Nikkei Asian Review

By William Pesek

Echoes of 1997 and 2007 in frothy Asian equity markets

The Donald Trump rally coincides with two anniversaries for Asian stocks — neither very comforting.

The obvious one is 2007, just before the “Lehman shock” pulled the rug out from under global markets. Last week, Asian shares surpassed their 2007 peak, with the MSCI Asia Pacific Index up almost 30% this year.

The other is late 1997, when the so-called Asian flu began spreading to all corners of the globe. The Dow Jones Industrial Average’s 554-point nosedive on Oct. 27 of that year presaged a November that, 20 years on, still strikes fear in the hearts of policy makers, corporate executives and hedge-fund managers.

The question, of course, is whether today’s equity boom will end as nastily as earlier periods of exuberance?

The froth factor

Weeding through investment views around Asia, there is little sign of notable concern, never mind panic. And that is precisely why investors should worry this 2017 rally is running ahead of underlying economic fundamentals and ignoring risks of a reversal.

The surge in shares from Tokyo to New Delhi and from Hong Kong to Jakarta is largely driven by investor momentum. As stocks rise, skeptical investors are racing to get in on the action. That might be less problematic if a disproportionate amount of that thrust were not based on President Trump making the U.S. economy great again.

The odds are dwindling in sync with the decline in Trump’s approval ratings. Even if his Republican Party manages to cut taxes, it might damage Washington’s creditworthiness more than raise incomes. Nevertheless, the Dow’s 23% jump over the past 12 months — roughly since Trump’s victory — is carrying global markets along for the ride. In Asia’s case, all too many bourses are running ahead of Wall Street for questionable reasons.

Hong Kong’s Hang Seng Index, for example, is up 31% over the last 12 months, compared with a 7% drop in 2016. India’s benchmark index is up 30%, compared with a 7% loss. South Korea is up 29%, compared with a modest 3% gain. Japan’s Nikkei Stock Average is up 24% after rising 5% in 2016.

All that has changed in that time is the occupant of the White House. China’s growth is pretty much a repeat of last year’s. Japanese wages and inflation are still negligible five years into Prime Minister Shinzo Abe’s revival scheme. Europe’s contribution to demand remains spotty, while the Brexit drama puts efforts to fine tune economies on hold. Again, the Trump effect.

Looked at economy by economy, it is easy to understand why Olivier d’Assier, head of applied research for Asia at Axioma, worries “we are very close to the irrational exuberance that Greenspan talked about” in the mid-1990s. Then-Federal Reserve Chairman Alan Greenspan, it is worth noting, was referring to the Nikkei’s boom and bust in the 1980s when he warned of U.S. asset bubbles. Moreover, d’Assier told Bloomberg, “investors need to ask themselves where is the value when new highs are being reached everywhere and the risk of a trade war between the U.S. and China is increasing.”

What Trump gives in the form of trading momentum, his administration could yank away in an instant. With Trump’s legislative agenda in tatters, China doing little to curb North Korea and Russia investigations swirling, Trump may start a trade battle to rally his base. His new Fed chairman, Jerome Powell, is another wildcard. A more hawkish Fed agenda couldroil Asia.

Vietnam’s stock surge, on its own, might make more sense if Hanoi were working faster to strengthen the financial system and tighten corporate governance. Korea’s would seem more rational if not for Kim Jong Un’s missiles, record household debt that is denting consumption and a government dragging its feet on reforms to up competitiveness.

India’s advance might seem less excessive if bad loans in the banking sector were not at 15-year highs and Prime Minister Narendra Modi were acting more boldly to overhaul antiquated labor, land and tax systems. The 22% gain in the Philippines (it fell 3% in 2016) seems a bit much as the President Rodrigo Duterte’s men focus more on shooting than retooling.

And then there is the Nikkei’s stunning 127% boom since Abe took office in December 2012. Abenomics is in a bit of sweet spot, as Japan enjoys its longest expansion since 2001. The weak yen filled corporate coffers and pumped up profits coming in from abroad. The absence of notable wage gains and inflation, though, shows the limits of relying on ultra-loose monetary policies.

One tweet away

Abe has pulled off few big reforms to modernize labor markets or increase productivity. Efforts to internationalize boardrooms have been overshadowed by the scandal about Kobe Steel’s fudged data, Takata’s potentially deadly airbags or Toshiba’s accounting irregularities. And as Nikkei Asian Review explored in a Nov. 15 cover story, any reduction in BOJ largesse could slam the Nikkei.

Caveats abound here. Based on MSCI data, forward price-to-earnings ratios in emerging Asia are about 12.8, roughly half their 1997 level, but in the same vicinity as 2007. An argument can be made that expectations for global growth are lower today than in 2007. Add in the historic drop in interest rates over the last 10 years — drops that could be reversed in 2018 — and you have valid arguments for stock sticker shock. Valuations in Japan are roughly 14.6 times forward earnings, slightly above emerging Asia.

Twenty years after the 1997 crisis, Asia is generally still too reliant on exports and not enough on domestic demand-led growth. That was clear enough a decade later when the U.S. economy had its own reckoning, one that slammed exporters.

Now, Asia’s froth confronts the most erratic American leader it has arguably ever seen. The $1 trillion infrastructure boom Asia thought would boost global demand is not happening. A giant tax cut for the wealthy, financed by Chinese and Japanese savings, would mean little for global growth. And Asia lives just one angry Trump tweet storm away from a trade crisis.

It is impossible to say how investors in 2027 will look back upon today’s bull run. Will posterity buzz about an “anniversary effect” that sees Asia losing the plot every 10 years? Let us hope not, but there are valid reasons to fear things could end badly again.

William Pesek is a Tokyo-based journalist and author of “Japanization: What the World Can Learn from Japan’s Lost Decades.” He has written for Bloomberg and Barron’s.

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