• Lessons from the 1997/98 Asian financial crisis
• Commodity super-cycle is mature
• The relative attraction of ASEAN equity markets
Macro
• We seem to be in good company nowadays. We have occasionally drawn parallels be-
tween Asian ex Japan’s financial crisis in 1997-98 and the one plaguing the European
Monetary Union today (something we first mentioned back in August 2011 and more re-
cently in our 2012 Year Ahead Outlook). Now, we find JPMorgan is writing along the same
lines. Back in the late 1990’s, a USD10/bl of oil (yes, USD10/bl!) and lower commodity prices
helped cushion the global consumer. And it could do so again during the current EU debt
crisis. That might be good news for those net importers of oil currently but the Asian crisis
did not end until we had decisive policy action from the Fed (cutting interest rates) and the
HKMA (buying up the Hang Seng Index) in September 1998, did we see confidence return
and global equity bottom. This time, the responsibility for decisive action will be the job of
the ECB and EU leaders but whether they have the will or the means is another mat-
ter altogether.
The Asian financial crisis was centred around a collection of countries that accounted for
~5% of global GDP. Many of these countries (e.g. Thailand, Indonesia and Korea) main-
tained fixed exchange rates to the USD. These were over-valued. Large current account defi-
cits continued to build, up until the point where external financing became unsustainable.
When global investors withdrew from the region, the result was a chain reaction collapse in
our region’s currencies and stock markets. GDP plummeted and inflation soared.
Initially, the crisis was viewed as a regional event with limited repercussions for the rest of
the world. Asia ex Japan’s GDP fell -7%, shaving -35bps off global GDP (this would be
equivalent to a -1.5% drop in EMU GDP today). Nonetheless, the drop in EM Asian GDP
would have been far worse, were it not for a huge swing in net exports. The 40% (-25%
when we account for inflation) devaluation in regional FX rates helped here. G3 export
growth, which had been booming in early 1997, began to register several consecutive quar-
ters of contracting export demand.
However, by the end of 1997, there was still no discernible spill-over into financial mar-
kets (although the SET Index, the IDR and the KOSPI had fallen far). Global stock prices con-
tinued to gain in 1997 and early 1998 and even non-Asian EM credit spreads held their
ground.
The most notable financial effect was to impact WTI crude oil and commodity prices.
Both took a tumble. Crude oil, for example, fell from USD25/bl in early 1997 to USD10/bl by
December 1998. Base metals were off by over -20% (chart above). The situation in global
financial markets, however, only began to deteriorate in 3Q98, when Russia (under stress
from lower oil), devalued the RUB and defaulted on its foreign currency debt. In turn, the
Russian crisis engulfed the US hedge fund, Long Term Capital Management (LTCM) and
heightened fears of global contagion. Confidence ebbed and global stocks fell. The time-line
of events in Asia can be tracked in the LHS of the table below.
Lower crude oil prices were helpful – they helped cushion the decline in the global economy,
which left unchecked might have sent the G3 into a recession. Market panic eventually
prompted policy action (and the old adage; ‘equity investors can stop panicking when cen-
tral banks start panicking’). The New York Fed moved first and bailed-out LTCM. The Fed-
eral Reserve followed up with rate cuts (while the HKMA took the nuclear option by buy-
ing equities in the Hang Seng index). These actions, however, helped to restore confidence
and financial conditions in 4Q98. Bizarrely, the policy responses might have been targeted at
Asia ex Japan and Russia but money stayed in the US and eventually led to an investment
bubble in the tech stocks.
As we look to a new potential risk from a Greek exit from the EMU, concerns have risen as
to how this will affect markets and confidence. Like it was in 1997-98, activity outside the
Eurozone should be cushioned by lower commodity prices (reasons why are underweight).
What is more concerning, however, is the outlook for a decisive policy response akin to
what happened in regards the NY Fed, Federal Reserve and HKMA in 3Q98. This is the key
to restoring confidence but it is not clear whether European policymakers have either the
will or the proper tools to limit the damage. With interest rates at close to 0% for major
central banks, there is also a unique concern that if the will is there, the firepower is not.
There is still hope; policymakers might be ineffective but they are not impotent and we be-
lieve that the ECB has a major role to play here. Latest numbers show that Eurozone’s
money supply is contracting again; M3 fell by EUR51bn in April while private credit was
down EUR55bn m/m. This is clear evidence that the effects of the ECB’s 3-year LTRO have
now worn off and he ECB has more work to do. Where the ECB can make a difference this
time round, however, is to announce that it will stand behind the market and buy Spanish
and Italian government bonds with a yield cap of between 6% and 7%....as it becomes
clear that little else has worked with any lasting impact. Until then, risk assets in equities and
commodities will struggle.
Commodities
• The value attached to commodities has rarely been as high as it is now. As Glenn Stevens,
Reserve Bank of Australia Governor, put it recently; ‘five years ago, a ship load of iron ore
was worth about the same as about 2,200 flat screen TV’s. Today, it is worth roughly
22,000 flat screen TV’s .’ It is easy to see why the AUD was higher over that time; exporting
commodities that went up in price while importing goods that declined.
Nonetheless, a recent UN Paper written by economists, Bilge Erten and Jose Antonio
Ocampo (entitled ‘Super-cycles of commodity prices since the mid-19th century’, February
2012) believes the commodities boom of the last 10 years is now showing signs of ex-
haustion. That’s because commodity prices have experienced a near +300% jump since
bottoming. This is far more than in the two super-cycles that followed the industrialisation
of the US in the late 19th century to early 20th centuries and the reconstruction of Europe
and Japan after World War II. Commodity prices might enjoy a resurgence upon aggressive ECB intervention later this year
but we feel that the vast bulk of this cycle’s price gain is now behind us. Our preferred
reflation trade therefore remains global inflation-linked bonds where inflation expecta-
tions are much lower than they are in the commodity space. For those who follow the AUD,
we believe there is weakness ahead (as it tests 0.9664 and maybe 0.9388)….it sounds like
we should buy a flat-screen TV instead.
Equities
• ASEAN equities are trading at a valuation premium to the rest of Asia ex-Japan, but
ASEAN’s solid growth fundamentals help to justify it. JPMorgan ran a stress test on ASEAN’s
exposure to Eurozone via both financial and trade channels. The results indicate that Euro-
zone contagion risk is likely to be limited in Singapore, Philippines and Thailand (the 21
May edition of the Daily Research Update has more details).
Overall, export exposures to the Eurozone are much less than their peers in North Asia.
Foreign bank exposure (should EU banks repatriate capital) looks manageable as well (although Singapore does not come out strongly in this screen, however). Nonetheless, the
Philippines’ short-term debt foreign debt-to-FX reserves ratio is only 16% while Thailand
comes out top as the least vulnerable to potential bank capital flight (as the red boxes in the
table shows below). Thailand’s short-term debt to FX reserve ratio is only 7.3%.
Besides limited Eurozone risks, earnings upgrade momentum continues to provide support
for the MSCI AC Asia ex Japan index and the ASEAN markets in particular. The key differ-
ence between 2011 and this year is inflation and earnings downgrades. This year, markets
might be discounting EPS upgrades over the next few quarters, now that energy prices are
off their highs. Lower foreign ownership should also help sustain ASEAN’s valuation pre-
mium in a global environment where domestic-led growth is still a scarce item.
Philippines is the only market in Asia ex Japan that is expensive relative to its history, but
most ASEAN EM funds are not fully invested. The country’s growth potential should also jus-
tify the valuation premium. Last week, President Aquino approved two toll road projects
worth USD1.1bn and is also inviting private companies to build infrastructure projects,
such as airports and light rail systems. Many conglomerates are also rolling out their ambi-
tious spending plans to build shopping malls, office towers and residential projects. The
country is poised for an investment boom, adding to growing business optimism about the
country’s medium term prospects.
Our favoured ASEAN equity play is the JF ASEAN Fund while the First State Asian Equity
Plus Fund currently boasts overweight allocations to both the Philippines and Thailand. The
fund is also overweight Hong Kong and Singapore, two markets we recently added to. First
State is more bottom up and tends to target higher quality companies in both these markets.
This shows in its performance. The fund may not out-perform when markets are strong (i.e.
1Q12) but strong stock selection can be seen in its long-term track record, where it is a
steady outperformer.
