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Monday, March 03, 2003

Asian Stock Markets in Review

That Japans economic problems have produced a generalised collapse in the stock market there, with values tied down back at early 1980s levels, is common knowledge. What few seem to be prepared to think through are the long term consequences of a continuation of this state of affairs. The vote for a traditionalist at the top of the BoJ means that the dripfeed deflation is set to continue into an indefinite future. This reality is also reflected in the level of long term interest rates, with a yield curve which is now virtually flat over ten years, and aspiring towards the horizontal even up to 30. So as one economy shrinks slowly into the sunset, others continue to grow. With time relative valuations will change significantly. Of course what is happening now in S Korea and Taiwan is comparatively small beer compared to what could happen if and when China's financial architecture comes of age.

Tokyo, traditionally the home to Asia's biggest and most profitable companies, has long been the starting point for most investors looking at the region. But now, the biggest, most heavily traded companies in Asia are often found outside of Japan. In electronics, Sony Corp. lost its top spot in the sector, in U.S. dollar market-capitalization terms, to Samsung Electronics of South Korea late last year, according to Thomson Datastream. Japan's biggest microchip maker, NEC, has trailed Taiwan Semiconductor Manufacturing Co. since mid-2000. In the property sector, Mitsubishi Estate fell behind Hong Kong companies Cheung Kong Holdings and Sun Hung Kai in the early 1990s.

Japan is still the world's second-largest economy behind the U.S., and its stock market is still bigger than the rest of the region's combined. But as the country seems ever less likely to throw off its economic malaise -- the latest disappointment was last week's appointment of a new central banker unlikely to make the radical changes Japan needs -- investors are speaking out. In a January report that sent Tokyo financial circles abuzz, Nikko Salomon Smith Barney strategist Alexander Kinmont put forth the view that "Japan is of no general importance except as a laboratory experiment concerning deflation." As Asia's and Japan's valuations draw closer together, he wrote, the region would increasingly be thought of as one block. Partly, it is a story of Japan's weak economy, and debt-laden corporations involved in too many disparate businesses. But just as important, a few companies elsewhere in Asia -- despite setbacks including a weak global economy and falling stock markets -- are gaining market share and building up bigger brands than their Japanese counterparts. Eventually, logic dictates, they will attract more investment dollars, and smaller companies will follow in their footsteps.

Many of these big companies beat out their Japanese counterparts on a number of investing criteria. Samsung, for example, trades at about seven times next year's estimated earnings, according to Thomson, compared with 23 for Sony. Often, Asian companies outside Japan are far more profitable. Samsung recently reported record net profits of 7.05 trillion won ($5.9 billion) for 2002. Its profit amounted to 17% of total revenue, up from 9% in 2001. Sony's net profit for the year ended in March 2002 was $115 million, or just 2% of total revenue. Stocks outside Japan are also frequently easier to trade than their Japanese counterparts. "While Japan's market capitalization looks large relative to the rest of developed Asia, it is an essentially illiquid market," wrote Mr. Kinmont in his report. Because they have some significant advantages such as greater liquidity and profitability, why aren't Asian companies outside Japan trading at higher values? Some reasons are out of their control. One key factor: Global pension-fund and other institutional money, which tends to have a big influence on markets, is generally invested according to guidelines that often restrict the funds to developed markets only. Most of Asia, including South Korea and Taiwan, is considered an emerging market, which rules them out for many big pension funds. If these countries were to win developed-market status from index-setter Morgan Stanley Capital International, which would require meeting standards on factors including the size of the economy and the securities-regulatory environment, it would automatically mean a large influx of funds that would drive up stock prices, money managers say.

Second, while Asia has made progress since the 1997-1998 financial crisis in restructuring its industries and cleaning up its bad debt, it is still tarnished in the eyes of some investors. "I still think there's an overhang," says Ayaz Ebrahim, regional chief investment officer for HSBC Asset Management. "Not all investors have bought back into the program." Third, broad economic factors are creating changes that will make it hard for stocks in certain sectors, whether in Japan or elsewhere, to make further gains for the time being. Take chip stocks, which have started trading more like cyclical stocks, meaning they should see big gains only when the global economy starts turning up. Many analysts say that if that cyclicality holds, most chip foundries deserve lower valuations. Fourth, Japanese stocks are still expensive -- despite a drop of 40% in the Nikkei 225 since the start of 2001 -- because local Japanese investors continue to hold them. Much retail money has left the market along with the Tokyo Stock Exchange's long slide, but banks, finance companies and conglomerates are supporting stock prices through their complex web of cross-shareholding.
Source: WSJ

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