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Market Turmoil: Can Asia Ride Out the Storm?

 
 

Asia is suffering the fallout following financial market turmoil triggered by fears of higher U.S. inflation. Can the region ride out the storm?

Fears of a sharper pace to interest rate increases by the U.S. Federal Reserve were triggered by higher than expected wages growth in the world’s biggest economy. The January U.S. payrolls report released February 2 showed wages rising at their fastest pace since mid-2009, up a higher than expected 2.9 percent.

The resulting surge in 10-year U.S. Treasury yields to near a four-year high of around 2.8 percent saw U.S. stocks slump, pushing Wall Street into “correction” territory with stocks down by more than 10 percent over two weeks.

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Despite rebounding Friday, U.S. equities suffered their worst week in two years, with the benchmark S&P 500 index down 5.2 percent, its biggest decline since January 2016.

Asia-Pacific markets did not escape the fallout. As of Friday’s close, Japan’s Nikkei Stock Average was down more than 8 percent from the previous Friday’s close. Both the Chinese and Hong Kong stockmarkets dropped by nearly 10 percent over the week, Australian stocks lost almost 5 percent, and India’s stockmarket slipped by 3 percent.

Commodities also suffered, with gold, metals, and oil all falling. The general retreat from “risk” assets also saw the largest exchange-traded fund tracking emerging market dollar debt post its biggest daily outflow on record.

“When the U.S. market sneezes, Asia and emerging markets get pneumonia,” Bank of America-Merrill Lynch strategists wrote of the losses.

The next test for U.S. financial markets will be American inflation data due February 14, which will give traders more clues as to the pace of U.S. interest rate increases in 2018. Prior to the past week’s correction, traders were expecting three rate hikes by the Fed this year, but a stronger inflation reading could raise expectations of further Fed action.

“Clearly, the pace of gains was unsustainable,” Ajay Kapur, strategist for Bank of America-Merrill Lynch, told Barrons.

Equity Bulls

However, Kapur said despite the market rout, the fundamentals remained the same.

“Nothing has really changed in Asia over the past few months,” he said.

Kapur sees Asian company earnings (excluding Japan) rising by at least 20 percent this year, following last year’s 24 percent rise, indicating that further growth is ahead for Asian stocks.

“Asia is in a much earlier cycle than the U.S. As such, central banks in the region have the luxury of taking their time to normalize monetary policy,” Jasslyn Yeo, strategist for JPMorgan Asset Management, told the financial publication.

“Asian companies are still seeing strong growth in revenue, margin expansion, and earnings growth.”

Merrill Lynch favors China, South Korea, and Taiwan, “where valuations are reasonable and earnings are still being revised upward.”

Yeo suggested Japan and South Korea, “which are leveraged to the global trade cycle, where earnings growth is still strong and where the recent correction provides investors better entry levels.”

Nikko Asset Management also sees Japanese stocks further advancing in 2018, on the back of solid earnings growth.

“With the Nikkei index breaching the 24,000 mark, its highest level in 26 years, Japan appears to have put its ‘lost decade’ of growth well behind it. And with the 30,000-point level now well within the Nikkei’s sights, maintaining an underweight bias on Japanese equities may further adversely affect investor portfolios in the years to come,” the Tokyo-based company said in a February 1 report.

“We believe Japan’s current bull market is well supported by corporate fundamentals, in particular, strong earnings growth. In addition, Japan’s tightest labor market in decades is boosting demand for labor-saving investments, which has been a boon for firms in capital goods sectors.

“At the same time, many companies are offering higher value-added products and services, both domestically and overseas, while continued corporate cost-cutting efforts are raising margins to a record high level. These developments are also contributing to a decoupling of Japanese corporate earnings from currency fluctuations.”

The stronger global economic outlooks projected for 2018 by both the International Monetary Fund (IMF) and the World Bank suggest the world economy can ride out slightly higher U.S. interest rates, which reflect faster growth in the United States, itself a positive for Asian exporters.

In its latest update, the IMF pointed to the “broadest synchronized global growth upsurge since 2010,” with stronger than expected economic growth in Germany, Japan, South Korea, and the United States, along with emerging markets such as Brazil and China.

The IMF sees the world economy expanding by 3.9 percent this year and next, up from last year’s 3.7 percent, while the World Bank expects a more modest 3.1 percent rise this year, “the first year since the financial crisis that the global economy will be operating at or near full capacity.”

However, as cautioned previously by Pacific Money, a number of Asian markets are considered vulnerable to capital flight, particularly India, Indonesia, and the Philippines. Record private debt in China and South Korea also poses a risk should the U.S. dollar strengthen and funds flow out of emerging markets, forcing a potential response from monetary authorities.

‘Period Of Pessimism’

Capital Economics chief economist Jonathan Loynes has warned of a “period of pessimism” ahead for financial markets, with the recent sell-off underlining previous complacency.

“The severity of any further sell-off in global financial markets may be limited by the general health of the global economy and the scope for policymakers to respond if necessary. Nonetheless, the episode supports our repeated warnings that markets were previously positioned for an unrealistically benign combination of continued strong growth and very low inflation,” he said in a February 6 report.

A noted “bear,” Gerard Minack, suggests the risk is that the Fed makes an error by tightening policy “too far and too quickly, prematurely choking off economic activity.”

“If we get [U.S.] wage pressures coming through and pushing up, then that’s the kind of thing that could cause a proper correction in equities,” he told the Australian Financial Review.

Other risks for Asia include a full-blown trade war between the United States and China, along with the nightmare scenario of military conflict on the Korean Peninsula.

In the meantime, the slump in stockmarkets “would have to go a lot further to cause economic growth to slow significantly,” Capital Economics chief global economist Andrew Kenningham said.

For a region eyeing the benefits of stronger global growth in the Year of the Dog, Asia will be hoping that the market dogs’ bark is far worse than their bite.

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