Global Economics

Asia: Market Mayhem Worsens


The U.S. mortgage market crisis continues to pummel Asian equity markets, and the selling was fast and furious across the region

Aug. 16 began in Japan's capital city with a 4:15 a.m. earthquake and ongoing tremors that continued nearly right up to the opening of trading on the Tokyo Stock Exchange. That turned out to be the perfect metaphor for another day of heavy losses at that bourse—and even more ferocious ones in Asian emerging markets such as Seoul, Jakarta, and Manila, where stock prices plunged in the 6% to 7% range.

Over the past two weeks, the market mayhem emanating from the U.S. mortgage credit crisis has steadily vaporized wealth across the region. By one closely watched measure, the Morgan Stanley Capital International Asia-Pacific Index, regional stock markets tracked and weighted by size in the benchmark have just about surrendered all their gains in 2007. "These are very difficult market conditions. It is extremely ugly," says Paul Schulte, chief equity strategist ex-Japan at Lehman Brothers (LEH) in Hong Kong.

Every major Asian market took it on the chin today. The Nikkei 225 Index slipped 327 points, or 2%, taking it to the lowest level since Nov. 29. The index, which at one point was down 616 points, recovered in late trading but has still lost more than 1,000 points in the past week. The Hang Seng index shed 3.25% and even stocks traded in Shanghai, which haven't lost much ground in recent weeks, lost 2%-plus of their value. (Still, the Shanghai Stock Exchange Composite Index is still up 78% so far this year.)

The damage was particularly harsh in Seoul, where the market was closed on Aug. 15 for a holiday. South Korean stocks went into a free-fall and the Kospi lost 6.93%, its biggest drop in five years. Foreign investors, whose ownership accounts for more than a third of the market's capitalization, have far less of an appetite for emerging-market assets, given the great uncertainty hanging over credit markets worldwide.

Kiwi Dollar Decimated

"It is not a domestic issue but a global problem," says Chung Doo Sun, senior fund manager at PCA Investment Trust Management. "A nervous trading pattern will persist as long as the subprime problem stays." Downturns of a similar magnitude were felt in Jakarta, where stocks fell 6.6%, and in Manila's bourse, where shares tumbled 6%.

And one Asian currency, the New Zealand dollar, suffered its biggest drop in 20 years vs. the greenback and fell sharply against the Japanese currency, as investors dumped high-yielding government bonds. New Zealand government paper had been a favorite among yen "carry trade" investors, who borrow yen at low interest rates in Japan to finance better yielding investments abroad.

In the region's biggest economy, the carnage was such that the Bank of Japan again felt the need to inject funds in to the money markets. The BOJ, which had absorbed $13.7 billion of funds from the money market on Aug. 14, following earlier injections, today added a further $3.4 billion.

Yen Touches Five-Month High Against Greenback

In Tokyo, financials and big exporters again bore much of the ebbing investor confidence. Shares in Mitsubishi UFJ Financial Group, Japan's biggest bank, were down 2.6%, having shed 5.3% a day earlier. Sumitomo Mitsui Financial Group and Mizuho fell 3.2% and 1.5% respectively. Year to date, the stock prices of Japan's Big Three banking groups have each fallen by more than 20%.

Among leading exporters, Toyota (TM) and Honda (HM), down 2.7% and 3.6%, respectively, as the yen appreciated, briefly touching a five-month high against the dollar of 115.71 to the dollar. In late June, the yen-dollar rate was 123.

Yet, while the impact of the market turbulence is global, Japanese investors have more reason than most to grimace. Despite a solid economy and rising corporate profitability, up 15% in the last quarter year over year, the Nikkei 225 index is down 4.4% year to date. The Dow Jones industrial average, at least as of the close of trading on Aug. 15 in New York, is still up 3.4% on the year.

Japan Stocks Tied to Overseas Moves

Japan's big banks, in particular, may be feeling hard done by. After all, unlike many American and European counterparts, they are largely unexposed to the subprime chaos. On Aug. 15, MUFG said its subprime exposure was no more than $42.5 million, compared to quarterly earnings of $1.3 billion. It added that mortgages offered at U.S. subsidiary Union Bank of California do not include subprime loans.

Shinsei Bank (SKLKF), a smaller rival, earlier posted a $30 million charge (hardly a huge sum) in its quarterly earnings, while neither Mizuho or SMFG is believed to have large exposure. "Japanese banks are free from any crisis of funding and their exposure to subprime in the US is quite limited," says Hironari Nozaki, an analyst at NikkoCitigroup in Tokyo.

Richard Jerram, chief economist at Macquarie Securities in Tokyo, cites two factors that may explain why Japan's stocks seem to be suffering. First, Japanese shares tend to be heavily influenced by movements overseas when compared to other markets. This is perhaps a throwback to the domestic economy's weak performance during the 1990s, when listed companies were quite reliant on the fortunes of export markets to boost growth.

Not All Doom and Gloom

A more important factor today is that foreign investors represent a high proportion of turnover on the Tokyo Stock Exchange, owning about 30% of stocks but accounting for almost 60% of trading volumes. That means that when the global appetite for risk weakens, Japan's market can be particularly volatile as foreign investors move out en masse. "In other markets there's a greater breadth of participation so the market is not as sensitive to any single group of investors as there is in Japan," says Jerram.

Still, for all that—and despite today's sell-off—it's not all doom and gloom. Jerram eyes two sources of potential good news. First, Japan could become a safe haven because its institutions and consumers aren't exposed to the subprime problems in the U.S.. Also, its expansion, the economy has grown for 10 consecutive quarters, hasn't been fueled by a credit boom. Corporate bonds outstanding in Japan is just under 10% of gross domestic product, which is the same ratio as sub-prime and other high risk mortgage loans in the U.S., while broad liquidity has only growing at 2.5% a year.

Second, there are signs that the yen carry trade might not be quite the destabilizing force many investors have long feared. The practice, which involves borrowing yen at low interest rates and investing it in higher-yielding funds elsewhere, has long been suspected as a likely source of instability should investors suddenly begin unwinding trades. Indeed, Korea's Finance Minister Kwon O Kyu warned earlier this month that a rapid unwinding of yen carry trades could "create as big a turmoil as that in the 1997 foreign exchange crisis" in Asia.

Yet Jerram notes that the net noncommercial short-yen positions on the Chicago Mercantile Exchange (CME) have fallen by 80% since the end of June—seemingly signaling that the unwinding may have already happened to a large extent. Importantly, he argues that 5% strengthening of the yen in the same period isn't significant in macroeconomic terms. "If the carry trade has primarily closed, that's one market concern that has diminished," he says. Looking at today's market woes across Asia, investors should be happy for small mercies.


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