Hot retail money makes markets harder to call
One difference between the current market volatility and the Asian financial crisis of the late-1990s is the wider participation of retail money, much of which tends to come and go quickly, says Schroders fund manager Louisa Lo.
Focusing on domestic consumption and infrastructure-related companies is how Louisa Lo, head of equity for Asia ex-Japan at Schroders Investment Management in Hong Kong, navigates the current high volatility in the market. She spoke with AsianInvestor recently about how best to manage portfolios at this time and how she still draws lessons from the 1997 crisis.
WhatÆs the appropriate way to act during these times of high volatility?
Lo: The key issue has been whether or not Asia will see a decoupling from the US. The Asian stock market is still highly correlated with the US. In terms of the real economy, we are seeing to some extent some decoupling. Asia is in a different economic cycle compared with the US. The US market has seen excessive consumption for 10 years. Consumers are very leveraged, there is a housing problem there. Asia has already been through the financial crisis and Sars so we donÆt have the excesses. We have a much stronger balance sheet on the macro-side and the micro-side. The currencies, the current account positions and foreign exchange reserves are much stronger. Companies have become more disciplined; the weaker ones have disappeared since the financial crisis.
Having said that, Asia still has exposure to the export side. This part will be affected. But our argument is weakness in the US will be mitigated by strong emerging markets in the Middle East, China and India. Asia will weather the external weakness much better than the past.
In terms of the stock markets, money is fungible. It comes and goes. We will still see a high correlation with the US. In the last year, we saw a lot of money going into Asia. Investors were looking for the Asian decoupling story, the Asian miracle. Some of that money went to places like Korea, Taiwan, China, India, and the rest of the Bric (Brazil, Russia, India, China) markets. Most fund houses saw a fairly decent rise in asset size in products that invest in those markets. Whether the money going into those products are sticky money or not is yet to be tested. If sentiment deteriorates, youÆll see more selling from that hot retail money.
From its recent peak last year, Asian stock markets are probably down around 25% as a whole. China is down around 40%. High beta stocks are down 50% already. To some extent, that gives investors some comfort that stock markets have come back down to more realistic levels. Analysts are lagging behind in terms of earnings downgrades. So I am still waiting for the numbers to come down.
To what extent do issues raised by the snow storm in China, such as the issues of inflation and infrastructure, factor into your analysis?
With the CPI number going up to almost 7%, that has gotten the local government very worried. The loan growth quota has been in place. For every quarter, banks are given a quota. But what IÆve heard is a lot of banks have already used up their quota. So there is definitely tightening happening. It will be more expensive to borrow in the interbank market.
If you look at it historically, inflation has always been a trigger for the austerity program in China. For this time, I think the inflation rate is actually understated. Once inflation and property become social issues, those are triggers for China to address the social issues. It is quite tricky in terms of how they are going to address it. What you are going to see going forward is China continuing to tighten until they see the inflation number come down, which is probably not likely to come soon. The snow storm, for example, will increase inflation pressure.
The export side will be really heated. That will be a negative scenario for the export sector. For banks, you will probably see loan grow slow down in the near-term. If markets continue to decline, investment gains will go down for the insurance companies and so that is quite negative for them. The government is likely to maintain the tightening mode at least until the National PeopleÆs Congress in March.
What sectors are you focusing on in Asia?
In our portfolios, we are more focused on domestic consumption and infrastructure-related companies, as well as companies with strong cash flow. Our experience in the 1997 Asian financial crisis taught us that we should go back to the blue-chip stocks with strong balance sheets.
Domestic consumption and infrastructure are becoming a common these among fund managers who are trying to navigate the current volatility.
Are you seeing an overcrowding in these sectors?
We have already positioned our portfolios in these sectors. The real concern is valuations are not cheap.
One other interesting theme is the technology sector in Taiwan because of its valuation. In the last few years, these technology companies in Taiwan have never really been re-rated.
When the earning downgrades come, the negative sentiment will worsen. That will give investors another opportunity to enter Asian stock markets at the low level. Some of the banks, the China property names are still on the high side in terms of share prices. We have yet to see them come down really. We just need the last leg of redemption to come, all the retail money to get out of the market, and then we will see another opportunity to come in.
What are your portfolio allocations in the region?
We are underweight in Korea, Taiwan, and China. We are overweight in most Southeast Asian markets, especially Malaysia and the Philippines. The more bombed out markets are starting to look more interesting. Malaysia and the Philippines are more isolated from the global economy.
The Philippines is benefiting from the overseas remittances, which are quite strong. In terms of the political front, we are seeing actual progress being made. The only risk for the Philippines is if the external factors actually impact the country.
Malaysia is also a strong domestic consumption story. But we have started to sell some of our holdings and have been putting the money elsewhere because we have been satisfied with the marketÆs performance.
Longer-term we still like Asia. The economic cycle is at a different stage compared with the US. Basically, you will see a structural change into a more domestic model. We are still positive on the consumption story in Asia.
We are looking for buying opportunities going forward. If the market re-tests the August level, that will make a lot of stocks quite interesting for long-term investors.
What is the most challenging part of managing your funds right now?
I witnessed the Asian financial crisis and Sars and I saw markets dropping as much as 10%. The challenge is really the volatility. Fund flows nowadays are quite a lot. One difference now is we are seeing a lot more retail participation and thatÆs whatÆs making the volatility much higher.
Going forward, the key thing is to focus on the stock level. When the liquidity flows come in and out, a lot of the stocks will be hit anyway. So its best to go for the blue-chips, the stocks that you know are fundamentally sound. You have to go back to the basics. Look at the cash flow, the balance sheets and earnings. Sticking with stocks like that will make you survive and do better during this time.
WhatÆs the appropriate way to act during these times of high volatility?
Lo: The key issue has been whether or not Asia will see a decoupling from the US. The Asian stock market is still highly correlated with the US. In terms of the real economy, we are seeing to some extent some decoupling. Asia is in a different economic cycle compared with the US. The US market has seen excessive consumption for 10 years. Consumers are very leveraged, there is a housing problem there. Asia has already been through the financial crisis and Sars so we donÆt have the excesses. We have a much stronger balance sheet on the macro-side and the micro-side. The currencies, the current account positions and foreign exchange reserves are much stronger. Companies have become more disciplined; the weaker ones have disappeared since the financial crisis.
Having said that, Asia still has exposure to the export side. This part will be affected. But our argument is weakness in the US will be mitigated by strong emerging markets in the Middle East, China and India. Asia will weather the external weakness much better than the past.
In terms of the stock markets, money is fungible. It comes and goes. We will still see a high correlation with the US. In the last year, we saw a lot of money going into Asia. Investors were looking for the Asian decoupling story, the Asian miracle. Some of that money went to places like Korea, Taiwan, China, India, and the rest of the Bric (Brazil, Russia, India, China) markets. Most fund houses saw a fairly decent rise in asset size in products that invest in those markets. Whether the money going into those products are sticky money or not is yet to be tested. If sentiment deteriorates, youÆll see more selling from that hot retail money.
From its recent peak last year, Asian stock markets are probably down around 25% as a whole. China is down around 40%. High beta stocks are down 50% already. To some extent, that gives investors some comfort that stock markets have come back down to more realistic levels. Analysts are lagging behind in terms of earnings downgrades. So I am still waiting for the numbers to come down.
To what extent do issues raised by the snow storm in China, such as the issues of inflation and infrastructure, factor into your analysis?
With the CPI number going up to almost 7%, that has gotten the local government very worried. The loan growth quota has been in place. For every quarter, banks are given a quota. But what IÆve heard is a lot of banks have already used up their quota. So there is definitely tightening happening. It will be more expensive to borrow in the interbank market.
If you look at it historically, inflation has always been a trigger for the austerity program in China. For this time, I think the inflation rate is actually understated. Once inflation and property become social issues, those are triggers for China to address the social issues. It is quite tricky in terms of how they are going to address it. What you are going to see going forward is China continuing to tighten until they see the inflation number come down, which is probably not likely to come soon. The snow storm, for example, will increase inflation pressure.
The export side will be really heated. That will be a negative scenario for the export sector. For banks, you will probably see loan grow slow down in the near-term. If markets continue to decline, investment gains will go down for the insurance companies and so that is quite negative for them. The government is likely to maintain the tightening mode at least until the National PeopleÆs Congress in March.
What sectors are you focusing on in Asia?
In our portfolios, we are more focused on domestic consumption and infrastructure-related companies, as well as companies with strong cash flow. Our experience in the 1997 Asian financial crisis taught us that we should go back to the blue-chip stocks with strong balance sheets.
Domestic consumption and infrastructure are becoming a common these among fund managers who are trying to navigate the current volatility.
Are you seeing an overcrowding in these sectors?
We have already positioned our portfolios in these sectors. The real concern is valuations are not cheap.
One other interesting theme is the technology sector in Taiwan because of its valuation. In the last few years, these technology companies in Taiwan have never really been re-rated.
When the earning downgrades come, the negative sentiment will worsen. That will give investors another opportunity to enter Asian stock markets at the low level. Some of the banks, the China property names are still on the high side in terms of share prices. We have yet to see them come down really. We just need the last leg of redemption to come, all the retail money to get out of the market, and then we will see another opportunity to come in.
What are your portfolio allocations in the region?
We are underweight in Korea, Taiwan, and China. We are overweight in most Southeast Asian markets, especially Malaysia and the Philippines. The more bombed out markets are starting to look more interesting. Malaysia and the Philippines are more isolated from the global economy.
The Philippines is benefiting from the overseas remittances, which are quite strong. In terms of the political front, we are seeing actual progress being made. The only risk for the Philippines is if the external factors actually impact the country.
Malaysia is also a strong domestic consumption story. But we have started to sell some of our holdings and have been putting the money elsewhere because we have been satisfied with the marketÆs performance.
Longer-term we still like Asia. The economic cycle is at a different stage compared with the US. Basically, you will see a structural change into a more domestic model. We are still positive on the consumption story in Asia.
We are looking for buying opportunities going forward. If the market re-tests the August level, that will make a lot of stocks quite interesting for long-term investors.
What is the most challenging part of managing your funds right now?
I witnessed the Asian financial crisis and Sars and I saw markets dropping as much as 10%. The challenge is really the volatility. Fund flows nowadays are quite a lot. One difference now is we are seeing a lot more retail participation and thatÆs whatÆs making the volatility much higher.
Going forward, the key thing is to focus on the stock level. When the liquidity flows come in and out, a lot of the stocks will be hit anyway. So its best to go for the blue-chips, the stocks that you know are fundamentally sound. You have to go back to the basics. Look at the cash flow, the balance sheets and earnings. Sticking with stocks like that will make you survive and do better during this time.
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