| |
A random walk over the
cliff?
By John M Mulcahy
Foreign fund managers appear to be persuading
themselves all over again that Asian manufacturers of
hairdryers and branded snake soup hold the key to wealth
for their Belgian-dentist or Upper West Side-dowager
clients. Asian stock indices everywhere are racing ahead
this year, driven principally by inflows of foreign
institutional funds.
The Morgan Stanley Capital
International Emerging Markets Free, known as MSCI EMF,
is up more than 25 percent in US dollar terms so far
this year, as is the MSCI Asia Free. Individual stocks
in many Asian countries have performed even better than
that. In contrast, major developed-market indices, such
as the Dow Jones (+13 percent), the Standard &
Poor's 500 (+14 percent) and the FTSE (+6 percent) have
seen more modest gains this year.
This can be
dangerous. The hot money that sloshes in can slosh right
back out again, as Asian governments and corporations
learned to their tears in 1997 and 1998 during the Asian
financial crisis. Nonetheless, institutional buyers are
being wooed again by the lure of the mysterious Orient,
as they were in the heady days of the late 1990s when
investment guru Barton Biggs proclaimed China to be big
enough to warrant his attention and (by inference) that
of his following, collectively responsible for hundreds
of billions of dollars in managed savings. They seem to
have forgotten that the climate for foreign investment
in Asian stock markets went rapidly downhill thereafter.
The competitive currency devaluations precipitated by
the Thai baht's free float in 1997 was the inflection
point, but that proved merely to be the catalyst for a
prolonged economic crisis whose consequences are still
evident.
Net foreign buying of stocks in markets
from Seoul to Singapore is creating a frisson of energy,
as the bloodied and battered Asians dragons dare to
dream that the good times are here again. According to
Nomura International, net buying of stocks by foreigners
in Korea, Taiwan, Thailand, Indonesia and the
Philippines for the year to date totaled US$14 billion,
compared with net selling in these markets of about $1.5
billion in 2002.
Indonesia has seen net foreign
buying of $189.7 million; Korea $3.9 billion; the
Philippines $77.5 million; Taiwan $9.3 billion and
Thailand $485.5 million. In Hong Kong, which does not
officially differentiate between foreign and local
investors, market share of the bigger stockbrokers has
been above 50 percent for most of this year, compared
with levels as low as 28 percent in 1999/2000. That is
the clearest indicator of foreign institutional
involvement in the market.
The diversity of
performance is evidence enough of the fact that
investment is at least as much art as science. In 1999
and 2000, "value" investment guru Warren Buffett was
patronizingly dismissed as the busted flush of
professional investors. By his own admission, Buffett
"just didn't get" the valuation of the "new" economy. He
was not alone, and one of the pioneers of the modern
hedge fund, Julian Robertson, the irascible founder of
Tiger Management, also threw in the towel as he failed
to understand the concept of virtual profitability.
Robertson continues to enjoy his retirement,
presumably smug in the awareness that his lifelong
belief in the virtues of sound balance sheets, fat
profit margins and reliable management has been
vindicated. For the guru Buffett, meanwhile, normal
service has been resumed, and he is back on the top of
the mountain, or at least the Omaha steak-house,
dispensing common-sense wisdom to his acolytes as he
watches his portfolio of value investments soar. The one
current risk to his exalted status is his co-option into
Arnold Schwarzenegger's Californian kitchen cabinet.
But what of the ranks of fund managers hoping to
succeed Buffett and Robertson as the new messiahs of
investment? Is it simply a debate about value versus
growth? How are they positioning themselves for the next
stage of the global economic and investment cycle? Not
too many reputations survived the 1997/98 Asian
reversal, as managed funds crashed and burned. Hedge
funds proliferated as investors turned their backs on
benchmarked long-only funds, but when last did anyone
successfully set up a short on a stock in Indonesia or
even Taiwan?
There is no certainty about the mix
of factors that drive portfolio investment flows or
asset allocation, although it is accepted that there are
some common macro-economic issues - interest rates;
business cycle conditions in industrial countries;
regional equity returns; inflation (historic and
expected); credit ratings; exchange rates; foreign
reserves. Individual investors, institutional and
private, will often argue that they ignore macro issues
and buy stocks at the right value, but that principle is
more commonly breached than respected.
Property
stocks in Hong Kong, ignored with studied disdain by the
vast majority of institutional investors for years,
became popular again on August 5. It is hoped that
"Superman" Li Ka-shing's pronouncement on or about that
date that the Hong Kong property market was in good
shape was a serendipitous intervention and not the
cornerstone of fundamental analysis on the subject.
After all, as one of the biggest players in the Hong
Kong market he can hardly be described as unbiased.
Since Li's wisdom descended, the property
sub-index on the Hong Kong Stock Exchange is up almost
25 percent. The buyers are foreign institutions, the
sellers mainly local punters. So who is right? It is
possible to argue that both are right, in that locals
may have decided they have made enough profit to exit,
while foreign institutions may also be right, in that
the market probably has further to run.
But that
does assume that the greater fool theory prevails. The
parcel must be passed in order to generate a profit, and
the key assumption in this headlong rush back into Asia
is that there will be enough liquidity to facilitate the
exit. Fund managers are as human as the rest of us, and
as driven by the fear of missing out. The herd mentality
is far more pervasive in investment than we are led to
believe, and there is far more buying at the top and
selling at the bottom than the institutional fund
management fraternity would have us believe.
The
random walk by foreign funds through Asia, on one level
a justified and long-awaited recognition of the region's
recovery, is in danger of becoming a lemming-like plunge
over the cliff, as earnest analysis is abandoned in
favor of the nod and wink about next week's hot stock.
The rapid rise in valuations has meant that funds
underweight in the region before the latest fun started
are almost certainly underperforming their competitors.
They will thus force the pace, creating a flow
of liquidity that will eventually become a
self-fulfilling prophecy – if enough investors believe
the markets are going up, and are prepared to put their
clients' money where the fund managers' mouths are,
supply and demand will dictate that markets will rise.
However, in the process they will buy companies that are
either expensive by their own criteria, or they will buy
companies that six months ago would not have passed
their own rigorous sniff test.
As the momentum
builds, investment bankers and stockbrokers will dust
off almost-forgotten prospectuses in preparation for a
new round of initial public offerings (IPOs), and
placements of companies that brokers would not have
dared to mention to their risk-averse clients a year ago
are now allocated only to the best clients. Have any
lessons been learned from the lean years?
Anecdotally, fund managers report that global
asset allocators, whose function is to make judgements
that shift the emphasis of portfolios - bonds to
equities; US to Europe, etc - have been reducing
holdings in US markets and increasing their exposure to
Asia. Japan is the biggest beneficiary of this process,
based on the belief that, yes, this time will indeed be
different. After a decade of recession and innumerable
stimulatory packages, Japan is probably more
recognizable to global investors as the Land of the
False Dawn rather than the Rising Sun. According to the
global allocators, who are either prescient or haven't
had their fingers burned often enough, the time has come
when Japan has exhausted every possible opportunity to
disappoint, and is again worthy of their attention.
"Overweight Japan" has been the epitaph on many a
foreshortened fund-management career, and only time will
tell whether they are finally proved right.
Japan, according to one of the persistent bulls
of that market, Merrill Lynch's Jesper Koll, believes
corporate restructuring, broadening domestic demand and
monetary inflation will expunge Japan's deflation within
the next year, and there will follow a period of
consumer price inflation and positive economic growth.
It is a measure of Japan's condition that predictions of
inflation should be viewed as the single most bullish
indicator. It is a distortion of reality worthy of Lewis
Carroll that countries almost characterized by their
fiscal rectitude – Japan and Germany – should find
themselves in a position where the only solution is
inflation.
The Japanese equity market was
recently described by a US mutual fund manager quoted in
Barron's as "cheap" at 18 times prospective earnings. In
other words, Japanese stocks are trading at an average
18 times next year's profits. That is cheap in an
economy with zero growth and persistent deflation. If
nothing changes in Japan's macro-economic condition over
the next decade, an improbable but not impossible
situation given the past decade, an investor could well
be waiting 18 years for the company to accumulate
profits equivalent to its current valuation. At what
price does it become expensive? That is not the right
question for a young fund manager to be asking the
global asset allocators at this stage, and foreign
institutions are again convincing themselves they are
buying from people who don't understand where the market
is going.
Most people with a pension fund are
likely to be investors in the Japanese market, and it
would be dangerous to be complacent about the fact that
local investors are not participating in the buying
binge. An economic recovery in Japan has been the
elusive goal for a succession of prime ministers and
finance ministers in Tokyo. It is possible that local
investors are so inured to disappointment that the glass
will always be half-empty, and that fortune will favor
the brave, but history suggests sustained bull markets
across Asia require joint participation of foreign and
local investors.
In the wake of the 1997
currency and economic crises, cities such as Bangkok and
Jakarta, once exotic playgrounds to the stewards of the
world's wealth, disappeared off the Bloomberg screens of
fund managers from New York to London, and Edinburgh to
Boston. To some locals, the departure of these perceived
fair-weather friends was their first taste of the fickle
favors of the global funds. The 1990s flow of Bordeaux
and fine XO rivaled FDI (foreign direct investment)
flows as exotic Asia cast its spell over a generation of
money managers. To be fair to these pension and
hedge-fund managers, most did not sashay off to the next
pot of gold, as they were often holed below the
water-line, and the end of the Asian miracle took its
toll on careers everywhere.
The persistent
failure of the US markets to reward the pessimists has
left global portfolios with a dilemma - there is a
recovery in the US, but it is so anemic in nature that
it cannot possibly produce earnings that will justify
current valuations. Besides, we haven't had an
irresponsible Klondike-style hunt for the hot stocks in
Asia for almost a decade, apart from the short-lived
dot-com bubble. Surely the time has come for a revival
of the Asian tigers or dragons or whatever we used to
call them - or has it?
The game does appear to
be on again, as karaoke bars re-stock the Cohiba
humidors and investment bankers sharpen their pencils,
or whatever it is they need to do to their Bluetooth
organizers. From the perspective of a tepid economic
climate in the US and Europe, the prospect of dipping
into rising aspirations (and spending power) of Asia's
billions is always tempting. The emerging middle class
in China and India, the chastened but no-less formidable
ASEAN consumers, the North Asian tech specialists are
all still there, waiting to be blessed/afflicted once
more by a flood of capital from the West.
According to the Bank Credit Analyst (BCA)
emerging-market stocks have passed their 2002 peak, and
have "broken out" in technical parlance. "This has
happened despite churning equity markets in the major
countries. The outlook for emerging markets remains
encouraging. First, currencies are cheap and monetary
conditions are very stimulative in most countries.
Second, emerging markets are leveraged to global trade
and should do well if global business conditions
continue to improve, as we expect."
It is now a
recognized fact that the principal economic culprit
behind the collapse of Asian economies was a surfeit of
cheap credit and capital. In a sense, the one was a
function of the other, as capital flows underpinned
economic growth, producing surpluses that provided
further liquidity, fueling capital flows in a seemingly
virtuous circle. It turned vicious when that familiar
syndrome, known as "easy come, easy go" encouraged
companies to ignore their "core competencies" such as
they were, and diversification became the watchword.
The executives of some of these companies
obviously liked a lot of things, so they bought the
companies that produced them, but when the music, or the
madness, finally stopped, very few reputations were
intact: Accused were the companies, for their casual
attitude to credit, and the shareholders, for their
tolerance of these excesses. While it was by no means
the worst example, the venerable Thai giant Siam Cement
was a case in point, accumulating so many diverse
businesses during the boom years that cement products
were seen almost as a quaint reminder of its origins.
Still, very few Asian "balanced" portfolios were without
some exposure to Siam Cement, and it was only in
hindsight that many institutional investors rediscovered
their critical faculties.
Asia has not been
alone in feeling starved of capital in recent years.
According to the United Nations Conference on Trade and
Development (UNCTAD), which compiles data on foreign
direct investment, global FDI flows peaked at $1.6
trillion in 2000, and by 2002 they were $540 billion, a
third of the value recorded in 2000. Curiously,
developed countries were most affected by the slowdown
in FDI flows, as multinational companies retrenched and
consolidated in the wake of the technology crash. It is
also true, though, that Asia suffered from the FDI
slowdown, and in an UNCTAD survey earlier this year 54
percent of respondents reported that planned investment
had been postponed. The timing of the survey - February
and March - coincided with the outbreak of the SARS
virus, and that clearly affected sentiment.
However, the consensus among respondents to the
UNCTAD survey was that FDI prospects appeared brighter
from 2004, and they were also confident about long-term
flows. The US, UK and Japan were seen as the most likely
countries to invest in Asia, and China was listed by six
countries in the Asia-Pacific region as likely to be
among the top three investors in their countries during
2003-2005. Sectors seen as most likely to benefit from a
recovery in the global economy by Asian respondents were
electrical, electronics and automobiles.
Detailed figures on FDI flows are due from
UNCTAD this week, but it is clear that 2003 has seen a
dramatic recovery from last year's trough. China,
together with Hong Kong, has a stock of FDI second only
to the US - China/Hong Kong's $881 billion vs $1,351
billion for the US - and for the first seven months of
this year FDI into China rose 27 percent to $33.4
billion from the same period in 2002. The sources of FDI
into China are varied, with companies such as Japan's
Bridgestone and Germany's Infineon placing big bets on
the world's most populous country.
Based on the
traditional maxim that FDI flows are a key pathfinder
for emerging equity markets, the collapse in
cross-border investment during 2001-2002 was a logical
adjunct to the poor performance of stockmarkets. The
perception that the worst is over, and especially that
2003-2005 will see a strong recovery in FDI flows, bodes
well for the Asian markets. Indeed, a concrete indicator
of Asia's economic revival is contained in an interview
with a FedEx Express executive. While the executive
singled out China as the driver of trade into and out of
Asia, FedEx, the world's largest express delivery
service, is also expanding in Japan, Taiwan and the
Philippines. In fact, FedEx's daily international
package volume surged by 16 percent during its fourth
quarter, ended May, compared with its 6 percent global
growth.
So far, the confidence that portfolio
investors are expressing in Asia seems to be well
placed, and fund managers can rest easily on their
growing overweight positions in Asian markets. But
nightmares will not be avoided as long as the local
punters are missing in action.
John
Mulcahy has been covering Asia for 20 years, as a
journalist with the South China Morning Post and Far
Eastern Economic Review and as equity research head at
Vickers da Costa, Peregrine and UBS.
(Copyright 2003 Asia Times Online Co, Ltd.
All rights reserved. Please contact content@atimes.com for
information on our sales and syndication policies.)
|
| |
|
|
 |
|
