The region has been hit by concerns over a US slowdown and rising risk aversion in the wake of the US sub prime mortgage crisis, with many investors seeing Asian markets as a high beta play on US Growth. Foreign investors have consequently sold down Asia aggressively as a way to reduce risk in their portfolios.
Rising inflation has also negatively affected Asian equity markets. Inflation, especially food inflation, is now at multi-year highs in most Asian countries, with inflation numbers in China, India and Indonesia particularly high. The possibility of further monetary tightening around the region and the impact of rising input prices on corporate profitability have to be monitored closely.
Finally, valuations had begun to look stretched, sparking some profit taking. After a 40% run in 2007, Asia ex Japan started 2008 with a PE (price-to-earnings) of 16x, the first year since the start of the decade where Asia entered the New Year trading at a premium to most other global equity markets. It is therefore perhaps not a surprise that Asia, particularly China and India, experienced the most profit-taking/foreign-led selling in the first quarter of 2008.
The global economy is weakening and inflation in China remains a threat. Therefore, Asian markets are likely to remain volatile over the next couple of months. Several Asian markets, especially the Indian equity market, also remain vulnerable to changes in global risk appetite as foreign inflows have been the major driver of these markets. We therefore continue to monitor fund flows and global risk sentiment closely, while cash levels in our portfolios have also risen marginally.
However, Asia should be supported by still strong corporate earnings growth, as there is no sign of any immediate impact from the US subprime crisis on Asian earnings. In fact earnings growth in Asia remains strong, led by China and India, which are forecasted to grow earnings by around 20%2 in 2008 according to our estimates.
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