from the region over the past few days and weeks.
Markus Rosgen of Citigroup in Hong Kong points to data from EPFR Global (a company that tracks global fund flows) showing fund outflows last week of close to $28 billion, compared with inflows of $10.37 billion in the same period last year. This has taken total assets under the management of these funds in Asia down to $126 billion, a drop of 44% so far this year.
“Asian funds have been affected the most against Latin American and EMEA (Emerging Europe, Middle East and Africa) funds,” he says.
In a recent survey by Merrill Lynch, which is now in the process of being taken over by Bank of America for $50 billion, most fund managers continue to believe that the pain has a way to go.
Merrill’s composite index of risk appetite hit a record low in September as investors took on more defensive strategies and shortened their horizons, the survey said; fund managers continued to keep their cash levels high.
Merrill said it was disturbing to see that a net 39% of respondents thought liquidity conditions - referring to depth of markets and ease of trade - had deteriorated. Investors are using an ex-ante (forecast) equity risk premium of 3.9%.
On the economy, the survey found that fear was increasingly evident, with many managers believing the global economy is already in recession or is likely to be in the next 12 months.
Fund managers remained gloomy on corporate earnings and operating margins, believing consensus earnings expectations are still unrealistically high.
Merrill pointed out that the biggest surprise was a collapse in inflation expectations. The net percentage of respondents who expected higher core inflation has fallen back to levels last seen in 2001. Merrill said this could be an over-reaction to the fall in commodity prices, or may also reflect fears of a global slowdown.
The proportion of managers who believed in a stagflationary environment dropped sharply from 87% in June to 66% in September.
On risk appetite, asset allocators have been overweight in bonds for the first time in the survey’s history. At the same time, a record number favour US stocks, with corporate America having the most favourable earnings outlook relative to other regions.
On emerging market equities, they have the most negative net underweight stance since 2001.
In September US equity funds attracted $4.28 billion in the first week despite a drop of 3.5% in the value of portfolios.
Merrill said a major factor behind the more positive stance on US equities was the sharp rebound in the dollar. A net 43% of asset allocators believe the dollar is undervalued, and continue to shun the euro.
On emerging market currencies, the view has also changed. Merrill said that three months ago, a net 41% thought they were undervalued; in the latest survey only 15% held that view.
