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Pastimes : The New Qualcomm - write what you like thread. -- Ignore unavailable to you. Want to Upgrade?

To: foundation who wrote (6000)	3/15/2003 8:55:31 AM
From: foundation	Read Replies (1) \| Respond to of 12231

Asia Pacific: Cyclical, Secular or Just Jittery Andy Xie (Hong Kong) Morgan Stanley Mar 13, 2003 A confluence of dark currents is occurring and geopolitical shocks are foremost on the minds of investors. Most would attribute market volatility and the sluggish global economy to such factors. I think not. The trade cycle is the most important force currently shaping the global economy, in my view. The secular deflationary force makes each cycle seem less pronounced. Geopolitical tension is icing on the cake that accelerates the cycle a bit. Asset bubble deflation, technological development and globalization remain powerful deflationary forces that shorten cycles. Profitability determines how long a cycle lasts. The current deflationary forces shorten and mute cycles, as profit margins do not increase much with growth and balance sheet holes soak up liquidity. Economic cycles remain prominent among economies that are maintaining competitiveness. However, many economies are losing competitiveness in a deflationary world. Singapore and Taiwan are candidates in this category. Their cycles become more muted over time. Korea has carved out a niche between China and Japan. It is much cheaper than Japan and several years ahead of China in terms of technology. Its competitiveness is likely to remain over the next three years. This is why its stock market is cyclical and not in a secular decline. It will change only when Korean companies have lost their technology edge over Chinese counterparts. Cycle Dominates in the Short Term Global trade has experienced an inventory-inspired cycle. Among developed economies, inventory reduction in 2001 turned into inventory buildup in 2002. The manufacturing economies in East Asia latched onto this inventory cycle and experienced rapid export growth. This inventory cycle is now peaking out, while final demand in the developed economies is yet to recover. This is why the trade cycle is turning down. The data on the trade cycle are still mixed. Taiwan’s exports in the first two months of this year rose 12.2% from a year ago compared with 14% growth in the second half of last year. Korea’s exports rose 24.2% compared to 20.3% growth for the same periods. Japan’s exports peaked in November and are decelerating significantly. The CRB index is off by 3% from the peak reached last month. The data suggest that global trade is not accelerating. Final demand data in the US and Europe remain soft. This combination suggests that Asia’s exports are likely to decelerate significantly in the coming months. Financial markets have sensed trade peaking for quite a while. Korea’s main stock index, the KOSPI, is off nearly 30% in three months. The Taiwan stock market is down 16% from the high in January 2003. Japan’s TOPIX is down 10% in a month. Financial markets in East Asia are highly sensitive to the trade cycle and appear to be anticipating a significant export slowdown in the second quarter of this year. The cycle will turn up again when fiscal stimulus in the US, interest rate reduction in Europe and oil price decline lift final demand in the global economy. The turning point is probably six months away, in my view. Financial markets may sense the turning point in weeks rather than months ahead. The pessimism today may give way to euphoria in six months, which would be another mistake, in my view. Deflationary Force Overlaid on Cycle The deflationary trend in the global economy remains intact and exerts a muting force on the economic cycle. The balance sheet holes that were created during the bubble are soaking up liquidity and making monetary stimulus less powerful. Technology and globalization are decreasing investment costs, which boosts effective nominal interest rates and needs fiscal stimulus to offset. The contest between stimulus instituted by authorities around the world and deflationary forces leads to short cycles. Stimulus usually covers a soft patch in demand between cycles. It reduces pain during a downturn. The economy comes back afterwards in a normal business cycle dynamic. In today’s world stimulus works for a short while and then disappears into balance sheet holes and horizontal supply curves. There is no sustainable growth dynamic beyond the immediate impact from fiscal or monetary stimulus. The global economy could turn stagnant when every major government in the world has cut interest rates to zero and runs a budget deficit of over 5% of GDP. It would be a world of deflationary malaise and no cyclical excitement. The world is entering an ice age. People are trying to stay warm by burning the wood they still have. Every time someone burns some wood to stay warm, it radiates warmth to everyone. When the last wood has been burnt, people will finally accept that the ice age has come. Geopolitical Diversions Iraq and North Korea are diversions for financial markets, in my view. North Korea has been spooking investors for the past three months. It is an imaginary monster, in my view. It has a collapsing economy, starving soldiers and antiquated weaponry. I do not believe that North Korea is about to launch an attack on anyone. North Korea’s nuclear materials are scary. However, the risk to the world is more from the potential for accidents in the Chernobyl mold than the potential for North Korea to launch a nuclear attack, in my view. North Korea can hurt other countries through reckless actions at home rather than military attacks. There will be strong incentive for North Korea to tone down its approach when the Iraqi conflict is over. The division in the world community over Iraq is more fundamental. It is the beginning of a global realignment similar to what took place between WWI and WWII. The risk for investors may be rising permanently. However, markets are now focused on the risks associated with how the Iraqi conflict would turn out. It is a much smaller risk than associated with global realignment, in my view. Could anyone seriously question the military outcome? The chaos scenario isn’t likely either, as there would be enough upside for everyone involved. The price of oil is likely to decline precipitously in the near future, in my opinion. More supply, warmer weather and weaker trade could cause Brent crude to drop below US$20/bbl in the near future, in my view. Korea vs. Australia Korea seems to lead Australia in anticipating the cyclical downturn. The Korean won now trades at W10.6 to the Japanese yen. It is down from under W10 last month. This is consistent with its historical pattern. When the cycle turns down, the Korean won tends to trade at close to W11 against the yen, while it tends to trade at W10 against the yen when the cycle is moving up. Korea’s equity market is experiencing a classic sell-off at the bottom. The KOSPI has come down about 30% in three months. It is the index most sensitive to the global cycle, in my view. Korea’s markets will have fully adjusted when the central bank cuts interest rates, which may spark a bond sell-off. Korea’s credit cycle is turning down hard. The market fears a credit crisis, and corporate scandals reinforce the fear. However, isolated balance sheet holes would not turn into macro disasters in Korea. Its power structure can move liquidity around the system quickly. Australia is at the other end of the spectrum in terms of adjusting against the cycle. The Australian dollar is a commodity currency that has turned bubbly recently. The rise in the CRB index justified some of its appreciation. Yield chasing has turned it into a bubble, in my view. Hong Kong retail investors were lining up for guaranteed return funds in Australian currency. Queuing is the best bubble indicator in Hong Kong. The CRB index is about 3% off the peak reached last month. It is likely to decline further with deceleration of global trade. This fundamental force is pushing the Australian dollar down. The bubble demand can unwind quickly in a downtrend. In my opinion, the Australian dollar has a difficult time ahead.