2010 was notable, given continued weakness in most of the developed world, for the strong performance of many regional economies. More than ever, Asian economies seem able to grow under their own steam, finding their own sources of both supply and demand.
"Regional economies have become increasingly decoupled from their Western counterparts"
There is no doubt regional economies are still vulnerable to a major growth relapse in the developed world, but it appears that the current sluggishness in the US and Europe is not a problem for the region. In fact, the current situation may actually be optimal for Asia as weakness in the developed world takes pressure off the commodities prices, which the large emerging countries such as China and India compete for.
However, the country which posted the highest economic growth, China, had the worst performing stock market. Having turned on the stimulus tap in early 2008, China raised its banks’ reserve requirement ratio six times and interest rates twice in 2010. Although there are indications the economy, in particular the property market, is responding, we expect monetary conditions to remain tight for the foreseeable future.
But monetary policy cycle aside, the long-term fundamentals for Asia remain good. Balance sheets at a household, corporate and government level are strong, and growth potential remains substantial. As mentioned, regional economies have become increasingly decoupled from their Western counterparts.
However, this has not been the case for stock markets, which have become more correlated with major developed stock markets in recent years, reaching what are now very high levels. Indeed correlations across all financial asset classes have increased since the onset of the crisis three years ago, the only major distinction it seems, being whether a particular financial asset is considered risky or a safe haven. While this phenomenon can be explained by the increasingly global nature of investment flows, we suspect that correlations cannot go much higher.
Although ultra-loose monetary policy in developed economies has generally been positive for equity markets everywhere, it has also had some negative effects. Asian economies, unhindered by large levels of debts have seen economic growth rebound, causing consumer price inflation to rise to troubling levels.
Many Asian governments have been reluctant to abandon their pro-export policies, resulting in trade imbalances remaining unaddressed. While there has been some appreciation of nominal exchange rates, this has been against a generally weak US dollar. On a trade weighted basis, many Asian currencies, notably the Chinese yuan, have not appreciated to the extent that they should have.
Rising social tension resulting from increasing price inflation and greater confidence in economic performance are likely to prompt Asian central bankers to shift policy in favour of stronger exchange rates.
Published in Professional Investor
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.