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Market faces biggest dislocation since Asian crisis
Commentary: Watch China policy moves and get defensive
By Craig Stephen
Last Update: 12:01 AM ET Nov 3, 2008
HONG KONG (MarketWatch) -- Asia may not be the epicenter of the current financial turmoil but the steep falls in equity markets and currency gyrations are beginning to feel very much like the Asian crises a decade ago.
Just a few weeks ago when such comparisons first appeared, they were dismissed as scaremongering -- not anymore. The dislocation in currencies and equity markets has easily set some investor portfolios back 10 years. The new landscape will take some getting used to with the yen at multi-year highs, the Nikkei back where it was in 1983 and Hong Kong dollar strengthening in tandem with the U.S. against a range of currencies.
The crisis 10 years ago provides some insights on what might now lie ahead. Then after the initial currency shock in July 1997, the Hang Seng Index took another 13 months to bottom in a crescendo of selling, as the full impact of the deflationary spiral hit home.
And if you think stocks today are cheap, earnings for the Hang Seng Index eventually fell by half. A decade is also the length of chart you will need if you are looking for technical support on some bellwether Asian stocks such as Hutchison Whampoa HUWHF.
The recent sell-offs have been driven by a mass deleveraging and fund redemptions. As the most liquid market in the region, the Hang Seng Index has taken the brunt of the selling. It reached a level down 65% from its peak which took it to levels not visited since January 1996. It is easy to argue it's oversold, but more to the point, can we be sure we are close to the end of the liquidation pressure?
A big hurdle is that we need worries about the solvency of banks and other financial institutions to end. Otherwise the thirst for cash means we are still facing a liquidity crisis for markets. It's not just fund redemptions pressuring equity markets. With a range of non-cash bank instruments and derivatives rendered illiquid, equities have acted like a liquidity conduit of the last resort. Particularly in Asia given relatively thin money markets.
It is also hard to see where the next money market dislocations will come from. Reports suggest the shipping industry is in chaos as contracts are defaulted along with letters of credit.
In these circumstances, preserving capital is key, and defensive stock exposure is highly recommended. Transparency in earnings is essential so bad news surprises can be kept to a minimum. Large caps are also the only place to be as stock liquidity is at a premium and fast drying up in all the small and medium caps. Last week's bounce in the Hang Seng Index, for instance, only lifted the large caps.
In these precarious times for corporations, cash is king. That means companies will be favored that have a strong cash generating business and better still a sizeable chunk of cash on their balance sheets with little debt.
Into this category fall various telecom stocks around the region. While the consensus now is that most economies will face a slowdown, this is unlikely to impact mobile phone usage which has an almost utility-like quality in Asia. Industry heavyweight and core holding China Mobile CHL is worth watching as it gets sold off, given that it has a quarter of its balance sheet in cash.
Another sector with relatively defensive qualities is the Chinese Web sector, as usage and penetration growth is unlikely to be hit by the economic slowdown. These industries are also not particularly capital intensive -- a virtue in a time of tight credit. Even if advertising budgets are cut, there is some evidence brands are still upping the share of the pie going to new media.
Continuing the cash and liquidity theme, dependable yields are also going to be highly sought and should provide some downside protection, especially as they get into double figures. In family-owned listed companies in Hong Kong for instance, dividends are often generous as that is how the main shareholder gets paid -- tax free. Infrastructure is one sector to watch for dividend income and often comes with near guaranteed returns.
In terms of policy stimulus for the market, many eyes will be watching what China does to prevent a slowdown in growth in its giant economy. Expectations are Beijing will ramp up domestic demand with some hefty spending, again possibly on infrastructure.
Hong Kong will also be watching carefully as China has the ability to grant lucrative favors if the economy starts to nosedive too fast. In 2003, it pulled a rabbit out of the hat after releasing millions of its citizen tourists into the city-state -- almost single handedly lifting it out of a SARS stupor. Neighboring Macau was revitalized after another policy initiative -- this time to open the casino industry up to new investment and competition.
China's growth will also be crucial to a host of commodity related industries around the region. The trusty Asian fund manager strategy of buy everything China buys and sell everything China sells make have taken a hit, but may be too early to discard altogether.
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