The bull market rally for Asian equities may prove unsustainable, as regional economic activity will stay weak once the initial boost from fiscal stimulus packages fades, analysts have said this week.
“The market rally is coming on the back of an unprecedented amount of policy stimulus”, Johanna Chua, Citigroup’s chief Asia economist in Hong Kong, said. “But, even though Asian economies are seeing some signs of stabilizing, we are still significantly below previous output peaks.”
The MSCI Asia Pacific Index gained 1.9% this week and has now rallied 12% in April – the steepest monthly gain since October 1998 while valuations are the highest since the bull market of 2004. Investors have been buoyed by news this week of better-than-expected economic data from the US and the 4.8% monthly rise in South Korea’s industrial production in March.
China’s manufacturing purchasing manager’s index (PMI) rose in April as fiscal stimulus boosts industrial activity and triggers market confidence that the country can power global growth.
But Jing Ulrich, head of China equities at JP Morgan, warned: “While a fifth monthly improvement in the PMI reinforces our confidence that the Chinese economy is starting to turn around, it appears sensible to guard against excessive optimism.”
Analysts caution that Asian equities are rebounding against the ominous backdrop of a recession-ravaged West, poor corporate earning results expected later on in the year, and the threat of a global swine flu pandemic.
Investors have brushed off the swine flu threat as an event risk, which suggests that the market is now pricing in a “sustainable rebound in the global economy”, said Brian Jackson, senior Asia strategist at RBC.
Jackson says the rally has been fuelled by the excess cash on the sidelines from the recent deleveraging cycle. But Asian markets could be under abrupt selling pressure as price-to-earnings ratios on the Asia MSCI now stands at 22x - the highest level since March 2004.
Nevertheless, “the liquidity rally could go on in the near-term because money has to go somewhere”, said Chua.
However, there is significant risk of a precipitous drop in economic activity once companies finish restocking their inventories, the immediate effect of government fiscal stimulus wanes and if G7 markets stay effectively closed to Asian exporters.
Nevertheless, most analysts agree that Asian markets will outperform the S&P 500 in a two to three-year horizon due to the region’s stronger relative growth prospects.
Asian markets have soared in the bull run, as investors tactically allocated capital to the region to gain exposure to the long-term structural shift in economic power from the West to East. It is not clear there is sufficient risk appetite to sustain the recent gains in Asian bourses and justify relatively high current valuations, said analysts.