Last week, a series of data caught our attention. Singapore’s Purchasing Managers’ Index (PMI), for the first time since it exited recession in April 2009, fell below 50, the neutral line. It is currently standing at 49.4, a 2.8 points drop compared with the July data. This fall in PMI signals a worsening business condition—in particular, the contracting of the manufacturing sector. A breakdown of the index shows some discouraging signs. New orders (-3.2), new export orders (-2.5), production (-5.7) and employment (-2.9), all fell to below 50. Taiwan’s HSBC PMI, too, experienced a fall, from 50.5 in July to 49.5 in August.
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While the above data are disappointing, they are not unexpected. The global economic environment remains the key headwind for Asia. Take the US, for example. Though the recently released PMI data showed an inexplicable increase in August, the boost in current production appears to be headed for inventory: For instance, auto sales in August in the US were weaker than expected. Further, new orders received by US manufacturers less inventory are falling fast towards zero, having lost 20 points in barely three months. What this means is that inventories at customers are rising faster than new orders received by US manufacturers. This portends reduced production activity in the coming months.
In addition, the declining new orders (excluding inventory) are traditionally correlated with Asian exports. This typically translates into weaker manufacturing activity in Asia through the export channel, which is what the recent Singapore and Taiwan’s PMI data indicate. Further, there are also Asia-specific growth risks.
The Singapore government, for instance, announced various measures intended to rein in the appreciation in private residential prices. They rose 38% year-on-year in the second quarter of 2010, compared with a contraction of around 25% year-on-year in the same quarter in 2009. The property index indicated that the prices of property have already exceeded the peak seen prior to the Lehman collapse in 2008. And Singapore is not alone in this respect: Hong Kong too saw a drastic spike in property prices.
Reliance on administrative tools is not bad policy, per se. But they can be blunt and can be either too little or too much, since their use is discretionary. However, allowing prices to reflect economic reality would be smoother, giving participants time to adjust. Measured against this yardstick, Asian governments have failed. Asian currencies are still appreciating far too slowly, if at all, despite record capital inflows. Second, given high nominal growth rates, policy and market rates should be higher than where they are now.
The failure to allow exchange rates and interest rates to reflect the underlying economic momentum not only risks perpetrating Asia’s familiar boom-bust cycle, but also betrays a lack of confidence in the underlying economic vigour. Thus, it is clear that Asia wants to have the cake and eat it too. It wants the rest of the world to take note of its economic strength, while at the same time, feeling so unsure of it, not to risk any prudent “leaning against the wind” policy decisions. This is reminiscent of how Asia behaved in 2007-08. The intervening crisis has not really helped to change mindsets. That is a pity.
Due to this reluctance, there is a real risk of the inflation genie jumping out of the bottle. Real interest rates in many of the Asian countries remain low and largely negative, indicating that key policy rates have not kept up with inflation rates. The reluctance to put interest rates up appears to be back among Asian central bankers. While the global uncertainty surrounding the US economy is one of the key considerations behind this reluctance, Asian governments have to contend with domestic inflation risks. That the prices of agriculture and industrial metals are climbing steeply and rapidly in recent times elevates the inflation risk in Asia.
Of course, my belief on Asian long-term growth story is intact. The aforesaid risks are more likely to be cyclical squalls rather than structural storms. However, the near-term risks to the Asian growth story need to be recognized, especially since Asia’s stock markets have not priced them in.
Relative to mature markets, the Asian markets are such that it is not unreasonable to invest at a higher price-earnings or price-book multiples, given high nominal growth, both currently and prospectively. Further, in the last decade, Asian stocks have delivered superior and positive returns compared with the losses investors experienced in the US and in Europe.
At the same time, relative to their own history, most Asian bourses are somewhat pricey near-term. The starting point matters. While the Morgan Stanley Asia (ex-Japan) index delivered 39% return in dollar terms from April 2000 until June 2010, it delivered 239% return in the period from April 2003 to June 2010. Timing matters to investors; patience is rewarded.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org