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Why the Current Rally in Asia Stocks Has No Legs

Monday, 20 Aug 2012 | 1:10 AM ET

The current rally in Asian equities is not as strong as the one seen at the start of the year and could fizzle out real soon, say analysts.

A Chinese investor monitors screens showing stock indexes at a trading house in Shanghai on June 1, 2010.
Philippe Lopez | AFP | Getty Images
A Chinese investor monitors screens showing stock indexes at a trading house in Shanghai on June 1, 2010.

The MSCI Asia ex Japan Index, which rose a whopping 22 per cent over November 25, 2011 to February 29, 2012, when it hit this year's peak, gave up all its gains in the following months up to June 8. But since then it has recovered, posting gains of about eight percent. However, equity strategists are not impressed with this rally.

The current uptick in regional stocks is not grounded in strong fundamentals, they argue. Together with less certainty over monetary stimulus compared with in the first quarter, falling volumes and weak earnings outlook, global economic growth also remains poor.

"The key difference between now and then (first quarter) is one of expectation," Herald van der Linde, Head of Asia-Pacific Equity Strategy at HSBC in Hong Kong said in a report last week. "The LTRO (long-term refinancing operations) facility was unexpected in the first quarter. In the third-quarter rally, it is more about the anticipation of monetary stimuli in the West...In addition, the global growth backdrop is quite different now versus in the first quarter."

The two rounds of LTRO by the European Central Bank (ECB) in December last year and February this year lent European banks about one trillion euros ($1.23 trillion) at an interest of 1 percent and helped calm jittery markets.

But this time around, despite ECB President Mario Draghi hinting at more bond-buying and the expectation that the U.S. Federal Reserve would join in for a globally coordinated measure to boost growth, there has been no further easing measures from the two major central banks. China too is expected to embark on fiscal and monetary stimulus after the two interest-rate cuts in June and July, but the markets are still waiting.

Low Volumes, Lower Earnings

At the same time, trading volumes are a fraction of what they were in the first quarter, when most of the inflows in to stocks were from institutional investors, said Mark Konyn, Chief Executive Officer of Cathay Conning Asset Management.

For example, the average daily volume in Hong Kong equities in June and July was about HK$44 billion ($5.7 billion), compared to HK$63.21 billion in the first three months of the year.

"Key differences between the first and the third quarters relate to volumes," Konyn said, adding that there is very little momentum in the current run in Asian equities. "The market could pull back if markets get ahead of fundamentals."

Plus earnings momentum in the region is "low" at the moment and just can't support the current rally, according to HSBC's Van der Linde.

"In February analysts were upgrading their numbers (earnings forecasts)," he said. "This time, it's different. Indeed, there are signs that earnings momentum is falling across the region."

Big companies in Asia are reporting weaker earnings as demand from air travel to white goods fall across the region. China's biggest home appliance retailer Suning Appliance said at the end of July that first-half profit fell 30 percent from a year earlier and telecoms equipment maker ZTE reported that earnings plunged nearly 48 percent in the June quarter. Also, Hong Kong's flagship carrier Cathay Pacific reported its first net loss for the first six months of the year since 2003.

"Asia ex-Japan earnings' outlook is not rosy. Consensus (earnings per share) forecast for both this year and the next are about 6.3 percent lower from estimates made at end 2011," said Tham Mun Hon, Regional Strategist at Maybank Kim Eng Securities in Hong Kong.

While Tham said there might be further upside from here and Asian stocks could even revisit 2012 highs, it will be accompanied with a lot of volatility as investors will keep taking short-term profits.

"This is still not a time for a buy and hold strategy," Tham said. "EU problems will not be resolved for a long time to come and the U.S. is not gaining strength at a pace that makes investors comfortable."

- By CNBC's Jean Chua.