Pricey Chinese stocks may have tumbled on Wednesday, yet the Asian equity boom is far from over. Abundant global liquidity and strong investor appetite for risk are the two biggest pillars supporting rich valuations.
Like the administrative moves that caused the Chinese market to decline in early February, the recent tripling of China’s securities-transaction tax won’t have a lasting impact.
The government in Beijing seems to be in no mood to arrest the swelling trade surpluses, the root cause of a liquidity-fuelled stock rally.
That may be a key reason why a return of sanity to the overheated Chinese market—the “dramatic contraction” that Alan Greenspan, the former US Federal Reserve chairman, has warned of—won’t happen. And even if it did, it might fail to cause a sustained sell-off in Asian equities.
The global economy is in robust health; the US sub-prime mortgage crisis seems to have blown over.
According to Stephen Jen, Morgan Stanley’s global head of currency research, the US may be re-entering a Goldilocks phase of good growth and stable inflation. Moreover, with crude oil holding at more than $60 a barrel, there won’t be a shortage of petrodollars chasing risky assets.
All of this hints at a further expansion in Asian equity valuations. Company managements, too, are playing a role.
According to Bloomberg, some 350 companies in Asia, outside of Japan, have squeezed more sales out of every $1 in assets over the past four years, without sacrificing margins.
Sure, at some point, managers in Asian companies will run out of opportunities or ideas to create wealth for shareholders. That point may not be here yet.
From retailers in Singapore and Hong Kong to semiconductor companies in South Korea and power-equipment manufacturers in India, the wheels of business have been spinning faster and more profitably across Asia.
Siam Cement Pcl, Thailand’s third-largest publicly traded company, is now twice as revenue-efficient in the use of its assets as it was in 2002. At VST Holdings, a small computer-parts distributor in Hong Kong, revenue per unit of assets—also known as the asset turnover ratio—jumped 51% from 2002 to 2006.
“The strength of the global cycle has no doubt been a factor helping to improve asset turnover in recent years,” Daniel McCormack and Tim Rocks, Hong Kong-based analysts at Australia’s Macquarie Bank Ltd, note in a study.
“But we also think that there is an underlying structural improvement taking place. Asian companies are being better managed and one aspect of this improvement is more efficient utilization of their assets.”
Once existing assets have been utilized to the hilt, Asian companies will probably borrow more to boost returns on equity.
“Fortunately, the news on this issue is also good,” McCormack and Rocks say. “The de-leveraging that has occurred across Asia in recent years means that balance sheets across the region are currently in excellent shape.”
Out of the 350 Asian companies that have been flogging their assets with growing efficiency, some 200 today have less debt—net of cash—as a percentage of equity than in 2002.
One can argue that all the good news is already there in the elevated prices. Most Asian markets are at or near record highs, though on a price-to-earnings, or P/E, basis, they are 14% cheaper than their pre-Asian crisis peaks, says Mun Hon Tham, a Hong Kong-based strategist at ABN Amro Research.
“With earnings improving, lower gearing and rising return on equity, investors may see further P/E expansion,” Tham says. Investors looking at stock prices in relation to book values may conclude that Asian markets have run ahead of themselves.
Yet, price-to-book ratios may have gotten pulled up by rising returns on equity, according to McCormack and Rocks, the Macquarie Bank analysts.
Then there are the “carry trades” to consider.
A cheap Japanese yen is an important source of liquidity for Asian stocks. Borrowing in yen to buy Asian equity may lose its appeal if expectations begin to firm up about a recovery in the Japanese currency.
After the Chinese government tripled the stamp duty on share transactions, the yen rebounded from a record low against the euro on Wednesday. Traders bet on an unwinding of short positions in the Japanese currency.
If this is a sign of risk aversion, it may be temporary.
The Chicago Board Options Exchange’s VIX index—a barometer of nervousness—isn’t yet signalling choppy waters: It’s 18% below its five-year average.
The volatility in the Morgan Stanley Capital International’s Asia-Pacific Index has also ebbed from its elevated level in early March. It may not make sense to get too jittery about China.
The World Bank on Wednesday predicted China’s current-account surplus this year would be a staggering 11% of gross domestic product. To the extent that the yuan equivalent of the dollars entering China on the trade account won’t be fully absorbed by the sale of bonds and bills, they will chase local stocks.
The equity boom in Asia will continue.