The croynism at the heart of Asia's crisis
The Jonathan Davis column
Saturday 17 January 1998
My crystal ball is certainly no better than anyone else's, but what is clear is that there are two distinct sides to what is happening. One is the developing economic and financial crisis in a number of Asian countries, all of whom trade with each other and therefore are vulnerable to contagion from each other's problems.
At the root of the problem is the apparent indication that the so-called Asian miracle is running out of steam. The rapid growth of the past 20 years is slowing down, with many of the tiger economies which led the way now showing signs of losing their competitive edge. The Japanese economy has been stalled for several years now, with its Government unable to find effective measures to restimulate growth, but what is new is that the second tier of Asian countries, such as Korea and Indonesia, are also now feeling the heat, with their currencies weakening and their industries afflicted by over capacity and rapidly disappearing demand.
This in turn has been compounded by a serious banking crisis of the kind that traditionally follows periods of rapid growth, with many banks and banking institutions which lent freely in the years of fat, finding themselves over exposed. This financial crisis has exposed many of the fault lines in the way that these countries have managed their financial affairs - too much cronyism, too many complex interparty loans, a collapse in collateral values, and so on (not that this is a problem from which western banks have been immune in the past!).
After years of effective state control, the Japanese have finally allowed a leading bank and a large stockbroking firm to go bust, but there are many more financial institutions which are technically insolvent. With no inflation to erode the value of their bad debts, it seems clear that it is going to take quite a long time for the bad debts and financial problems in many of the leading Asian cou ntries to be worked out of the system. The second aspect of the crisis is the reaction of the financial markets to this unfolding story of newly apparent economic problems. As always tends to happen in such circumstances, sentiment towards Asia as a focus of investment is rapidly turningsour . The wild exuberance which led many stockbroking firms to carry on peddling the merits of the Tokyo stock market when it was absurdly overvalued in the late 1980s is being replaced by unmistakable signs of anxiety in many markets. Typically, Hong Kong, the most volatile of all the world's leading stock markets, is taking a lead again (was it only a year ago that the market was booming?), but institutional investors in Europe and the United States, who were merrily still buying int o both the Asian and emerging markets story a year ago, have also started to take fright at the way the crisis is developing, retreating to "safer" havens. The stock market statistics tell their own story. Of the 15 largest developed country markets last year, only one went down last year - and that was Japan (which fell 21 per cent and is currently stuck in a trading range around the 14,000-15,000 level). All the other 14 markets rose. Of the 11 leading stock markets in Asia, only three - China, India and Taiwan - rose in local currency terms. Most of the others were down, by anything between 20 per cent and 60 per cent over the year. Not surprisingly, vi rtually all UK unit and investment trusts invested in Asia, either as country or regional funds, have taken a pasting over the past year. The latest performance statistics paint a sorry picture. In the year to mid-December, for example, the average Japan-only unit trust was down by 28 per cent over one year, 39 per cent over three years and 3 per cent over seven years. The average FarEast fund (excluding Japan) is still comfortably ahead over seven years (plus 60 per cent), but down 31 per cent over both one and three years. Because of widening discounts, equivalent investment trusts have turned in an even worse performance. As theseare average results, some of the individual fund outcomes are inevitably worse still - pity the poor investor who opted to buy a Thailand unit trust three years ago. It has lost nearly 80 per cent of its value over the period. But what now? There is no question that the crisis, in both economics and sentiment, is a real one. Conventional wisdom now is: avoid the region like the plague. It is too risky. But, of course, for many Asian countries the advice is far too late. The ri sk has been there from the beginning in many Asian countries: it is the flip side of the above average returns which the region has generated for most of the 1990s. The case for buying individual country funds outside Europe or the United States hasalwa ys seemed weak to me, given the specific risks involved in many individual emerging markets. Regional funds are not much better, in my view, unless you really think you are capable of distinguishing which region is going to do better than another. As I said last month, however, the case for putting a modest amount of money into a diversified emerging markets investment trust at a discount of 20 per cent is another matter. Provided you are a genuinely long term investor, the value looks attractive to me. It is, after all, when things are at their gloomiest that the best bargains become available. It will undoubtedly spill over and affect our own stock markets in due course, though how badly is impossible to say. The other lesson to remember is that just because markets keep going up, it does not mean they cannot be overvalued at the same time. Ju st look back to what they were saying about how attractive Japanese shares still looked in 1988/89 on a p/e ratio of 60! Even in markets, where hopes are free and plentiful, reality has a nasty habit of catching up in the end.
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