Asia may be key to global revival
The global economy enters 2009 in an unusually fragile state. The first half of last year proved difficult enough, but after the collapse of Lehman Brothers in September 2008, the going got considerably tougher. It became clear that many of the world's major economies were heading for recession. But how deep and protracted would this be? We have consistently argued against the likelihood of a prolonged depression, but still think global growth will slow sharply. At a forecast one per cent in 2009, global growth will be at its lowest levels since the second world war. In this time of crisis, the focus has largely been on the Western developed economies. But you need to look the other way too, at Asia.
Over the past few months, a steady stream of poor economic data has emerged from Asia, as an increasingly hard-hit western consumer has progressively hurt Asian exports. This has put paid to the hypothesis that Asian economies would in some way be able to 'decouple' from the global trend.
During the course of 2009, however, we are instead likely to be asking how closely Asia will be able to 'recouple' itself to the recovery in global growth. We think recovery in the global economy will emerge in the second half of the year. This is likely to be true in Asia as well. For an investor, signs of the beginning of the end of the recession are likely the key to a turnaround in risky assets.
The extent to which Asian economies have been damaged by the collapse in global demand has varied considerably across the region. On one hand, growth has taken a considerable knock in very small and open economies like Singapore and Hong Kong. A growth recovery in these countries is highly dependent on a recovery in global demand (electronics account for a sizeable proportion of exports in Singapore and Taiwan, and Hong Kong's fortunes depend considerably on how export-driven businesses in the mainland's Pearl River Delta are faring). On the other hand, larger economies like China and India, where external trade represents a much smaller share of GDP, have seen growth slow rather than collapse, with reasonably large domestic markets providing some cushion.
But in 2009 it may become important to make distinctions within the region on a number of other fundamental factors. First, consider countries' fiscal positions. Authorities in the region have already been quick to provide fiscal support packages to counter the slowdown, both on a stand-alone basis and via expanded budgets, and we are likely to see more as we go into the annual budget season.
Not surprisingly, there is a fairly high correlation between a country's financial room for manoeuvre (as measured by its fiscal balance) and the size of its spending stimulus. At one extreme, China's substantial stimulus spending package (with a value of $586 billion) should begin to have a visible impact on growth within the year. At the other extreme, Malaysia and India stand out as having the weakest fiscal balances in the region (with public deficits of -4.8 per cent and -7.5 per cent of GDP, respectively, in 2008). This will limit their ability to provide large fiscal stimulus packages. For investors differentiating on the basis of the expected near-term growth outlook, this distinction may end up being significant.
Differences in fundamentals become most important for investors focusing on Asian currencies. Over a longer time horizon, fundamentals like current account balances, foreign debt and its maturity pattern, and the reserves-to-debt ratio are key determinants of currency performance.
The deflation debate is unlikely to pass Asia by. A number of Asian countries are likely to see headline inflation dip below zero. But, as for the rest of the world, we believe that a few months of negative headline inflation are unlikely to lead to a sustained period of deflation. In fact, some countries have already been down this road: Taiwan experienced a period of negative headline inflation for most of 2001-03, and may now be in for another, albeit shorter, round. Rather, low inflation could open the door to an even sharper policy response – both, as discussed above, on the fiscal side, and on the monetary policy side. Countries like Taiwan and South Korea have cut rates more sharply and more quickly than expected. We believe this is likely to be a continued theme for the early part of 2009 as policymakers cut rates by more than markets are pricing in.
Expectations of economic revival will encourage investors to add risk as 2009 progresses. This is the correct response, but judging quite when and how to do this remains difficult. A good first step is perhaps to identify the areas where 'gloom and doom' has been overdone. Investment-grade credit is an obvious contender, with spreads now similar to those in the 1997 crisis. But quality remains all important here, with rising defaults the biggest risk.
Asian equity valuations may also appear attractive, although any recovery here has so far proved elusive. As we discuss, it is important to consider momentum indicators as well as valuation in your analysis. Combining the two suggests that it is sensible to remain defensive on Asian equities for now, but to add risk during 2009, with a move towards more cyclical sectors such as industrials, materials and financials. We still think it makes sense to approach Asian equities as a leveraged play on world equity performance.
The road ahead will be rocky, with further upsets certain. But we also see some real opportunities.
The author is the MD and Head of Research & Investment Strategy at Barclays Wealth
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