International | Aug 14 2008
By Greg Peel
China’s stock market, and the bulk of Asian stock markets (except India, Thailand and the Philippines), have performed rather badly in 2008. It has only been more recently that the writing has appeared on the wall for the Chinese and other Asian economies – slowdown-wise – but throughout 2008 Asian producers have suffered from rampant commodity price inflation, undermining margins.
Commodity prices have now come off sharply, on the basis of the aforementioned slowdown, so shouldn’t it follow that Asian stock markets can now turn back to positive? After all, China’s export economy is now much diminished compared to the growth in its domestic economy, so the impact of a slowdown in the US, Europe and Japan should not be as influential as it would have been 2-3 years ago, while the impact of cheaper raw materials and energy costs should be a fillip on the domestic front.
But looking at the numbers – Shanghai down 14% this month, Korea 5%, Singapore 7% etc – clearly commodity price falls are not helping at all. On the other hand, the MSCI world index is up 2% for the month, driven along by falling oil. What gives?
The analysts at GaveKal offer some answers.
Firstly, the bursting of the commodity bubble meant the end of the “momentum” trade. Momentum traders work on the basis that a market “story” will gain momentum as more and more investors start to believe it. Take “oil at US$200/bbl” as an example. To momentum traders it matters not whether this is a fair prediction or otherwise, it matters only that enough people either believe, or believe they’d better believe it in case it’s true. Hence momentum traders jump on for the ride – be it short or long – and hope they can get off before the momentum runs out and Newton’s Third Law comes into play.
Oil never made it US$200/bbl, so when the momentum ran out, it was a mad scramble to get out of momentum trades. Hence oil is now US$30 lower, and all other commodities have been taken to the cleaners as well.
But the strong commodity story was predicated by a strong emerging market story – commodity prices rose because of the China effect. So if you’re trading commodities on momentum, then you should be trading emerging markets on that same momentum. That is, long commodity players have also been long China, et al. So as commodities are being sold off in a hurry, so too are the share markets in Asia and elsewhere (Australia is a good example, being a Chinese coat-tail rider).
Secondly, GaveKal notes that of the biggest 100 listed companies in Asia, 86 are either financial or commodity related. These are sectors in which the 2008 global story has played out (again, witness Australia: are there any other sectors?), and where movements have been crushingly volatile. Battered and beaten, investors have decided Asia is just “too hard”.
Thirdly, it’s just a matter of valuations. Asian markets soared even as the credit crunch was hurting in developed markets, and Asian currencies also flew as the US dollar dived. Asian stocks just became too expensive on a currency-adjusted PE basis.
But a more interesting reason might be one of simple relativities, as GaveKal ponders.
The US stock market in particular has been knocked down very hard. Staying away from dodgy financials for the moment, the rest of the market had been hurt by rising inflation and oil in particular. But now that the inflation problem is correcting, US stocks are looking “attractively cheap” – not only relatively, but absolutely as well. The US dollar has bounced, and suddenly, for US investors, it’s a case of “why take the risk on the other side of the globe when opportunities are looking more plentiful at home?”
For most of this century the US dollar has been in decline, and the US economy has been tepid. For most of this century the big growth story has been in Asia. We are only now beginning to see the flipside of the impact of a weak greenback – the export economies of Europe and Japan are tipping into recession. Yet as the second quarter earnings season in the US has shown, and the first quarter before it, the US export economy has begun to boom, driven along by a weaker dollar. And from iPhones to stealth bombers, there is plenty the US manufacturing and intellectual property industries can offer the world.
For most of this century, the US trade deficit had been blowing out as Americans spent with gay abandon on cheap exports from China and elsewhere, all on credit. This was the cause of US dollar weakness long before the credit crunch even began. But this week we learned the US trade gap narrowed by 10% in June, to its lowest level since 2001.
Is America the new emerging market?
It’s an interesting idea, and one that would really put believers in the long term Asian story in the doldrums. However, GaveKal is not waving the Stars & Stripes with patriotic vigour. The analysts note that Asian stock markets are looking oversold, Asian central banks are now in easing mode, and valuations are becoming attractive once more.
“This might be a good time to start nibbling on Asian assets,” GaveKal offers. “Indeed, this could end up being a tremendous buying opportunity”.
