By: Marshall T. Mays, Founder and Director, Emerging Alpha Advisors | Asian Bond Market Forum | Pacific Organic Dairy Products

November 11, 2009 7:33 pm EST
Chinese Yuan banknotes and U.S. dollars
Politicians are so scared now, they have forgotten what is wrong

The accumulated shock from Western financial giants’ wounds reached a crescendo in the first quarter of this year. The relief of finding an apparent floor in consumer demand has led the markets to bounce back everywhere. But the fear of a collapse in the house of cards has kept politicians pushing money, instead of financial reforms that could create new growth. Thus, the Dollar will chase growth where it can find it, but there are many disappointments still lying in store.

Financial PR reaches new limits

I must make a confession. I really underestimated the salesmanship of Barack Obama this spring – as Hillary Clinton did a year earlier. The combination of cheerleading and surplus liquidity sustained Asia’s markets through May (up 34% from 9 March), over a bumpy summer for an average total gain of 48%. The political fashion was so strong that the Financial Times is about the only holdout not embarrassed to contest the sightings of little green men.

What recovery?

Bulls say this is just the beginning, since higher Asian growth will trump Atlantic growth over the foreseeable future. Bears say this is just a reflex rally with hot-money fuel, so fire in the basement will chase everyone from the house just as it has in the past. Once the rejoicing over the end of market freefall is done, the weight of growing unemployment, weaker consumption and more consumer defaults across the OECD will push the market back down in a long, slow grind.

Slow ride on a rollercoaster

So what does this mean for Asia GDP growth and stock market valuations over the next few years? The markets should rebound, as they have, in a relief rally, as job cuts provide a 3rd-quarter earnings bounce. Then the realization will finally sink in that new growth will be much weaker than that in the five years 2003-07 – and the mid-70s. We estimate 1.5% less on average. The equity markets would then pull back to more modest valuations. Each will do so, depending on how well its banking system is working. Here is where China still has a big weakness.

We all ate dessert first

There will be a few years of weak growth, then the stress imposed on the US economy by necessarily higher taxes and the increasing volatility of energy will take its toll. After the US Dollar finally bottoms out in 2013, rising interest rates will start to kick in. All this will drag US GDP and the markets back down for the next dip of recession in 2014 or 2015. There is no free lunch and we are all paying for the desert of the decade since the 90s crisis.

The market risks ahead – the echo from Asia

A lot of this hot government money has come from Asia. Gradually, these parked funds – money in excess of real-sector demand – will get pulled out of the markets and put into the ground, mostly into Asian public works projects, aka “infrastructure”. As it does, the flood of money will ebb and the institutional investors who are net buyers in September and October gradually will become net sellers.

When will the level of consumption match productive capacity again?

Western consumers are recovering from consumption whiplash and exploring the limits of thrift for the first time in 25 years. So, there is little need for capacity expansion anywhere in the world right now, even in semiconductors. We saw little expansion outside of China over the last six years. So, we know where the pressure to destroy excess manufacturing capacity lies and we can now see what it is doing to pricing power: Chinese consumer deflation at -1.8% and worse for upstream industry. That deflation will soon be exported, as the shipping indices show.

But … Asia’s markets are different, right?

In spite of proclamations from Asia lovers and a PRC leadership desperate to hold onto power, the tail has not yet begun to wag the dog. Asia’s growing middle class gives it a strong anchor against the American storm and subsequent European slump, but its capital markets are very volatile. And most of its governments are still trying to prove themselves competent financial regulators (the global benchmark has, admittedly, fallen considerably). Asia’s markets fell faster and further than those in America. Asia will need Western capital markets for a few more years still … but not many.

Asia as the future

Yet, the real economy is what matters. Even though a mass of private debt has been nationalized into public debt, it still has to be paid for with consumption growth. For the next five to ten years most of that nationalized debt will be in the West and most of the consumption growth will be in Asia. The terms of trade may shift dramatically in this new tale. New dog pack; new rules.

The views and opinions expressed herein are those of the author(s). Core Compass’s Terms Of Use applies.

About the author

Marshall Mays is a Director of Emerging Alpha Advisors, a fund management company covering 15 Asian markets, where he advises on equity and debt portfolio strategy, and on risk management. He is also a Director of the Asian Bond Market Forum, an independent research institute dedicated to building Asia’s financial infrastructure. He has spent over 30 years investing in Asia, managing investment and IT-dependent businesses. He has also advised the People’s Bank of China on a consolidated regulatory framework for China’s financial system (banking, securities and insurance).

Asian GDP growthOECDChina
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