Growth in Asia propels US
stocks By Joergen Oerstroem
Moeller
Editor's note:
This
article was written the day before Wall Street
suffered its worst setback in more than four
months on Monday, with the Dow
Jones Industrial Average falling 158 points.
Various factors contributed to the fall:
weak retail-sales estimates spurred concerns about the holiday
shopping season; the US dollar continued to
decline for a fifth day; and crude-oil prices
rose. But Monday's stock selloff ended a steady
run-up in prices in recent weeks, andthe argument presented in
this article is by no means negated.
It looks like something is wrong. Wall
Street is not behaving in accordance with
conventional economic theory. It goes up when it
should go down.
All omens point to a
sluggish US economy in 2007. The latest revised
growth predictions forecast a fall from 3.6% in
2006 to 2.9% in 2007. The increase in labor force
plus growth in productivity, the instrumental
forces behind the high growth for a number of
years, will be less favorable in the years to come
and bring the economy down to a trend growth of
around 2.5%. [1] Admittedly, such figures are full
of uncertainties, but all indicators announce a
lower trend growth in the coming years.
Stock markets should react to such
predictions by falling or at least not moving very
much, but contrary to conventional wisdom, Wall
Street and Nasdaq are actually rising. Not even 16
consecutive increases by the Federal Reserve of
the short-term interest rate, bringing it to
5.25%, has dampened the market.
When
analyzing behavior out of tune with theory, the
observer can say that the theory is correct and
the stock market will realize that sooner or
later, or that the stock markets know or react to
factors most of us do not incorporate in our
analysis.
Let us go straight to the second
option. The stock market knows that we are living
in a global world. Most of the companies listed on
Wall Street get most of their profits from the
domestic US market, but less so every year.
Revenue from the US market is still very high, but
growth in revenues and profits from Asia outshines
US figures. Such companies as Microsoft, Oracle,
General Electric and Dell switch more and more to
the buoyant and unstoppable growth machines in
Asia - China, India and the majority of Southeast
Asian countries. They sell to these countries,
they invest in them, and they move more and more
of their research and development to them.
This has the following consequences for
stock prices on Wall Street.
When
investors look at buying stocks, they among other
things focus on price/earnings (p/e) ratio. Basic
arithmetic tells us that with 1.2 billion people
in China and an annual economic growth rate of
about 10% in the years to come, the increase in
purchasing power will be of a magnitude not yet
seen. Add to this 1 billion Indians and about 500
million people in Southeast Asia, and they far
outweigh any increase in US purchasing power. This
is in particular true as a rising middle class
with strong purchasing power emerges.
A
stock may show a traditional p/e of, let us say,
15, but if we add in the growth prospects from
Asia, a p/e much higher does not look out of tune.
If p/e is above the average or normal level, the
question is how long it takes for earnings to
catch up - to produce earnings higher than
estimated, thus bringing p/e back to normal. That
depends on growth prospects and, as just outlined,
the huge and fast-growing Asian markets will
sharply reduce this length of time in the future.
A large part of the investors operating on
Wall Street may still be American, particularly
where pension funds are concerned. They want to
buy a share of tomorrow's production to finance
future payments, and to achieve such a
performance, they look to companies getting an
increasing share of profit on growth markets. This
is where money is earned and production will take
place. The pension claims from a growing number of
people above 65 years of age dwarfs a fixed return
from bonds, hence in reality eliminating bonds as
a viable competitor to stocks, which explains why
pension funds will gradually swing their
portfolios from bonds to stocks and opt for
overweight in companies having gained a firm
foothold in Asia.
It is actually quite
rational for stock markets to go up even in the
shadow of a short-term economic slowdown and a
growth trend falling to 2.5% for the US, because
the market has concluded that this is not where
growth is going to take place anyway.
As
long as growth prospects for Asia remain bullish,
there is no reason to expect falling stock prices
on Wall Street for those companies acting as
global players.
There are three key
observations to learn from this analysis:
To realize that an increasing number of
American companies are only American by name and
legal status but in reality global companies
having chosen for historical and other reasons to
maintain their headquarters in the US.
To understand that pension funds are buying
stocks expected to produce high earnings in the
future, giving the pension funds the money they
need to honor claims. Pension funds cannot live
with a fixed income from bonds. They need to opt
for a share of future production, and the answer
is to buy growth stocks.
To look at future stock prices not on the
basis of an X-ray picture telling how the
situation is right now but a flow - dynamic -
analysis telling which markets will be decisive in
the future.
Note 1. The
Economist, October 26, 2006.
Joergen
Oerstroem Moeller is visiting senior research
fellow, Institute of Southeast Asian Studies,
Singapore, and adjunct professor, Copenhagen
Business School.
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