The panic is over, but the worry has just begun. Desperate measures by central banks and governments have hopefully saved us from a complete collapse of the global financial system, yet markets remain unimpressed, managing only a brief relief rally on Monday.
It’s easy to understand why. There’s precious little good news anywhere. Take US retail sales for September: they were frankly terrible, down 1.2% on the month. It looks as if the redoubtable US shopper is finally tapped out, with all the consequences that implies for the global economy.
But beyond the recession fears, there’s a second reason for the turmoil. Increasingly, it looks like the financial world has changed. An enormous deleveraging is underway as investors from hedge funds to Russian oligarchs are forced to dump assets bought with borrowed money, sparking huge sell-offs in virtually every market.
If this change sticks, then the world will be a better place. We’d prefer to see an investment climate founded on solid companies and real growth, rather than financial chicanery. But the adjustment will create a lot of pain – and Asia won’t be spared all of it…
Asian real estate is set to suffer
By and large, Asia is much less leveraged than the West – including both consumers and companies. But there are sectors that depend on cheap, readily-available debt, such as the real estate business.
While we tend to think of America and Britain when it comes to real estate excesses, the real estate bubble was a global one. Asia was not immune, although it was probably more of a frothy boom than a real bubble there. Prices never became as insane nor was leverage as high as in the West.
Nonetheless, half the wealth of India, Malaysia, Singapore and South Korea is now tied to property, according to brokers CLSA. And most countries are seeing their once-buoyant markets sink. Prices in some Indian cities are reported to be down by 15% or more and it’s no surprise that DLF, the country’s largest property firm, has significantly underperformed the Sensex benchmark since the market peaked in January.
Hong Kong and Singapore haven’t been as hard hit yet. But their economies are heavily dependent on the financial sector. With cost-cutting banks now slashing jobs in Asia, big falls are likely next year.
A sharp slowdown in real estate in the most overheated markets was always on the cards. But with the credit crunch becoming much worse than almost anyone had expected, the fallout will now go further. And since real estate investment is a major part of many economies, the effects will be felt far beyond the sector.
Take China, where real estate accounts for around 10% of GDP. Investment in the sector was growing so fast that the government clamped down on lending to property firms and homebuyers last year in an effort to prevent things from getting out of hand. That move worked only too well: prices for newbuild apartments have plummeted in many cities and developers are abandoning projects or going broke.
Now, with the Chinese economy slowing, it looks likely that curbs will be relaxed to help support growth. But it’s unlikely that business will pick up quickly. On current trends builders are heading for real trouble. They’ve slashed prices, yet volumes are still collapsing as buyers hold out for even bigger falls (see chart below).
Growing signs of a serious slowdown
The real estate slump is one reason to expect Asian growth to disappoint next year. And there are plenty of signs of a slowdown elsewhere, like the Baltic Dry Index which has collapsed back towards pre-2002 levels.
The Baltic Dry Index measures the cost of shipping raw materials such as coal and iron ore by sea. A collapse in the index means that shipping rates are falling, suggesting that global trade is slowing sharply.
To be fair, the precipitous drop you can see may be overstating things, since speculation may have driven costs up beyond reasonable values in the first place. While you might think that shipping rates would be safe from speculation, there are rumours of people booking ships with the intention of selling the booking on again – just like property flippers.
What’s more, risk-averse banks are reportedly reluctant to issue letters of credit – guarantees of payment that play a vital role in the import/export business – meaning that a lot of goods that would otherwise be shipped may be waiting in warehouses and on docks (there’s more on this in this week’s MoneyWeek – sign up for a three-week free trial). So there may be pent-up demand for goods that’s not being filled.
But plenty of other indicators are also pointing to a slowdown. Consider Chinese electricity production, which is probably a better indicator of the country’s growth than the official GDP statistics.
In September, electricity production was up 9% year-on-year, after 5% growth in August and 8% in July, down from 14%-16% earlier this year. Since electricity production is widely reckoned to be growing faster than GDP in China, this suggests a very abrupt slowdown in the third quarter.
GDP may not be as bad as the electricity numbers suggest – output was undoubtedly affected by coal shortages and the Olympic-imposed industry shutdown around Beijing. But it suggests that anyone expecting 9%-plus growth in China over the next few quarters could be disappointed.
In fact, we’ve just learned that the first estimate of China’s GDP growth for the third quarter – released today, ahead of schedule – came in at 9%, down from 10.1% in the second quarter and below the consensus estimate of 9.5%. What’s more, based on the electricity numbers, that could still be an overestimate. Many economists believe that the authorities have a history of overstating growth during downturns. We’ll be watching this – and other confirming numbers such as electricity, steel and raw materials demand – closely over the next few months.
Slower growth will feel like a recession
What could disappoint investors even more is that growth doesn’t need to fall to zero to feel like a recession for the Chinese. To the West, 6% growth is pretty impressive. To a country that’s grown at 10%-plus for several years and needs to expand quickly to continue lifting people out of poverty, a slowdown like that would be a serious jolt. And if China slows, the effects will ripple through Asia. For many smaller countries, China is their key export market.
More self-contained economies such as India and Indonesia won’t be so affected by China, but they are facing their own slowdown. Their economies have been helped by rapid credit growth – as you can see in the chart below, loans outstanding for both have grown much faster than in China (although there’s reason to believe that China has a significant informal lending sector outside the banks). With credit getting tighter, this pace is going to slow and that will have a big impact on economic growth.
What does this mean for investors? None of this is a long-term problem for Asia and there’s still good reason to expect the region to recover faster than the rest of the world. Once the stockmarkets settle down a bit, we’ll be back to looking for ways to invest in our favourite themes. But we’re becoming increasingly cautious about the near-term.
Serious value is now appearing for long-term investors, even in sectors like manufacturing which will be clobbered by the global slowdown. Many solid firms are now priced as if they’ll be going out of business. But for many sectors such as real estate, construction, discretionary consumer goods and banks with loan books full of risky assets, the problems may only just be beginning.
Turning to the markets …
Asian markets bounced sharply after Western governments announced a series of unprecedented support packages for their troubled banks, but the rally quickly ran out of steam. Only Japan posted a strong gain over the five days, with the Topix benchmark rebounding after closing below book value (the net value of its member companies’ assets) for the first time.
There were slight signs of improvement in the credit markets. In Hong Kong and Singapore, three-month Hibor and Sibor – the rates at which banks borrow from each other – are starting to fall back after rocketing when the latest wave of fear hit the markets. However, they remain well above normal levels, while fear remains high in the bond markets. The iTraxx Asia credit default swap indices – which measure the cost of insuring against companies defaulting on their debt – are at or near record levels.
In South Korea, the government was forced to guarantee $100bn in lenders’ foreign currency debts and loan them $30bn in US dollars. Korean banks borrow up to 12% of their funds in the international markets, which has fuelled worries that the global credit crunch could cause severe liquidity problems for them. The government also announced tax incentives in an effort to boost investment as the economy slows.
And in India, the central bank surprised everyone by slashing rates by one percentage point to 8%, the first cut since 2004. The move is intended to improve investor and consumer confidence, but some analysts felt that the suddenness and size of the cut could suggest that the central bank is panicking about a possible hard landing for the country.