Rough seas ahead, but Asian equity markets outlook remains bright

Jan de Bruijn, Asian equity fund manager at Threadneedle, comments: Rough seas ahead, but Asian outlook remains bright

It is still too early to have a totally clear picture of what the impact of the current credit crunch will be on Asia in macro terms. Though a level of stability has returned to the markets (although the sharp re-bound in itself reflects the increased volatility), no-one is yet clear as to what the actual losses will be, nor who will be left 'holding the baby'. There could also be knock-on effects that would hit Asia, for example the unwinding of the yen carry-trade. The big question therefore is whether we are in the 'calm before the storm' or whether the credit crunch crisis simply plays itself out over the next few months, resulting in continued volatility but under manageable conditions. Under this scenario the Asian markets will have some choppy trading days, but the overall trend remains positive.

Asian exposure to CDOs

A further unknown is the extent of the exposure to the CDO/CLO/sub-prime market of the Asian financial institutions. Though initially claiming no exposure, some institutions have started to admit to 'some' exposure. So if a skeleton or two eventually emerges from the cupboard, sentiment would be hit hard. Our team view is that there is only limited exposure with the exception of financial institutions in Singapore, Taiwan and China, but even here exposure appears to be limited to less than 3 per cent of assets.

Market performance still tightly correlated

What recent market moves have clearly shown is that though Asia may be decoupling from the West in macro terms, it certainly is not in market terms reflecting how mainstream Asia has become in investors' portfolios. Last week's moves also reflected the rising influence of hedge funds and derivatives on market volatilities in Asia - much of the sharp sell down in some stocks was due to hedge funds raising cash to meet potential redemptions, stock being recalled and the unwinding of derivative positions. It was indiscriminate selling, and not based on any objective/fundamental analysis, but more on selling positions that had performed well year to date and were liquid.

Domestic demand remains key support

So where does that leave us? Economically the Asian countries are in a strong position and longer term the markets will continue on an upward trend. But, there is no question that a slowdown in global growth will reduce the contribution of exports to Asian growth. However, as we have been arguing for some time, growth in Asian domestic demand is quickening and most of Asia has the capacity to increase infrastructure and construction spending to counter a global slowdown to a certain extent. Threadneedle’s Asian funds have long had exposure to this theme, and we feel comfortable to continue to maintain our positions in this space. Nevertheless, we are aware that the game may have changed, and that risk premiums have probably risen permanently as markets have belatedly once again recognized the old adage that ‘if something sounds too good to be true then it probably is’ - i.e. if offered an 8 per cent return with a supposedly low risk for a CDO packed product, then think again. As a result we are in the process of reviewing our existing holdings to ensure we are not inadvertently taking on unwanted risk.