Bear Sterns on Asia
Jack and thread: Here is an excerpt from Bear Sterns report on Asia crisis and its implications.
Speaking of the 'crisis' they begin by saying.................
This is a regime shift. It may be as big as the ones in 1971 and 1982. With Indonesia's free-float of the rupiah in September, the world moved out of what we had view as an ideal environment for financial assets-ever-sounder world money, falling inflation, and rising dollar GDP. Since mid-1997, the world moved to uncertain values for currencies including the U.S. dollar, a debilitating speed limit on acceptable growth rates for emerging markets, and much slower world dollar GDP growth.
This is a grinding problem for world financial markets. Asia's problems are worse than thought. The crisis is far from over - we are closer to the beginning than to the end........
Southeast Asia's dollar GDP will not return to 1996 levels for 5-10 years. Even then, its future growth rate may be limited to 4% per year rather than the 8% enjoyed in the old regime.
The U.S. is in a good position for a prolonged world crisis, enjoying low inflation, low unemployment, a balanced budget, and an efficient economy.........
The 1997 models are obsolete. It will be difficult to estimate earnings or GDP under the crisis subsides and the nature of the new regime becomes clearer. Still uncertain are Asia's social reaction to its impoverishment, U.S. monetary policy, the extent of world deflation, China's slowdown, Brazil's recession, and the effect on corporate earnings of price stagnation and sluggish volume growth.
Currency stability is the key variable. Asia's prospects won't bottom out until one of the countries restabilizes its currency, and there are still no signs of this. Instead, more countries might devalue, adding to the crisis. We don't expect devaluations in China, Hong Kong, or Brazil, but even here, the risk rising. The ongoing defense of their currencies will be costly and drawn-out.
IMF programs are harmful. They focus on fiscal and structural reforms rather than currency stabilization. The resulting devaluations cause high interest rates, inflation, reduced competitiveness, unemployment, and deep political tension. Asia's problems also include the strength of the dollar and overleverage, but the key cause of the full collapse has been weak currency policy.
Japan is in recession, not crisis. It is in a completely different situation from the rest of Asia. It is a rich country suffering from years of deflationary monetary policy. It is underperforming it potential but is not at risk of impoverishing itself. If monetary policy were fixed, Japan would recovery rapidly. However, Japan is deeply harmed by Asia's crisis in terms of lost exports, bad bank loans, and the devaluation of its investments. This has negative implications for its equities and currency. ..........
Equities worldwide will feel pressure in 1998 for the following reason:
Tough comparisons. The world already faced plentiful supply and intense competition after years of booming investment.
Dumping. Faced with catastrophe, Asia will be dumping inventories and slashing prices. Rather than an isolated effect, this will cause broad-based price stagnation in goods and services far removed from Asia.
Lost Asian demand. The markets have factored in the idea of Asia's growth rate falling from 8% to , say 1%. The understates the problem. Purchases are being cancelled. Letters of credit have become unavailable. Demand in Southeast Asia and South Korea will be a fraction of previous levels. Dollar GDP there will be down as much as 20% - 40%.
Japan and Brazil are entering recessions, while China and the U.S. are slowing. Consensus forecasts lag badly.
World dollar GDP, the source for dollar-based corporate earnings, is contracting as a result of Asia's collapse, the dollar's strength, and very low nominal growth rates worldwide. (See following piece.)
Percent Global Growth of Dollar GDP
ÿ.....................................1997 1998 1999 2000 2001
Would Have Been...........5.7% 5.4% 4.7% 4.7% 4.6%
Forecast.........................-0.5% 1.4% 4.2% 4.8% 4.6%
Weighing on PE multiples, the world faces the uncertainty of future devaluations (HK, China, Brazil, etc.)
Outyear earnings. Asia's crisis will affect not only the earning base (a one- time loss) but also the rate of earnings growth. The new economic model being established in Asia won't support the previous high growth rates.
Balance sheet deterioration. In addition to the quality of bank loans, Asia's collapse will affect the value of accounts receivable, fixed assets, Asian goodwill, etc.
Currency translation problems. Foreign currency weakness will reach its maximum negative effect on dollar earnings in 1998 due to year-over-year comparisons and fuller exposure to foreign currency weakness as 1996 hedges expire.
Strain on productivity. In the old environment of expanding world demand, productivity gains came from producing more form the existing overhead. "Cuts" meant a slower-than expected addition to costs. As world demand growth slows, productivity gains will have to come from actual cost reductions, a much harder proposition.
Most techniques for describing the economic effects of the crisis underestimate the losses.
Economic estimates are normally expressed using real GDP growth stated in local currency terms (for example, 2% real growth in Germany.) This underestimates the difficulty of generating dollar earnings growth in a strong-dollar environment. Across Asia, growth estimates are on the order of 0%-2% in real local currency terms, yet dollar GDP in the region will be down 20% to 40%. .........etc etc
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