When the first ripples of the sub-prime crisis were felt in August 2007 and central banks responded with liquidity infusion, Asian stock markets rallied and made fresh highs in the last quarter of the year. That gave rise to excited talk of Asia decoupling from the problems in the US. Eventually, American misery sought international company and found it, as has often been the case in the past. Hope gave way to denial and then to acceptance. Now, the worry is whether Asia would be entering into a crisis of its own. The Morgan Stanley index of Asian (excluding Japan) stocks declined for five days in a row last week.
It was not supposed to be this way particularly since commodity prices are in a free fall. Asia being a net commodity importer was supposed to benefit. That logic worked in 1990-92 and again in 2002. This time around since crude oil peaked early in July and dropped more than 25%, Asian stocks have dropped more than 10%. Therein hangs a tale.
This episode has highlighted some structural deficiencies in the Asian political and economic scene. In the last few years, cyclical boom conditions were misinterpreted as evidence of structural improvement in East Asia. The reality is that, in the near-term, East Asia would continue to punch well below its weight.
The failure of Asian stocks to rally can be explained by a few factors. One is that East Asian economies are externally dependent. Regardless of what was said before, investors appear to have assessed that the negative earnings impact of the global slowdown on Asian stocks mattered more than the positive feedback from commodity price declines. They are right. Thailand’s and the Philippines’ second quarter gross domestic product grew at well below the anticipated rates and Singapore industrial production has been disappointing lately. The impact of weaker growth is amplified by the fact that earnings expectations in 2009 for many Asian stock markets are still too elevated. Expectations have room to adjust to reality.
The second factor is that Asian central banks, barring India’s, had barely tightened monetary policy in the last 10 months since commodity prices began to rise. They had, therefore, lost the opportunity to reduce rates when commodity prices declined and thereby create a domestic “feel-good” climate. In other words, there was no scope for monetary policy easing when the situation afforded since it was not tightened when the situation warranted. In fact, central banks are caught in the piquant situation of having to raise rates now (as Thailand and the Philippines did recently) to defend their currencies. This is a situation entirely of their own making and attests more to lack of institutional autonomy rather than lack of institutional capability.
The third factor is the political climate in Asia. In many countries, it is downright unstable and destabilizing for the economy and stock markets. In fact, a political hara-kiri index would put Thailand and Malaysia on top with India in a distant third spot. The sordid tussle for the seat of power in Malaysia competes for the top slot with the storming of the Prime Minister’s office, the imposition of emergency and the talk of a military coup in Thailand. Both countries face serious questions over their long-term economic future as competition from China, India and Vietnam threatens to weaken their historical growth drivers. Economics has disappeared from the preoccupations of governments.
Of course, the weight of the direction of the US stock market is hard to dismiss. In fact, historical evidence suggests that the larger the decline in the US, the tighter the correlation. US economic indicators, barring the dreadful employment data, had given hope that America might skirt an economic recession. But closer analysis has revealed that most of the indicators were literally inflated by rising prices. Real activity had little to do with how healthy the numbers looked. That the number of hours worked in the US economy has been declining for four months in a row sums it all up. The outlook for the US stock market looks grim as analysts and economists have to push back the start date for recovery to 2010 or later. Earnings expectations have to be scaled back before one could speculate on a credible bottom for US stocks.
In the final analysis, the failure of Asian stocks to perform in spite of the sizeable oil price correction underscores the fallacy of relying solely on the past as the guide to the future. Asia’s potential is often overstated while its performance is underwhelming. Cyclical upswings, mistaken for structural strength, actually mask weak systemic foundations. As economists around the world and Asian governments get busy downgrading their economic growth expectations for 2009, they have to reflect on the opportunities they missed in the last five years to chart a different course.
V. Anantha Nageswaran is head,investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org