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Investors Peer Past Gloom, Eye Asian Economic Rebound

Reuters
Monday, 13 Feb 2012 | 11:28 PM ET

If the World Bank is correct, 2012 will see the second slowest year of global economic growth in a decade, at a level consistent with a world recession that, like the 2008/2009 financial crisis, would not spare Asia.

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Its sister organization, the International Monetary Fund , warns that economic expansion in China could be slashed in half this year if Europe's debt debacle worsens — grim news given that China adds more to global growth than any other economy.

And around 600 of the world's best private sector economists polled by Reuters say global growth momentum is disappearing, along with their more robust estimates for Asian expansion.

So why have investors bought emerging Asian equities so enthusiastically that stocks outside of Japan have just had their strongest January showing since 2001 to enjoy one of the 10 most profitable monthly returns in a decade?

"In summary, much of Asia is in a sweet spot right now," Robert Prior-Wandesforde, director of non-Japan Asia economics at Credit Suisse in Singapore, told Reuters.

"Survey data clearly indicate that the world trade cycle is taking a turn for the better which is likely to show through in better Asian export and industrial data shortly," he said.

"History suggests that an improving growth and inflation mix is strongly associated with a better market performance. This is exactly what is happening right now," Prior-Wandesforde added.

Sweet spot or not, given the external headwinds emanating from deficient demand in the debt-ridden European Union and still under-spending consumers in the United States, investors certainly appear to believe in Asia's rebounding economic cycle.

Basic materials, energy and industrials were January's top performing sectors — all gaining close to 15 percent according to Thomson Reuters Asia Pacific ex-Japan sector indexes — and continue to be the best bets so far in February.

They've even been joined by technology stocks, one of the most cyclically-sensitive sectors in Asia.

Defensive non-cyclicals and utilities are the two worst performing of the 10 sectors covered by the indexes.

Asia's equity rally doubtless has a valuation driver at work too, especially after 2011's 18 percent fall.

But two thirds of that has been recovered in just seven weeks and foreign buying of Asian stocks in six markets tracked by Nomura has totaled $15.4 billion year to date — more than reversing the $14.1 billion of stock foreigners sold in 2011.

Reversing Risk Aversion

Analysts at UBS say investors were so risk averse by the end of 2011 that valuations on global emerging market stocks had been lower just 7 percent of the time in the last 20 years.

Sean Darby, Hong Kong-based chief global equity strategist at brokerage Jefferies, cautions about reading too much into the rebound given that scale of risk aversion.

"Market positioning was weak in Asia and emerging markets. The bounce was largely funds taking the weighting back to neutral at best," Darby said.

Much depends on whether Asia's economy is at the start of a cycle or the end of one, Darby said, pointing out that the best performance historically is delivered at the very beginning of cycles and not the end.

Credit conditions for many corporates remain tight given historically high loan-to-deposit ratios at commercial banks.

On the upside, a widely-anticipated fall in commodity and input prices adds further impetus to Asia's vast manufacturing sector and, by extension, to corporate profit margins.

It also reinforces the downward drift of consumer prices.

Analysts at Bank of America/Merrill Lynch forecast that 150 basis points will melt away from emerging Asian inflation this year versus last, leaving more leeway for Asian central banks to ease monetary policy to cushion a slowdown in economic activity.

Inflation eased in South Korea, Thailand and Indonesia in January from year ago levels and the cycle has peaked in China, while the central banks in Bangkok, Jakarta and Manila have all cut interest rates at least once in the last three months while policy in Beijing has had a pro-growth bias since the autumn.

PMI Pulse Picks Up

At the same time there has been a noticeable quickening in the pulse of purchasing manager surveys — the most consistent real time indicators of what is happening in the real economy.

China's PMI makes particularly interesting reading in this context given its close correlation with the U.S. S&P 500 stock index, the global barometer of real world corporate strength.

The S&P 500 began a bounce from 12-month lows at the start of October and has gained about 22 percent since. The China PMI new orders index began to turn upwards two months later, according to analysis from New York-based investment consultancy, MES Advisers.

As equity price moves typically discount the future two quarters ahead, the implication is that a healthy run-up in new orders and output is in store from factories in the world's second biggest economy.

An intriguing link with the S&P 500 is made by analysts at ING who point out that since the global financial crisis of 2008/09, the performance of that benchmark stock index — and not economic fundamentals — has been the main determinant of emerging market investment returns.

Michael Kurtz, chief Asia equity strategist at Nomura in Hong Kong, believes investors are just getting into their stride. His latest note to clients tells them to anticipate a further inflow of cash as fund managers upgrade exposure to Asian economic and corporate prospects.

"With surprisingly little fanfare, Asia Pacific dollar earnings revisions have turned the corner back to upgrades recently," Kurtz told Reuters.

"The gathering U.S. recovery and China's resilient PMI are making Asia's latest export data feel decidedly backward-looking," he said.

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