Thursday, May 21, 1998
Merrill Lynch economists project a continued bleak picture for Asia
Here, their strategy for weathering the crisis, which they say will deepen for at least the rest of the year
By Michael Brush
moneydaily.com
Overlooked during the impressive first-quarter rally in the U.S. stock markets, Asia is now back on the radar screen for investors. And the reason has nothing to do with civil unrest in Indonesia or nuclear testing by the Indian government.
Asia matters for U.S. investors because so many economies in the region are basket cases, and getting worse. They will continue to put a damper on U.S. growth -- as U.S. companies sell less and less there, and consumers here keep buying more from the region. Just look at Wednesday's bigger than expected trade deficit figures for March, if you need proof.
"Anyone who thought the Asian economies could make a V-shaped recovery this year has been sadly mistaken," says Bruce Steinberg, the chief economist at Merrill Lynch. "The economies continue to shrink rapidly with no evidence of stabilization. They are likely to continue to contract for at least the rest of the year."
In one sense, at least, that is good news. If Steinberg is right that Asia will help slow U.S. growth to 2.5% this year, then there is no reason to worry about the Fed raising interest rates. Concerns about a possible Fed hike have helped take the edge off the stock markets recently.
The bad news is that the slowdown induced by Asia helps create an environment in which it is hard for companies to raise prices -- and that is bad for earnings, since costs may start going up if workers get more money because of the tight labor markets.
Given these trends, here's what Asia means for your investment portfolio, say the Merrill Lynch strategists.
* Bet on bonds. On a risk-reward basis, U.S. bonds are the "asset class of choice" over next six to twelve months, says Steinberg. Interest rate-sensitive stocks will also benefit in the U.S. as market interest rates fall because of a slowing economy.
* Consider European stocks. The next asset class in line is European stocks. Yes, they have come up a lot recently. But continental markets still have more room to move because Europe is at the start of an economic cycle, and there is more restructuring to be done there, says Michael Hartnett, the senior international strategist at Merrill Lynch.
* Be wary of Asian exposure, and favor non-cyclical stocks. Tech stocks have some of the biggest foreign exposure, and a lot of it is in Asia. Look for companies with stable earnings in non-cyclical businesses -- or those that make products people continue to buy regardless of the state of the economy.
* Don't bargain hunt in Asia. It may seem like a good time to bottom fish in Asia because of the apparent value there. Not true. "This is illusory, given the really bad conditions of the Asian economy and how long it will take to repair it," says Steinberg.
Speaking of repairs, when will things get better in Asia? Not until at least two problems are resolved, the Merrill Lynch analysts told investors in a conference call Wednesday.
First, Japan has to turn around. One reason Mexico recovered so quickly from its financial crisis in early 1995 is that it was able to get a boost from the strong U.S. economy. Japan, which could pull up the rest of Asia, is in the dumps.
Yes, demand from other parts of the world might provide a boost, except that growth is expected to slow down in many areas, like the U.S. What would help the Japanese economy: Steps by the government to cut sales taxes -- not just income taxes. Also look for moves by the Bank of Japan to reinflate the economy.
Second, there has to be progress in the efforts to clean up the balance sheets of banks in the region. As long as they are crippled, there will be little money to lend. So far, the signs are not good. "GDP is contracting much more sharply than debt is being reduced, so the core regional problem of indebtedness and non-performing loans is worsening, not improving," says Hartnett.
That may not be as headline-grabbing as student protests in Indonesia, but when it comes to the future of Asian economies, it matters more.
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