Asia's Still Not a Popular Bet

A few meetings with U.S. investors is enough to dispel any notion that we have begun to see a major asset-allocation flow back into Asia ex-Japan. International investment remains firmly out of fashion in America, with the high-beta bet still provided by the Internet plays and the like. Flows into Asia will only really recommence in size after a longer period of outperformance, which may have to include a weaker Wall Street. This flood will eventually come, but it will take time. This year is not going to be a repeat of 1993.

The renewed softness of Asia's markets follows the correction theme outlined in Asia Maxima. True, the MSCI Far East Free ex-Japan benchmark index has not quite reached our resistance level of 320, with the recent high being 314. Still at the risk of being a little premature, Greed & Fear will raise some cash out of the benchmark markets.

Three percentage points will be taken from Korea, two from Singapore and one from Thailand. Five percentage points will be allocated out of the index. Of these, two will go to cash and three to India, which has just broken out of its long-term trading range, as anticipated.

The argument for India was made in a previous column. This market should enjoy positive momentum given the recent scaling of new highs. Indian retail investors will be excited, while foreigners, who have been tending to ignore India, will be forced to sit up and take notice. India is enjoying a cyclical earnings recovery without the risk of higher interest rates. The market has also proven in the past that it can run when the rest of Asia is not performing. This could be another such time. Added fuel for the fire will come if the BJP does well in the forthcoming elections. The BJP is the party of the stock market, though a coalition led by the Congress party would be unlikely to make any radical policy changes.

The remaining percentage point will be used to double the exposure to China, namely H shares and B shares, in order to take advantage of the recent correction in prices. China is engaged in a full-scale campaign to try and combat deflation. Whether it works will not be clear for another six months. In the meantime, the efforts to ease in a monetary sense are likely to remain positive for China stocks.

This is most clearly the case in the A-share market, where volumes are huge. Average daily turnover in China's A-share markets rose 388% to 36 billion renminbi, or $4.3 billion, in June-July 15 from 7.4 billion renminbi, or $0.9 billion, in the first five months of this year.

The more bullish position on China is not to imply the mainland's problems are over. For now, there is a monetary easing which investors can exploit. Whether the increasingly desperate policy works, in terms of execution, is another matter. Ultimately, the stock market boosting measures could backfire when the bubble bursts because of the resulting blow to consumer confidence. Greed & Fear remains of the view that China is the one place left in Asia that could still go seriously wrong.

It is interesting to speculate whether Lee Teng-hui's verbal intervention this past weekend was prompted by a sense that China is too preoccupied with its own problems to retaliate. Still the deliberate raising of the stakes, with the suggestion that China and the island are separate states, has, not surprisingly, made local investors nervous. Still, the market was ripe for an excuse to sell, with margin loans back at the old highs and with electronic stocks at the top end of their trading range. Greed & Fear's view is that foreign investors will rush back into their favorite electronic stocks on any sign that the local panic has subsided. Still, it is risky to make a big overweight bet here since the Taiwan premier's exact motivation remains, to Greed & Fear at least, somewhat unclear. However, it should probably be interpreted as political positioning ahead of Taiwan's presidential election next March.

The selloff in Argentine assets this week serves as a reminder to investors in Hong Kong of the dangers of the currency board system. Currency boards tend to be more favorable to bondholders than stockholders. That's why Argentine bank bonds are now a great buy if Argentina sticks to convertibility with a current spread of 13 percentage points over the Treasury equivalent. If Argentina moves subsequently to outright dollarization, this will clearly prove to be a stupendous buy.

A greater Argentine ricochet effect offset through Hong Kong seems unlikely at this juncture. HIBOR has risen only a relatively modest 19 basis points. Hong Kong will be tested more if and when China finally moves to allow a currency adjustment, an event that must surely await celebration of the 50th anniversary of the communist revolution on Oct. 1. Still, any rise in the risk premium at all is bad news for Hong Kong.

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