European Flu Threatens Asia

By ASSIF SHAMEEN | MORE ARTICLES BY AUTHOR

Nervous investors have driven local property stocks down as much as 40% even though real-estate prices have fallen just 5%. Economically, the region is in much better shape than the U.S. or Europe.

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Jonathan Garner, strategist for Morgan Stanley in Hong Kong, has tracked Asian markets since 1993, experiencing both the lows of 1997 and the highs of 2007. But even he was surprised at the sharp decline on Friday morning as Asia got whacked by problems that arrived from Europe and the U.S. At one point the Korean bourse was down 6% and Thailand 5%. China was getting hit, too. Garner notes that the country's so-called H-shares, which are traded in Hong Kong, briefly were changing hands at just six times next year's estimated earnings.

Asian markets regained their bearings as news spread about a new Group of 20 initiative to aid Europe, but it was still a devastating day. Seoul plunged 5.73%, or 103.11 points, to 1,697.44,; Hong Kong gave up 1.32%, or 236.70 points, to end at 17,675.25; Taiwan fell 3.55%, or 259.28 points, to 7.046.22, and Shanghai lost 0.41%, or 9.90 points, to finish at 2,433.16. The resources-heavy Australian market closed down 1.56%, or 61.7 points, at 3,903.2.; Bangkok ended 3.27% lower at 958.16 and Malaysia was down 1.58% to 1,365.94.

While cautious about the economic ramifications, most strategists agree with Garner that "the sell-down in Asia is clearly overdone." The shares, after all, fell harder than those in Europe or the U.S., which is where all the trouble started.

"The fact that Asian markets have performed worse than U.S. and Europe when the real problem is there, not here, seems a little unfair," says Markus Rosgen, Asia strategist for Citigroup in Hong Kong. But Rosgen says the reaction is understandable as Asia has been a huge beneficiary of fund flows from the U.S. and Europe over the past few years. "When you have uncertainties at home you want to have your capital closer to you," he says. "It may be illogical to be bringing capital back from attractive Asian markets, but it's a natural reaction."

The mayhem in global markets also undercut Asian currencies against the U.S. dollar. "Investors have taken the view that Asian currencies had appreciated a lot and that they might be better off taking their money out," says Rosgen. As funds flow out of the region, Asian currencies depreciate. It's a vicious circle.

But it seems to have gone too far. "The sell-off is already pricing in a severe downturn in the region," says Rob Subbaraman, chief Asia economist for Nomura Securities. "Sure, we are likely to see economies in Asia weaken over the next few months but not as much as what's reflected in the markets, which is that Asian recessions will be more severe than what we might see in the U.S. and Europe."

Asia's fundamentals are sound and the region is in far better shape than it was in the 2008 financial crisis, notes Subbaraman. "Asia does not have weak financial sectors like the U.S. and Europe, nor do Asian governments have as much debt," he says.

Moreover, "Asian policy makers have room to cut interest rates drastically, [and] they have a lot of fiscal fire power to undertake massive fiscal stimulus," he notes. Those tools aren't available in either the U.S. or Europe.

Yet Asia is also home to some of the most open economies in the world—like Hong Kong and Singapore—and the region is still dependent on exports to U.S. and Europe. "The bad news is that Asia hasn't decoupled from the developed economies and could be hit hard if things get rough there," says Subbaraman. "The good news is that the more market turmoil we see, the bigger the chance that we will see a strong, decisive policy response in Asia, and that only positions the region better over the long run."

The latest plunge should reinforce Asian markets' long-term attractiveness. Citigroup's Rosgen says the benchmark MSCI Asia ex-Japan Index now trades for less than 1.5 times book. At the depth of the 2008 financial crisis, Asian markets were trading at 1.3 times book. From an earnings perspective, MSCI Asia Index on a trailing basis is trading at just 10 times earnings. On a forward basis, Asian stocks are trading at just over 8.5 times next year's earnings—the cheapest they have been a long while. In nearly 30 of the past 35 years,"investors have paid a higher multiple for Asian equities than they are doing today," he says.

Morgan Stanley's Garner is betting that Asia's fundamentals will eventually shine through. "The only time Asian markets have sold at such low valuations ever was between September and November 2008," he says. "We are now lower than we were at any point during the Asian financial crisis in 1997-98 or in the aftermath of the tech bubble in 2001-2002," he notes. Morgan Stanley is forecasting earnings in Asia to grow 11% next year.

STILL, IT COULD GET WORSE in Asia before it gets better. Rosgen concedes that Asian markets could bear the brunt of the last leg of the global sell-down and capitulation. "We might see more days like this," Rosgen told Barron's after the Asian markets closed on Friday.

What will change sentiment in Asia? "We need a catalyst and that might be monetary and policy easing," says Garner. Brazil, Russia and Turkey have already moved in the past week, and the next move is likely to come from China. In 2008, China began to cut rates and reserve requirements for banks the day after Lehman Brothers went bust. If things get worse, China will move as decisively as it did in 2008 and that will trigger similar moves across the region, he says. "There is nothing that I have seen or heard in the past few weeks that has changed our bullish view on China," adds Garner.

The Morgan Stanley veteran believes valuations in Asia are now so low that investors need to position themselves in sectors that have been unduly and harshly beaten up—like energy, materials and financials. The more the Asian markets are hammered, the sharper the rally when it finally comes. "Investors need to have faith in the secular bull market in Asia that has delivered nearly 250% total returns in excess of developed markets over the past decade," he says. Rosgen adds that the markets that have taken the biggest hits in recent days—Korea, Hong Kong, Singapore—are the ones that would rebound fastest.

Whacked Harder

Though far from U.S. and European woes, Asian stocks got hit by them.

ASSIF SHAMEEN covers Asian markets from Singapore