Quarterly Economic Commentary – Asia Pacific Asset Management (December 08)

Introduction
Q0408 is best defined as a period of unprecedented government intervention into economies and monetary systems worldwide. Even as the financial crisis moves from the financial sector into the real economy, government bailout efforts, in our view, are ill timed and in some cases misplaced. We’ve already seen mounting job losses around the world, and a global recession in 2009 is now inevitably, if not already, in place.
 
Consider that in the past few months in Australia alone we’ve seen unlimited bank deposit guarantees, unprecedented interest rate cuts, Federal Government loans to the car industry, cash handouts to pensioners and families, increased first home grants and a second stimulus package of A$40 billion then you start to get a picture of just how dramatic this crisis really is.
 
As we move through this horror period we are beginning to see the first tentative signs of stabilisation. The question remains – how much longer before we bottom out? It would be misleading to suggest that a quick fix is pending but we do think we will see more positive growth prospects by the end of this calendar year as stimulatory efforts bear fruit.
 
Australia
The ASX 200 Stock Index lost -19.1% during the December quarter, taking the CY08 losses to -41.3%. Declines, unsurprisingly, were seen in all sectors during the quarter, with -20% plus losses in Financials, Materials, Energy, Industrials and Consumer Discretionary sectors. During Q0408 the Chinese economy revealed sharp growth deceleration extending losses in local resources stocks.
Inter-bank funding cost, which measures the difference bank charge for lending to each other, have now gone back below pre-September extreme levels, although they are still significantly higher than one year before. Thus the relatively lower cost of borrowing and government bank debt guarantees have prompted a rush of bond issuance by local banks in the past two months. We expect that we will see much more of this activity for the remainder of this year.

Asia
The MSCI AC Asia Pacific Stock Index fell -16.30% in USD terms during the quarter, influenced by regional external factors such as the equity market slumps in Europe and the US. Continued heavy foreign investor redemptions in Asian Equity funds, as well as internal factors, such as collapsing export income, exacerbated the large declines.
Japanese automakers, which, traditionally, have been more profitable than their European and US counterparts, announced unprecedented financial losses as well as job cuts and plant closures, due to reduced export demand and a rising Yen. Reduced import demand from developed markets has flowed negatively into infrastructure investment activities in China and India, whose strong economic growth profiles over the past 5 years had been led by such activity. As a result, other trade and commodity dependent nations throughout the region have also taken a battering.

Outlook
Australia
In Australia’s case, although the government stimulus packages have been specifically targeting the economy, we don’t think that government efforts alone will prevent the economy from going into a fairly deep recession.
When you consider the scale of the destruction caused by the financial crisis it is hard to imagine how the Governments measures will create the confidence necessary to right the economy in the short term.
We think that Australian Equity markets will remain under pressure for the next few months at least. Equity market direction will continue to track currency moves and not until we see a topping out of the US$ would we expect to see a lasting recovery in Australian stocks.
Although this scenario appears bleak we expect that Australia and Asia will perform significantly better than other regions around the world. We therefore expect them to outperform without necessarily generating positive returns through to financial year-end.
 

Asia
The Asia Pacific including Japan stock index fell nearly -45% in 2008, following the footsteps of US and European markets. While in the short tem it will remain hostage to liquidity constraints from foreign investor redemptions, we recognise the fact that Asian companies in general are in significantly better shape than their Western counterparts.
The sudden reduction in export income has manifested the problem of over-capacity in the Chinese and Japanese economies. While it is true that industrialisation and modernisation of China requires an enormous amount of commodity materials in the long term, a lot of the infrastructure projects conducted in the past few years were actually for export oriented capacity building, such as ports, roads, and power stations. Overcapacity is the main reason for the sudden drop in demand for commodities from China and Japan.   
While governments from developed countries are pushing stimulus packages to bail out debt-laden banks and corporations, Asian governments are targeting measures to stimulate domestic demand and inter-regional trade. If those measures work within the next two quarters we expect to see some signs of stabilization in the China and other AP Equity markets through to calendar year-end.
 

Summary
We fully expect more bad news to come out over the next three months or so, as problems with debt default continue to emerge in the US and particularly Eastern and Western Europe. Currencies will remain volatile and growth oriented currencies will likely take a further battering. We may see the A$ test its old low of US$ .49. Beyond this we foresee a period of stabilisation and moderate recovery in weakened currencies and stock prices across AP as US, Chinese, Japanese, and Australian stimulatory packages come into effect.