Cautiously Bullish on Asia

Things are looking up in the region. Asia's biggest threat right now is the possibility of the U.S. bull market topping out.
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JAKARTA -- The theme of the forthcoming

Asia Maxima

, due to appear following Easter break, is that it has become time to be long-term bullish on Asia, including Japan, on a relative basis.

Global fund managers remain predominantly in the U.S. and Europe and underweight in Asia. Such an investment stance is now the wrong one. Indeed, it has been the wrong one for the past three months.

The

MSCI Asia Pacific Index

was up 10.7% in the first quarter, compared with a 6.6% gain in the MSCI's U.S. counterpart and a 3.3% decline in the MSCI Europe. The last time this region outperformed was in 1994.

Greed and Fear is not, technically speaking, a global strategist. But the informal recommendation from this quarter is that it makes sense to have a lower cash weighting in an Asian equity portfolio than it does in an American or European one.

There are all sorts of problems remaining in Asia, but the key point is that the trend is now in the right direction -- forward. This is not to say that economic growth is going to bounce back or deflation is going to dissipate as quickly as the bulls contend. Unemployment is going to continue to rise, most particularly in Japan, and consumption is going to remain depressed in such a recessionary context.

This is only to be expected since the initial process of restructuring is deflationary, just as it was in the U.S. in the early 1990s.

So where investors are discounting renewed economic growth later this year there is clearly room for renewed disappointment. Japan and Hong Kong are good examples. The latest monetary statistics in Hong Kong released this week again reveal no sign of a pickup in loans for use inside Hong Kong despite low loan-deposit ratios. Still, Asia stands out spectacularly on a relative basis.

The biggest risk to Asia is, by a long way, external: the growing evidence of technical deterioration on Wall Street, a sign of a long bull market topping out through sheer exhaustion. The day the Dow hit 10,000 this week there were 94 new lows on the

New York Stock Exchange

and only 46 new highs. Wednesday there were 52 new highs and 183 new lows

Most people are understandably tired of hearing how overvalued Wall Street is. Greed and Fear only turned bearish on this market last summer, having been positive throughout the 1990s.

There followed the

Federal Reserve

easing, prompted by the collapse of

Long Term Capital Management

, a move which future historians will conclude only extended the cycle at ultimately much greater cost. The subsequent liquidity-driven rally was also predictable given the stock market's normal reaction to lower interest rates. But it is now running out of steam while the major stock indices have yet to respond negatively to the back-up in bond yields.

Dangers of Deflation

Technical indicators are now almost universally flashing sell signs. Greed and Fear is doing so unreservedly. For in a bull market as protracted as Wall Street's, the chartists' art is what matters most since this shows the rhythm of the market.

Clearly a big down move in the U.S. still creates significant short-term downside risk for all Asian markets in absolute terms. But the key point about Asia is that it has been at the forefront of the deflationary crisis. The deflationary meltdown therefore lies, hopefully, behind us.

However, financial excesses in the U.S. clearly pose the risk of a deflationary aftermath there, while the core Euroland economies are already flirting with deflation. Asia is therefore likely to emerge out of deflation first.

The biggest risks in Asia of more nasty twists of the deflation screw exist in China and Japan. In both economies, proof that the reliance on crude Keynsian demand stimulation is not working will force more focused restructuring.

This is already happening in Japan. In China all hopes are still being pinned on government pump priming. The key point is that much of Asia is already in deflation. Europe and the U.S. are not yet in it. Greed and Fear does not accept the premise that it is impossible for Europe and the U.S. to suffer outright deflation, a view ascribed to by the still vast majority. Present stock market valuations discount that cozy assumption, just as they did in Tokyo in 1989 and the rest of Asia prior to the 1997 meltdown.

To bang on about deflation is also to risk boring people. But the eagerness with which the trend followers have jumped on the bounce in the oil price to argue the end of deflation is astonishing. That people can pin so much hope on the self-policing abilities of

OPEC

is bizarre. The latest agreement means that nearly 10% of the world's oil supply will be voluntarily taken out of production.

That means a lot of foregone revenue for the sake of producer harmony. Greed and Fear does not buy it.

Christopher Wood is the global emerging market strategist for ABN Amro and the author of The End of Japan Inc. (Simon & Schuster, 1994). Under no circumstances is this to be used or considered as an offer to sell, or a solicitation or recommendation of any offer to buy. While Wood cannot provide investment advice or recommendations, he welcomes your feedback at

commentarymail@thestreet.com.