Finding something to crow about

FINANCE & ECONOMICS

Asian equities

Feb 17th 2005 HONG KONG
From The Economist print edition

Usually, investors look to Asia for growth. Time to think of income

FOR investors in Asian shares, the stars have been aligned auspiciously in the past two years. Traditionally regarded as a play on world economic growth, the region's equities have benefited from strong global expansion, rapid corporate restructuring after the technology bubble and, latterly, recovery from the SARS outbreak. As profits have soared, so have stockmarkets. The MSCI Asia (ex-Japan) index rose by over 40% in 2003 and by 14% last year.

February 11th, however, was the first day of the year of the rooster—a bird that can jump but not fly, as CLSA, a Hong Kong broker, notes. Stockmarket forecasts have lost altitude, not without reason. With global growth softening and interest rates rising, notably in America, investors' appetite for risk may at last be fading. Asian exporters face slower growth abroad, high raw-material prices, growing competition from China and diminishing returns from cost cutting. “Asia is the manufacturing centre of the world and manufacturers enjoy almost no pricing power at all,” says Eddie Wong, chief Asian equity strategist at ABN Amro, a Dutch bank.

According to Markus Rösgen, Citigroup's regional head of strategy research, this means that Asian companies' earnings will grow by less than 3% this year, after 45% in 2004. Expecting weaker profits at technology companies in particular, he would not be surprised if earnings fell by 10-15%. He is not the only pessimist. Institutional funds have already grown warier. A survey by Merrill Lynch of regional money managers, published on February 15th, found that the percentage who think the case for owning Asian equities is strengthening fell from 39% in December to 33% in January and 29% in February.

In such an environment, what might coax investors into parting with their money? Malaysia might: a revaluation of the ringgit, which some think possible, would boost the foreign-currency value of domestic assets. In Indonesia, there are high hopes that the new president, Susilo Bambang Yudhoyono, will crack down on corruption and encourage foreign direct investment. The Thai stockmarket, last year's laggard, should benefit from the overwhelming re-election of free-spending, business-friendly Thaksin Shinawatra. By contrast, China may be best avoided while it struggles to control its runaway growth; Taiwan is too exposed to a faltering technology industry; and South Korea remains mired in credit-card debt.

For industries rather than countries, manufacturers, particularly exporters, are likely to stay squeezed between slowing revenues and rising costs. Energy and mining stocks are exposed to China's appetite for commodities, which may slow as the economy cools. For technology firms, the overproduction of semiconductors, flat screens and computers does not bode well. However, industries focused on domestic consumers, such as banks, utilities, telecoms and retailers should fare better. And Asian shares still look cheap: using prospective 2005 earnings, CSFB's Stewart Paterson puts their price-earnings ratio at 12, against a consensus of 16 for Japan and America and 15 for Europe.

Although Asia may not offer investors supercharged earnings growth, it can certainly provide income. Since the 1997-98 financial crisis, companies have slashed debt and cut reckless overinvestment. Average gearing has fallen sharply, to a 25-year low, notes Mr Rösgen, while the ratio of capital spending to sales has fallen by half, to 8%. Nor are managers blowing the cash on mergers, on which only $10 billion was spent last year. Instead, they are paying it to shareholders. CLSA calculates that dividends grew by 25% a year between 1998 and 2004 (see chart). Indeed, Asian equities now boast a higher yield, 3.3%, than European shares (3.2%) or American ones (2.1%). “This is further proof of the transformation of Asian attitudes to shareholders. Asia is a lot less risky than it used to be,” says Percival Stanion, head of asset allocation at Baring Asset Management in London.

Tighter capital discipline should make Asia a safer, more stable place for investors and, in the short run, a more rewarding one. In the longer run, Asia ought to regain some of its appetite for risk. Its growth prospects, after all, are still remarkable—even if the rooster stays earthbound.

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