Global monetary policy and the China story were the dominant forces that impacted Asian equity markets, according to executives at fund management companies in Hong Kong.

Several investors cite monetary policy as the major driver of market performance.

ôThe most important development for Asian markets in 2006 was US inflation data and the often contradictory statements from Federal Bank officials,ö argues Nigel Richardson, chief investment officer at Axa Investment Managers Asia. He says that the Fed sent out hawkish messages that prompted the sharp decline in global equities in May and June; but as inflation fears calmed, markets enjoyed a strong autumn rally.

Mark Konyn, CEO at Allianz Global Investors, says the Bank of JapanÆs declaration of the end of quantitative easing played an equally important role. ôInvestors are prepared for interest-rate increases in Japan,ö he says. Next year the key things to watch will be the US housing market and its impact on the countryÆs GDP growth, and the impact of Japanese interest-rate hikes on investor sentiment.
Developments in China, however, had the most direct impact on local equity markets.

ôThe highlight of the year,ö says Kheim Do, director of equities at Baring Asset Management, ôwas the rise of China as an economic power and stock market destination. The economy is in a sweet spot, enjoying strong growth, low inflation, an appreciating currency, growing current account surplus and abundant liquidity.ö

Several industry players cite the initial public offering of ICBC as the great symbolic event of ChinaÆs rise. ôIt was the most significant event in 2006,ö suggests Konyn.

But the ICBC deal was not without controversy. The house view at Pictet Asset Management is that the listing can be taken as both a positive and a negative event.

ôFor bulls, it was a sign that Asian markets are entering a new era of transparency, and reflects the emergence of banks from the bad debts accumulated over the past 15 years,ö says Amy Cho, regional head of business development at Pictet Asset Management.

ôBut for bears,ö she adds, ôthe easy flotation suggests irrational exuberance; that anything can be sold if it is packaged well. The jury is still out.ö

In addition to the bank IPOs, China led a long-term trend of appreciating Asian currencies, notes Bratin Sanyal, head of Asian equity investment at ING Investment Management. This in turn helped fuel rising global demand for Chinese assets, which he considers a new and important development.

ôFor next year we are confident that currency appreciation will continue,ö Sanyal says, ôbut we also see the development of a consumer economy in China as significant. The strength of the Chinese economy will facilitate the shift to a focus on domestic demand and this is a theme we expect will continue into 2008.ö

Henry Chan, director of Asian equities at Barings, adds: ôA lot of the outperforming companies in China are in the financial and consumption-related sectors, rather than exporters. This signals the transition of growth derived from capital to a domestic consumption-driven era. In 2007 consumers will not only drive growth in China but will also become a strong engine of growth for the Asian region.ö

Several investors site oil prices as a major risk for Asian economic growth, along with a sharp downturn in the US consumer-led economy. But while a return to the high prices of 2005 when oil topped $70/barrel, fund houses expect commodity prices to moderate.

ôThe most predictable event in 2007 will be a significant fall in the oil price,ö says PictetÆs Cho. ôAt present levels of around $65/barrel there is a large speculative element supporting the price above the natural dictates of supply and demand. One sign is the level of inventory build-up in the US, Japan and Europe. A fall in the oil price would deflate interest in commodities while reviving the appetite for risk.ö

The big threats to Asian economic growth seem to be receding. Rising domestic demand can offset a slowdown in the US; oil prices may well go down; and China will continue to drive growth and the appreciation of regional currencies. For equity investors, Asia looks ready to outperform in 2007.