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Russell questions speed of Asian economic recovery

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Russell Investments has described the equity market rally across Asia as ‘breathtaking’, but has questioned its speed and size and whether Asia is now more vulnerable to any disappointm

Russell Investments has described the equity market rally across Asia as ‘breathtaking’, but has questioned its speed and size and whether Asia is now more vulnerable to any disappointment in the pace of the global economic recovery.

According to its quarterly Asian Barometer, looking at equity benchmarks from the recent low on 9 March through 11 September the Russell Global Index reflected a gain of 68.5 per cent compared to the 55.8 per cent for the US large-cap Russell 1000 Index.

The report says this outperformance is a result of the fact that Asian economies (aside from Korea) went into the crisis with low gearing levels, high savings rates, current account surpluses, strong fiscal positions and banks financed by domestic deposit. In addition, stimulus measures across the region, especially in China, were broadly successful.

The Asian Barometer also explains that Asia’s role as an exporter of manufactured goods means that it has benefited from the global inventory re-stocking that has driven the early stages of economic recovery.

However, the author of the Asian Barometer, Russell’s Asian and Australian investment strategist Andrew Pease, says global inventory re-stocking can provide only temporary support for Asia’s export growth.

‘The region’s short-term outlook is dependent on major economies pulling out of recession by the year end and while this appears to be underway, with Japan and Germany recording growth in the June quarter and the US economy likely to expand in the current quarter. The issue for Asia will be whether economic growth rates can be maintained in the face of weaker global export demand.’

Pease says the big question will be whether Asia, and especially China, can transition from export dependence to a domestic demand driven growth model.

‘Longer-term, the issue for Asian equities is whether regional companies can grow their earnings by enough to justify the premium valuation rating. We’re cautiously optimistic that this will occur but much will depend on the pace of global economic growth post the initial recovery from recession and on the strength of domestic demand within the region,’ says Pease.

The Barometer says the biggest turnaround in sentiment since April has been for Korea, where the forecast for 2009 GDP from the Consensus Economics survey has been revised higher by 2.3 percentage points to -1.5 per cent. GDP rose 2.3 per cent in the June quarter – the fastest growth in five years. The recovery reflected the rebound in exports (helped by the 17 per cent depreciation in trade-weighted Won over the past year) as well as aggressive monetary easing by the Bank of Korea and a series of front-loaded fiscal stimulus packages.

Pease says China’s economy has been remarkably resilient to global downturn with GDP growing at 7.9 per cent in the year to June. He says that the immediate challenge for China’s leadership will be to withdraw stimulus measures as exports’ growth returns. Further, there are already fears that housing demand is heating up again that credit availability will need to be tightened. He says that longer-term China needs to shift to a growth model less depend on fixed investment spending and exports and more focused on consumption.

The Russell Barometer says that after such a strong rally across the region it is difficult to draw robust conclusions about relative valuation. However, it explains that Hong Kong and Singapore still stand out on valuation grounds because these two markets have the lowest PE ratios.

Taiwan remains an enigmatic market with its forward PE ratio having declined from 30 times in April to 21 times in August. Taiwan’s PE ratio is the highest in the region relative to the normal level. The consensus expects 66 per cent EPS growth over the next 12 months.

The report says that the PE ratio for India is broadly in line with normal levels relative to the region and at 16 times, it is slightly above the ten-year average of 14 times. The consensus for India expects 31 per cent EPS growth over the next 12 months meaning a lot of recovery is already priced in.

While Asia has been the strongest performing region since the market bottom in March, the Russell Asian Barometer concludes that most valuation metrics now place the region as either fully valued or slightly expensive. However, the report does say that Asia deserves its premium rating and should continue to outperform developed markets.

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