Asian shares and investment grade bonds look very cheap on paper, but may not yet attract foreign investors, suggesting there is more downside to markets before a solid recovery.
The worst global crisis in a lifetime has shown up Asia's vulnerability as a region built on trade, with record falls in exports and industrial output from South Korea to Taiwan and big losses at blue chip companies such as Sony Corp.
That problem is compounded by another. In an environment of frayed nerves where the first impulse is flight, it pays to be in more liquid and more developed markets such as Europe and the United States. That shift is made easier in a world of cheap securities and attractive deals from government-guaranteed bank debt to corporate bonds from the likes of Nokia.
"The liquidity and technicals tend to be better within developed markets as they are established and well understood," said Brayan Lai, a credit analyst at Calyon in Hong Kong.
"There's no huge push to go searching for returns, as in the past, because everything is just cheap right now and there are opportunities everywhere."
Foreign investors ploughed $160 billion into Asian stock markets excluding Japan in 1998-2006, but last year alone pulled out $64 billion, according to HSBC estimates.
Despite modest advances into some markets this year, they have not returned in big enough numbers to make much of a dent. After a record 53.3 percent drop last year, the MSCI index of Asian stocks outside Japan fell 7.7 percent in January. Sure, that also reflects local selling, but foreigners own close to a third of overall Asian shares.
Purchases by overseas investors helped the MSCI Asia ex-Japan index provide compound returns of 22 percent from 2003-07, HSBC said. That will be hard to match as investors shift to other assets.
"The days of 22 percent are over," wrote HSBC strategist Garry Evans. "This all says that we may be in for a long period of non-trending stock markets." Foreign investors also remain wary of Asian credit markets - a segment where they account for the bulk of trading - with regional corporate spreads still far above those in the United States and Europe.
"I'm not a believer that an IG rally has begun," said Scott Bennett, a fund manager at Aberdeen Asset Management in Singapore, referring to investment-grade bonds.
"You can't ignore that there's a lot of bad economic data out from the US and Asia. GDPs are slowing down, fiscal deficits are rising, and fourth quarter numbers are hitting new lows," he noted.
The lack of foreign investors defies some compelling mathematics. The price-to-earnings ratio for Asian stocks excluding Japan for the 12 months ahead sank to an historic low of 8.7 in November, before recovering to 10.8 as of mid-January, according to Thomson Reuters data. That's cheaper than the S&P 500 index, which fell to a low of 9.5 in November and traded at 11.2 last month.
In credit, the Asia iTRAXX index soared to a record high of around 650 basis points in late October. The current levels of 350 bps marks a solid recovery, but still implies a default level worse than the Asian financial crisis a decade ago.
Equally compelling are data showing a region reeling from the slowdowns in key markets in China and the United States, with double-digit falls in exports and output from Singapore to Seoul. Corporate results are also grim. Sony has forecast a record annual operating loss and Toyota Motor Corp has forecast its first annual operating loss as demand for new cars withers amid the global economic slowdown.
That's not to say Asian financial markets won't recover, but it's hard to see big rallies. Manpreet Gill, Asia strategist at Barclays Wealth, reckons investors need to watch for opportunities to add risk, especially in investment-grade bonds. The question is one of timing.
"We think investment-grade bonds will perform well over the year, but possibly not right away," he said. "You need liquidity and some risk appetite to return to credit markets.
"For us, it's always been one of the necessary conditions for a return to risky assets in general, whether it be equities or investment-grade bonds."
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