High returns from some Asian markets are tempered by fears about unrest and a hard landing in the US. Despite this, the growth rates in the region look set to remain above those in the West.
East Asian markets have performed strongly recently, with the MSCI Asia ex Japan index rising by 8.1%, in sterling terms, in the three months to the end of October. Confidence has returned following the significant correction in early May. Investors anticipate that US interest rates have peaked and a soft landing will be engineered in America and other economies in 2007.
The initial public offering of ICBC, a Chinese bank, was heavily oversubscribed and became the world’s largest IPO when $21.9bn (11.5bn) worth of shares were sold. Healthy portfolio inflows have returned to the region. Even a military coup in Thailand in September failed to seriously impact the positive sentiment.
Over the past three months some Asian markets have provided stellar returns for investors. The leader of the pack has been India, which sold off heavily in May but has since rallied to new highs, with the MSCI India index rising by 23% in the three months to the end of October.
The Indian market has been driven by buoyant confidence among foreign and local investors about the economic outlook for the country (see chart top).
The Philippines has also performed strongly on improving confidence about the economy, while, of the major markets, Singapore has outperformed, driven by the property and banking sectors.
Some markets, however, have provided more limited returns. The MSCI Korea index rose by only 3% as sentiment was severely dented by a nuclear weapon test by the North Korean regime of Kim Jong-il, and poor results from global technology companies.
Hong Kong has also lagged, as the property sector has already rallied strongly, and the IPO of ICBC sucked a considerable amount of cash out of the financial system.
Over the next few months we would expect markets to be well supported for a number of reasons. Economic growth in Asia remains robust, especially in China and India. The significant fall in the oil price is positive for a region that is a net importer of oil.
Expectations of lower inflation should put a cap on interest rates globally. Risk appetite is high and liquidity should remain plentiful. The final quarter of the year is often a strong one for stockmarkets and year-end rallies are a common feature.
However, such confidence should be tempered by a number of concerns, which may impact markets next year and should be borne in mind by investors in the region.
Much of the good news is already reflected in share prices at current valuation levels. For example, on a price-to-book basis, the region looks expensive (see chart bottom). Valuations in India are high by historical standards. It is becoming increasingly difficult to find value in the region.
Euphoria over the potential of China may prove justified in the long run, but there are still risks associated with the country. Strong fixed asset investment has forced the government to raise interest rates and attempt to slow the economy.
Lending to the property sector has been excessive and there are still concerns about asset quality in the banking sector, despite the partial privatisation of some banks.
The American housing market has slowed substantially and the impact on consumption remains unclear. A harder landing in America than is widely expected would be negative for global stockmarkets, including the Far East ones – and in particular for companies exporting to the American consumer.
There are also long-standing concerns about imbalances in the American economy – large fiscal and current account deficits, which at some point could result in a significant fall in the dollar.
Broader global political issues could impact the region. The international response to Iran’s nuclear programme is uncertain. Israel might act unilaterally against the country’s nuclear facilities. Such escalation could result in another sharp rise in the oil price and would be negative for global growth. North Korea might test further nuclear devices, increasing political instability.
However, the long-term outlook for the region remains positive. Economic growth rates look set to remain substantially above those in the West.
China and India, in particular, have a long period of high growth ahead of them, and smaller countries such as Vietnam are emerging as growth dynamos.
The trend in outsourcing to Asia, in both manufacturing and services, continues. Substantial improvements have been made in corporate governance and a dividend culture is developing in some countries.