Market falls provide reality check for Asia Pacific equities

Following the sharp declines in Asian equities of the past days, Aberdeen believes any further share price corrections would be good for the financial health of the region and create opportunities for investors.

The recent market falls were a continuation of a trend that began during the last quarter of 2007. For most of the year, investors injected huge amounts of capital into Asian stockmarkets, despite rising raw material prices and concerns over the trickle-down effect of the sub-prime crisis. As investors sought to take advantage of the region’s strong economic fundamentals and long-term potential, money was channelled indiscriminately into both good and poor quality companies. Cyclical and heavy industrial sectors benefited as investors pinned their hopes on global – and in particular, Chinese - demand for commodities and energy. The phenomenal and speculative rise in share prices was, of course, unsustainable, and valuations became overly stretched. The global credit crunch finally sparked a significant sell-off of previous high flyers, notably cyclicals and Chinese financials, during the fourth quarter of 2007, albeit the MSCI Asia Pacific ex Japan index still returned 37% for the year.

Given an uneasy global market environment, 2008 is likely to be a much tougher year for Asian equities and investors need to be alert to the following risks:

the increasing possibility of a US recession. Although domestic-fuelled growth is an

emerging long-term theme in Asia, the region has not decoupled from developed markets.

Consequently Asia’s export-related companies may be impacted by a slowdown in the US.

despite recent share price falls, unsustainable disparities remain in valuations both between and within markets. In particular, Chinese stocks and many cyclicals are still factoring in ‘blue sky’.

inflation ticking up almost everywhere which may lead to policy responses that do not turn out to be the right ones. Rising costs are also impacting companies.

Although investors should be cautious, Asian economies remain fundamentally sound. Economic growth expectations look similar to this time last year, allowing for the weaker external environment. Real interest rates are still low and while the region has supplied liquidity to the rest of the world, there is ample scope for more of it to be directed at domestic assets. Meanwhile, the recent market volatility has created buying opportunities. Although previously high-flying poor quality companies have typically fallen furthest, the share prices of many well-run companies with strong business models have also fallen and are trading at attractive levels.

Aberdeen’s portfolio positioning continues to reflect where its Asian Equities team finds well-run, attractively valued companies. For example, Singapore has been a major overweight for some time.

Although its market was a relative laggard in 2007, fundamentally Singapore remains one of the strongest and best-managed economies in the region, offering high quality, efficient companies that operate internationally. Thanks to its wealth of well-managed companies with attractive growth prospects and its robust domestic economy, India is another key overweight. On the other hand, despite its impressive economic growth, we have been underweight mainland China for some time, because quality companies managed for shareholders are still thin on the ground (we still prefer to access Chinese growth via Hong Kong-listed stocks).

Hugh Young, Managing Director of Aberdeen Asset Management Asia Limited, comments: “Recent share price falls in Asia are not surprising given how hot and speculative some markets and sectors got last year despite the challenging global environment. Housing and credit market problems, record oil prices and rising inflation make the US economy increasingly fragile. We expect the nervousness that has been building in markets for the past couple of months to continue, with investors in Asia watching for signs of an export slowdown.”

“Although our focus on quality and value was not rewarded in 2007, we see the strong fundamentals of our portfolio holdings as advantageous over the long-term. While some sectors and markets now look vulnerable to further corrections, others still offer decent value to high conviction stock-pickers such as Aberdeen. We will continue to take advantage of any share price weakness to invest in quality companies at attractive prices.”