Asian share price valuations in question

Macquarie believes strong liquidity conditions are stretching Asian equity valuations while others still see a buying opportunity.

Asian stock markets have generally continued to perform well despite predictions of a correction in the third quarter of this year. This has led some fund managers and analysts to turn more optimistic about the region in the near-term while others, such as Macquarie, believe that the global economic recovery has already been priced into Asian stock valuations.

In a recent report, Macquarie says that markets have been driven by liquidity rather than fundamentals, and thus the current rally in various Asian bourses is unsustainable.

The MSCI All Country Asia ex-Japan Index is up 48% so far this year. In 2008, the index was down 54%.

"These strong liquidity conditions are pushing Asian equities to stretched valuation levels in our view," Macquarie says in the report. "We think a strong recovery in global final demand is now priced in. While hard signs of demand recovery are absent -- as they are at present -- we would lean into the current rally, progressively reducing beta as equity markets move further and further away from levels justified by economic fundamentals."

Inflows into emerging market equity funds, in particular, have rebounded during the third week of July as optimism about a recovery in US demand helped many individual equity markets gain between 3% and 8%, according to data from Massachusetts-based EPFR Global.

The diversified global emerging markets equity funds posted the biggest inflows last week, absorbing a net $1.08 billion, followed by Asia ex-Japan equity funds, which pulled in $973 million.

Macquarie notes that domestic investors have played a significant role in propping the markets thus far. After all, depositors are switching from time deposits into demand deposits because interest rate differentials between time and demand deposits are narrowing.

On the flipside, fund managers such as Douglas Cairns, Asia and emerging markets equities investment specialist at Threadneedle Asset Management, notes that it is a good time for stock picking as there is scope for earnings to surprise on the upside.

"Take the banking sector, for example, where analysts may have been too aggressive on their loan loss provisions now that growth rates are being revised up," Cairns says.

He notes that there is a strong appetite for financial services among investors because banks are looking for ways to grow their wealth management divisions.

For investors who are in this for the long haul -- with one year being the minimum investment horizon -- then the scenario is vastly different. Asian stock markets are generally expected to outperform US and European markets over the long run. The reasons for this optimism is plentiful, including the region's relatively strong domestic consumption, sound fiscal position, ability to counteract external shocks with central bank reserves and fiscal spending, less dependence on exports, and stronger financial systems.

Barings takes a long term view based on macroeconomic indicators to work out whether or not they are being adequately rewarded for taking the risk of owning shares or indeed other assets. 

"We do not claim to forecast how the market will move on a day-to-day or even a month-to-month basis," says Andrew Cole, manager of the Baring Multi Asset Fund. "But by taking a longer-term view of a year to 18 months we think it is possible to work out whether you are being adequately rewarded for holding shares."

Cole notes that it is Barings' view that multi-asset managers should not diversify across assets simply because they have the ability to do so. 

"The days of diversification for the sake of it are over and we believe that returns in a multi-asset portfolio will only come from taking active asset allocation decisions as the markets dictate," he says.

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