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Evidence of Asia's Recovery Unpersuasive

May 17, 1999

I made an uncharacteristically bullish prediction here six weeks ago when I wrote that the Dow Industrials would tack on 2,000 points by mid-summer if Asia's economies began to lift from their long dirge.

Remarkably, the blue chip average has already achieved half those gains and is currently trading around 11000. It's time we revisited the subject, since my longer-term projection was for Dow 15000, assuming that Asia soon comes roaring back to health.

Signs of economic recovery in the region are being touted with increasing frequency by the business press and on financial talk shows. Like Elvis sightings, however, the further you pursue the evidence the thinner it gets.

More on that in a minute.

First, though, we should note that Wall Street seems to care little about the evidence, whatever its quality. With $15 billion to $20 billion of fresh money to throw at stocks and bonds every month, fund managers understandably do not like to wait around for mountains of proof to materialize.

And with many more billions in international "hot money" chasing bargains all over the world, it's no wonder many institutional investors should take as their motto, "Act now, rationalize later."

So the big cats have been pouncing aggressively on every statistically bullish mouse that shows a whisker, driving share prices parabolic in some countries that just six months ago were snubbed as investment pariahs.

The effect has been spectacular, if not to say alarming. If you think our Internet stocks have been hot, you should take a look at brokerage stocks listed on the Korean exchange. They're up 300% to 500% from their 1998 lows, ranking among the world's best performers. The Seoul Composite hasn't done too badly either, having risen 290% from last June's bottom.

The bullish orgy since last summer has not been confined to Seoul alone. Thai shares have more than doubled off their lows, Singapore's have risen 140%, Malaysia's key index has surged 174%, and Philippine's 134%. Even in Japan, where talk of recovery has remained disquietingly muted, the Nikkei Average has risen smartly off October lows at 12879 and is now trading around 17300

One might ask, Is the exuberance rational? Statistics do indeed suggest a U-shaped upturn in the economies of Korea and Thailand and a stabilizing of those elsewhere in the region. But such recoveries are dangerously incongruent with the deep-V bottoms that we are seeing in the stock charts.

Clearly, share indices have gotten a bit ahead of themselves, prompting Fed Chairman Alan Greenspan to remark last week that, for all the hubris surrounding Asia's booming stock markets, the region's economic recovery is as yet "fragile."

I spoke with three experts last week who corroborate this view: Dr. Mark Faber, a Hong Kong-based consultant and internationally known figure whose opinions on Asia are widely quoted; Eric Fry, editor of "Grant's International" (formerly "Grant's Asia Observer"); and Tomas Larsson, correspondent in Thailand for "Business Asia," a newsletter published by The Economist.

Going sharply against the consensus, Dr. Faber turned bullish around the time Asian stocks were bottoming in early 1998. He reasoned correctly that shares prices were so depressed that they could only go up.

Now he sees them as frothy and imperiled by growing odds of a bear market in U.S. stocks, which he says carry extremely high valuations. Were the bear to come bellowing forth in the U.S., says Dr. Faber, the nascent recovery in Asia would get squashed.

Still, compared to U.S. stocks, Dr. Faber thinks there is value in Asian shares, particularly in Japan. Because most Asian issues are still trading well beneath their pre-1997 highs, Dr. Faber expects them to outperform ours regardless of whether the world's stock markets rise or fall over the next couple of years. He especially likes resource-based economies due to recent price firmness in a broad range of commodities. Thailand and Australia are two of the countries on his short list.

Ironically, the money that global investors have been pouring back into Asia could have a negative effect, Dr. Faber theorizes. "The sharp fall in interest rates that we have witnessed there in the last six months has postponed structural reform and prevented 'creative destruction' " among weak businesses, he says.

The implication is that the foreign liquidity that has sparked rallies in Asian stocks and bonds will provide no quick fix to the structural problems that underlay the 1997 Asian bust, and investors are deluding themselves to think otherwise, says Dr. Faber. Absent a bear shock from the U.S., however, he sees Asia slowly emerging from the doldrums over a period of several years, much as the U.S. did in the 1980s.

Reporter Larsson similarly believes the flow of foreign money into Asia can do little good right now, since the recipient countries already have high savings, low capital investment and turgid economic growth.

Moreover, like Dr. Faber he thinks it may prove to be counterproductive. "Cheap capital allocated inefficiently was what caused the Asian crisis in the first place. Well, now there's a lot of cheap capital available again, and there are still no efficient mechanisms to ensure that corporations are managed in a responsible way."

Larsson says that even though the flawed Asian model is alive and kicking, his gut feeling is that it can only lead to a repeat of Japan's experience, whereby Asia gets stuck in a rut. "Asia will see some economic growth -- the average rates will be low -- but we will see spurts of higher but low-quality, non-sustainable GDP growth, fueled by Keynesian fiscal stimulus packages."

Still, he says, the runup in stocks make sense, even if it will prove to be short-lived like a similar spurt that occurred in early 1998. "With strongly positive trade balances, IMF support and high - and in some cases increasing - savings rates, there's an abundant amount of cash floating around Asia. All this liquidity has found its way back into stock markets as interest rates have fallen, driving up valuations, and attracting the attention of foreign fund managers fearful of missing out on a bull run."

A worrisome sign for Larsson is that the money managers seem to be bypassing promising small-cap and micro-cap stocks whose growth could put Asia's recovery on more solid footing. Meanwhile, although capital flows may have stopped the Asian free-fall, that does not necessarily spell recovery, says Larsson.

"Grant's" editor Fry similarly sees only the frailest signs of economic progress: rising prices for stocks and bonds, bullish anecdotes from the trenches and a steady if less than robust pulse from the industrial sector. All of it together does not warrant the conclusion that a recovery has taken root, says Fry, who for 15 years managed an international portfolio of securities.

Concerning the steep rise in share prices, he notes that investors rarely have all the evidence they need to take the plunge confidently. That's why, when there is "just a whiff of an uptick, the hot money is all over it," he says.

The rallies are deceptive to the extent they are driven in large part by the presence of some big U.S. fish in a relatively small Asian pond, says Fry. He notes that just a small allocation shift by some of the huge American funds could produce "fireworks" in a stock market such as Thailand's, whose total capitalization is "less than that of a single U.S. stock, Amazon."

While Fry believes that the renewed flow of capital may reduce the impetus for structural reform, he says it is still better to have money flowing into Asia than out. He also says some of the more astute money managers will be vindicated down the road for paying what may now seem like hefty premiums for stocks. "If they don't pull trigger now, they will pay a lot more later on," he says.

For now, he regards the region as a stock-picker's dream. Fry says Australia and New Zealand look fascinating, and Thailand and Korea pretty good. But he is "agnostic" toward Malaysia and "wouldn't touch Indonesia with a ten-foot pole." The worst is probably over in any event, says Fry, who cautions that that does not necessarily mean share indices will not scrape bottom again before they head for blue sky.

China is the world’s biggest gold producer with more than 355 tons annually. Australia is second.
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