New Analysis - Asian Decoupling From Wall St Not A Sure Thing

Source : The Straits Times, Nov 12, 2007

More wild swings in regional share prices likely until US credit woes subside

IN RECENT months, as regional bourses hit record-high levels, it has become popular to bandy around the theory that Asian economies have successfully decoupled from the United States.

But like financial markets all over the world, Asian bourses took a severe beating last week as credit woes deepened in the US.

Yet, despite the battering, market sentiment is still undeniably bullish across the region.

Bullish or bearish?

WHILE fear stalked Wall Street and European markets, investors in Asia were celebrating the Shanghai listing of PetroChina, which became the first company on the planet to hit a market value of over US$1 trillion (S$1.44 trillion).

Across the border, China's decision to delay an initiative to allow its citizens to buy Hong Kong shares directly failed to dampen sentiment as traders cheered e-commerce provider Alibaba.com's listing. The counter nearly tripled in price on its debut.

Still, the picture across the region may not be as rosy as what some have been painting.

In the space of one month, Japan's Nikkei 225 Average has fallen 11 per cent, while China's Shanghai Composite Index is down 13 per cent.

And while the benchmark Straits Times Index (STI) in Singapore has dropped only 7.3 per cent, the fall was painful enough to make investors sit up and notice.

Even mighty Hong Kong, which had attracted billions following China's recent moves to liberalise the flow of investment funds overseas, was not spared. Its Hang Seng Index has lost 9.1 per cent in a fortnight.

Broadly speaking, major markets like Tokyo and Shanghai are already experiencing a correction - a term used to describe market conditions when bourses fall 10 per cent or more.

But market experts have, so far, been remarkably sanguine about the losses sustained by regional bourses.

They argue that Asian markets have risen so much this year that a 2 per cent or 3 per cent correction in a day would be normal. And the case for investing in Asian equities has never been stronger.

Some argue that Asian economies are growing strongly and the accompanying surge in intra-regional trades will more than offset any slowdown in the US, as the mortgage slump there deepens.

And cheap money, fuelled by the US Federal Reserve's interest rate cuts, will keep interest in Asian equities on the boil.

As Asian central banks are determined to keep their currencies down against the weakening greenback, this will attract savers to switch out of low-yielding fixed deposits and into equities, as inflation gallops ahead of interest rates.

But these arguments are beginning to look wobbly.

A part or apart?

STUDIES have shown that Asian and US stock markets are more correlated now than they have been in the past 30 years.

And much of the intra-regional trade is just processing. Asian manufacturers still rely on the giant US market to buy the bulk of their finished goods - so any slowdown in the US economy is still likely to hurt Asian economies badly.

In other words, a decoupling of Asia from Wall Street may simply not be on the cards yet.

Also, believing that credit woes will be confined to Western banks may be naive.

A bear market among global financial institutions will cast a pall over the rest of the global economy.

One good case in point was last week's plunge in US technology stocks - regarded until now as a safe haven - as investors were spooked by concerns that banks may pare their technology budgets to conserve capital.

It is now clear that the two interest rate cuts by the Fed have failed to salvage the crisis-hit credit markets that needed the bailout badly.

Even AAA-rated mortgage- backed bonds are being sold down at a fraction of their issue prices, and this has forced banks like Citigroup and Merrill Lynch to write down billions on their portfolios.

Instead, the Fed moves coincided with a spike in oil prices - which fuelled inflation fears - and a rapid fall in the greenback. Last week, for instance, the greenback fell to 110.79 yen, its lowest level against the Japanese currency since June last year.

For Asian markets, this is stirring fears of an unwinding of the yen carry trade - where traders and speculators have taken out massive loans in yen because of Japan's low interest rates to buy higher-yielding assets such as shares in emerging stock markets.

So after a bountiful autumn, during which strong performances by the STI and the Hang Seng attracted fickle foreign capital by the billions, a winter of discontent may be about to descend upon Asian stock markets.

Until the Western banks sort out the sub-prime mess in the US and re-capitalise their balance sheets, investors must be prepared for more wild swings in share prices.