Asian commentary

- Platinum Asset Management


With the exception of India, which continues to have a persistent problem with inflation, consumer price indices show little sign of coming back to life, so the debate seems a little premature. Nevertheless, most economic indicators show a strong recovery in activity with further impetus to come from planned infrastructure spending and potentially some rebound in exports as the inventory rebuild in the developed economics proceeds. Thus it is more a question of  “when” rather than “if” for increases in interest rates and a tightening in fiscal policy. Indeed the first moves in this direction have been seen in China where the government has been reminding banks to follow guidelines regarding mortgages on investment properties and banks appear to have slowed the frenetic pace of lending seen in the first months of the year.

While such moves to tighten economic policy may give stock markets a reason to pause, as we have seen in the China A share market in the September quarter, it would seem highly unlikely that such actions will have a significant impact on the economic resurgence that is taking place. In China, the investment plans of industry for capacity expansion and the government for infrastructure, along with resurgence in the demand for residential property, would seem likely to provide enough momentum to keep the economy humming along at a decent pace for some time to come.

Undoubtedly some of these investments, particularly in cement, steel, and aluminium seem destined to leave the country with excess capacity at some point in the future.

Ultimately the poor return on capital that will be earned on todays investment and commensurate bad debts for the banking system may weigh down economic growth further down the line. For the moment, however, the most likely outcome appears to be that China will grow strongly and drag the rest of the region along with it.

In India, the poor monsoon season represents a setback for rural incomes and this will slow economic activity to some extent. The secondary effect of higher inflation through increasing food prices is unhelpful as India already experiences relatively higher levels of inflation. However, in regards to this longer term inflation issue there has been some good news as the recently reelected Congress party has confirmed its intention to reform the taxation system. Included in the reforms is a proposal to replace state government sales tax with a unified national GST that has the potential to significantly increase the government’s revenue base. The importance of this is that the fiscal deficit in India has not historically been fully funded (through the sale of government bonds) and effectively money has been printed to fill the gap, a key underlying cause of India’s persistent inflation. A long-term reduction in the level of inflation would have important ramifications for economic growth and perhaps valuations in that country.

So what does all this mean for equity markets?

There has already been a substantial rebound from the lows of last October with Asian markets up just over 100% (in local currency terms) and they now sit about one third below the highs reached in late 2007 when the China growth story was at its peak. Valuations appear to be at relatively full levels with Asia ex Japan trading on an historic price earnings ratio of 18 times. While this figure may make markets look a little more expensive than they really are due to the depressed level of current profits, it is nevertheless at the high end of the range (with exception of the last days of the 2007 bull market) achieved over the decade since the end of the Asian crisis.

The implication of this is simply that the easy gains of the last six months are probably near an end. The fact that many recent initial public offerings around the region have opened below their issue price is perhaps a good indicator of shorter term prospects for markets. Until recently investors had poured into IP0s with an enthusiasm usually reserved for the final stages of a bull market. A final point of caution for investors is that although Asian economics, and to a lesser extent markets, appear to have finally achieved the long awaited decoupling from the West, it remains the case that foreign investors continue to have a significant influence over these markets. It is unlikely that Asia will be unaffected should developed markets suffer any setbacks.