Two bankers are competing to look after your money. One owns a grand, famous institution – but the man himself isn’t an impressive figure. He arrives late, seems disorganised, and there’s a hint of alcohol on his breath. Worse, there are dozens of red credit-card bills lying around his desk, which he covers up hastily each time you catch sight of them.
The other has a new, more modest building. But he seems efficient and well-organised, and his business is growing fast. And when you catch a glimpse of his personal bank statement, it shows a healthy balance.
So which one do you trust with your savings? The famous spendthrift? The up-and-coming saver? Or do you split the money between the two?
It may sound like a silly riddle, but it’s much like the decision that investors are making as the financial crisis rages. And overwhelmingly, they’re plumping for the first option. As Citigroup’s Yiping Huang puts it: “Despite the fact that the US is the center of the crisis, every time the crisis escalates, capital leaves emerging Asia.” It’s the old story of a “flight to quality” in times of stress.
Yet the “quality” that people are fleeing to simply isn’t there anymore. Despite its grandeur, America’s financial system is a shambles. Those overdue bills will have to be paid back, probably over decades. And that’s terrible news for investors in the US, unless you can cut deals like Warren Buffett.
So while the herd instinct means that as long as this panic continues, money will rush out of emerging markets and into Treasury bonds, we remain convinced that Asia is a far better place for your long-term investments…
One word sums up why Asia has such a bright future compared with the West – debt.
The table below from Christopher Wood’s Greed & Fear shows consumer debt as a percentage of GDP across the region.
As you can see, for the three key drivers of Asia’s long-term growth story – China, India and Indonesia – consumers’ debt levels are trifling, at between 10% and 15% of GDP. By comparison, the UK is burdened with 102% and the US (not shown in the table) is barely better at 98%.
And the amount going into consumers’ piggy banks tells the same tale. Chinese and Indian workers are big savers, salting away 20-25% of disposable personal income. Americans and Britons have forgotten the meaning of thrift, putting aside just 1-2% of theirs.
Asia is poised for a spending boom – but not quite yet
The result: Asia will embark on a huge consumer spending boom over the next few decades, while West cuts back and struggles to repay its debts.
Unfortunately this won’t happen overnight. The idea that with the hitherto indefatigable US shopper finally flagging, Asian consumers will pick up the baton and power the world economy to new heights next year is utterly wrong.
For starters, many of those three billion potential buyers in Asia remain very poor. The rise in wages that we’re seeing in China and India will help spread the gains of the last decade throughout society, but this will take time.
More importantly, even those who have money are often disinclined to spend, since they believe in saving for hard times, medical problems and old age. Only when they have a better social security safety net will they begin to open their wallets.
We’re likely to see reforms to help that along in the relatively near future, especially in China. But it won’t be instant and it won’t transform their economies in seconds.
The credit crunch comes to Asia
Since domestic demand can’t pick up all the slack from the US slowdown, we have a bumpy few months ahead of us. And unfortunately markets still aren’t prepared for this. With analysts continuing to forecast double-digit earnings next year, MoneyWeek Asia suspects that there’s a lot of disappointment yet to come on that score.
So it’s not just consumer debts we need to be looking at. We need to know that companies are in good shape and will be able to make it through the slowdown. And on the whole, things are encouraging. Debt levels are not generally an issue with Asian companies, as this chart from Citigroup’s Marcus Rosgen shows.
That’s good news, because the credit crunch has clearly come to Asia. The chart below shows the iTraxx credit default swap (CDS) indices for Asian investment grade and high yield (riskier) corporate bonds. A CDS is essentially insurance against a company defaulting on its bonds: the higher the price of a CDS, the more worried traders are about the company going broke.
As you can see, Asian CDSs have soared in the last few weeks as markets panic about anything riskier than government bonds. Why does this matter? Because CDS prices reflect (more or less) how difficult it would be for a company to borrow money in the debt markets and how much interest they would have to pay. And what these spiralling CDS indices are saying is that riskier companies – those with lots of debt or weak cashflow – may find it expensive or even impossible to borrow.
Signs of trouble in Hong Kong
Now, CDSs aren’t necessarily the most accurate measure of how tight credit is for all Asian companies. They may be in the US and Europe, where it’s very common for firms to issue bonds or for banks to lend them money and then sell the loan onto other investors. But in Asia, traditional relationship banking is much more important for most firms. In other words, the bank lends a firm money and holds on to the loan – the kind of banking that Western financiers considered too staid and dull for the 21st century.
So even if the credit markets are panicking, a firm with a good, long-term relationship with its banks is in a better position than CDSs would make you think. But nonetheless, credit is getting tighter. The chart below shows the rates at which banks lend to each other for the Hong Kong and Singapore interbank market. The recent spikes mean that banks have to pay more to borrow – and so they’ll have to charge more on the loans that they’re making.
And there are clear signs that vulnerable Hong Kong small and midcaps are struggling to get credit at all. In the last three weeks, watch retailer Peace Mark and swimwear maker Tack Fat have appointed liquidators after being unable to refinance loans, while clothing retailer U-Right has said that it’s unable to meet banks’ demands to repay its outstanding debt.
In these conditions, investors need to be cautious. Low consumer debt means that Asia can pick up strongly once the shock of the US recession is past. And healthy balance sheets mean that hopefully we won’t see too many firms going bust. But the weaker ones will go under as credit dries up. At times like this, low leverage and strong cashflows are an investor’s best friend.
Turning to the markets…
Many Asian bourses were closed for part or all of the week due to national holidays. Where trading took place, the mood was bearish with attention still focused on the US, and all the benchmark indices closed down on the week.
In India, Tata Motors has abandoned plans to build its new Nano – the world’s cheapest car – at a site in Singur, West Bengal. The state government’s compulsory purchase of land from farmers for the plant led to months of violent protests, and with no end in sight, Tata has decided to look for another site. Tata now risks missing its goal of having the Rs100,000 (£1,200) Nano on sale by the end of this year.
And in the financial sector, banks runs have now spread to ICICI Bank, India’s second-largest lender. The Reserve Bank of India, the country’s central bank, had to step with a statement that ICICI was well-capitalised and had no liquidity problems after rumours about the bank’s position led to a rush of withdrawals.
On the commodities markets, palm oil for December delivery closed the week at RM2,000/tonne in Kuala Lumpur, less than half its all-time record reached in March, while the SMR20 benchmark rubber price closed at RM8735/tonne, down from over RM10,000/tonne in June and July. Weaker commodity prices are a double-edged sword for Asia, reducing inflation but also cutting export earnings in Southeast Asia.