Monday, May 08, 2006

Are We Bubbling Yet?
Are Asian Markets Frothy...

Inflows into Asian markets are accelerating as central banks around the world deploy stimulative monetary policies in the face of growing pressure to let their respective currencies appreciate. Yet all this is happening in an environment where interest rates are also rising. Regional stock indices should continue to rise in the near term, but is it getting to a bubble stage yet?

Well, the inflows are not altogether the same for all markets. Singapore, HK, India and Japan have been having a bigger boost for a much longer period followed by Thailand, Indonesia and Taiwan, while Malaysia has only started to move out of first gear a few months back after Bank Negara finally allowed the ringgit to appreciate. Some fund managers are comparing the latest fund inflow with that of 1993, when investors poured huge amounts of money into Asia. This led to a phenomenal rally in the second half of 1993, followed by a major crash in 1994. That being the case, most rallies in Asia have not yet fully made up the lost territory following the 97/98 financial implosion. So far this year, foreign investors have bought stocks worth more than US$18 billion in the six regional markets of India, Indonesia, Korea, Philippines, Taiwan and Thailand - almost 50 percent of the total inflow seen in 2005. Inflows into these markets in April alone were especially strong, totaling more than US$6 billion.

As in my previous blogs - the investing environment is a bit unique over the last 6 months - there is the hedge funds effect (more funds setting shop in Asia); there is the preference to "small caps rather than large caps movement; there is the rise of huge private equity interest in major Asian countries (albeit a large number of American private equity funds have been particularly active in Japan, Korea, China and India already - what these funds do when they buy a company is that it causes a rerating in valuation in the same subsector); room for Asian currencies to appreciate (following the yuan's trend) thus reducing inflationary fears and improves overall potential gains for equity holders. These factors have translated into retail funds pouring into market momentum, earnings momentum, net fund-flow and directional market turnover.

International fund managers remained net buyers in Hong Kong, which saw a net inflow of US$544 million in March - the fifth positive month in a row. So far this year, US$1.2 billion has entered the local market. These inflows cannot last forever, and in fact should continue for a few months still. While these inflows will inventually lead to over-valuation, at least these funds are not used to finance the Asian liquidity cycle like the last time (in 93-97, cheap foreign funds were funding everything in Asia from buyouts to retail finance which were getting riskier by each passing day). So far, what I am seeing is that it is still mainly the funds controlling the market and not retail forces. There is a bit of quality in most rallies this time as most of Asia is just coming out of the difficult 1997-2003 period. This is not an earnings growth story at all, sure earnings are there and improving but its more of a recognition of undervaluation which is moving the rallies. The currency factor is important also.

Valuation wise, it is not excessive at the moment. Of course if we were to rate the equity markets on stretched valuations, it would look something like this (10 + very ripe for a correction; 8+ valuations are stretched and investors should be exiting; 6+ still some room upside; 4+ just started to come under investors' interest; 2+ undervalued).

India 8
Singapore 6
HK 6
Thailand 5
Indonesia 5
Malaysia 4
Taiwan 7
Japan 6
The Philippines 4
South Korea 6
China 7 #

# Almost every bourse cited looks appealing for the rest of the year with the exception for China (please read blog on China's interest rates for a better appreciation of a dullish year for Chinese stocks).

HK and Singapore seems to be moving in tandem as they have very strong property sectors, and that seems to be funnelling a lot of interest in wealth creation, property sales and REITs projects.

A good way to monitor effective risk levels of equity is to look at bond rates - gauge the risk free rate and sub-par rates, look at the trends, the differentials, and you will get a good idea of capital flows, excessive / healthy risk taking, liquidity in the system - all important factors when assessing market's volatility, inherent risk, and the quality of the rallies.

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