International | Aug 10 2006
By Chris Shaw
Since the US Federal Reserve announced it was pausing in its cycle of interest rate increases earlier this week there has been growing speculation US rates have now in fact peaked and the next move will in fact be down as the US economy enters a moderate slowdown.
HSBC points out we may not have to wait so long for a rate cut either, as after the last three peaks in US interest rates there has been an average of 23 weeks before rates were subsequently cut.
But assuming this scenario of a moderate slowing in the US economy and a peak in interest rates plays out, is this a good enough environment to justify the 8% rally in the MSCI Asia Pacific Index since mid-July? HSBC says no, as historically a peak in US interest rates has not necessarily been a positive for Asian equities.
All markets in the region have shown some volatility in post-rate peak periods, while overall the performance shows global growth and therefore US economic growth is a more significant element to Asian equity market performance than is a peak in the interest rate cycle.
It notes current consensus estimates are for US growth to slow to 3-3.25% in coming months, though there remains a deal of uncertainty relating to this estimate and it is this uncertainty that suggests Asian equity markets are unlikely to enjoy significant outperformance in the short-term.
Adding to this, the bank points out earnings forecasts throughout the region (with the exception of Japan) are being revised down, so it sees little potential for Asian markets to continue their recent rally.
ABN Amro agrees, noting the market is currently pricing in a 40% chance of a US recession. While such an outcome appears unlikely at this stage the implication is the US economy will at least slow further, so investors should be tweaking portfolios to account for exposure to sectors likely to experience a fall if US growth does continue to decline.
It suggests Korea is a good example, as the cyclical stocks in that market are exposed to the auto, materials and consumer electronics sectors, all of which are exposed to the US economy. As a result, the broker has moved to slightly underweight from slightly overweight on Korea, while adding to its positions in Hong Kong, Indonesia and Thailand.
Leaving the final word to HSBC, it points out Asian markets are not expensive at current levels, as the Asia ex-Japan forward Price/Earnings ratio is just 11.6x. This suggests a full scale bear market appears unlikely, even assuming the US economy slows by more than is expected.
