Asia markets review

During October, the US$ fell sharply due to bearish comments from the US Fed. In China, interest rates were raised for the first time in nine years. Oil and base metals prices rose sharply before being hit by profit-taking in the latter half of the month.

Global markets managed a small positive gain in October with the MSCI World US$ Index returning 2.47%. The MSCI All Country Pacific ex Japan Index (+2.56%) performed broadly in line with the MSCI World Index due largely to impressive gains from Australia, leaving the MSCI AC Far East ex Japan Index with more lacklustre gains of less than 0.5%.

Best performers for the month (in USD terms) were Indonesia (+6.10%), Australia (+6.01%) and the Philippines (+4.11%). John Howard's election victory in Australia solidified his power in both houses and will progress his economic reforms focussing on media, telecoms and more FTA's. Susilo Bambang Yudhoyono's presidential election win in Indonesia boosted investor sentiment ahead of reforms tackling corruption and fuel subsidies. In the Philippines, high expectations of successful tax reforms continued to boost the market.

China (-2.44%) and Thailand (-0.76%) were amongst the worst performing markets in the region in USD terms. The Bank of China raised interest rates signalling that administrative measures were not having the desired effect in slowing the economy. In Thailand, monetary tightening and escalating political tensions in the South weighed on the market.

Sector-wise, Banks gained over 5% as a result of solid quarterly earnings results. Economically insensitive sectors such as Healthcare and Consumer Staples also outperformed at the expense of cyclical stocks in IT and Materials.

Increasing hopes that the Chinese economy will avoid a hard landing, and greater confidence in the US economic outlook, are likely to be supportive of Asian equities in the near term. However clouds remain on the horizon. Principally, higher oil prices, worries over the 2005 US economic outlook and the unsustainably large imbalances in the US are likely to continue to hold back global equities. We also remain cautious on China where, whilst we expect a soft landing, we view that even a gentle slowdown could be painful for corporate earnings due to the significant levels of overinvestment in many sectors over the last two years.

Much of the rest of the Asian region looks in good shape. The positive political developments in Indonesia and Malaysia should allow for some continued re-rating in these markets, and having been depressed for some time, there are signs of a pick up in domestic confidence in Taiwan and to a lesser extent South Korea. Across the region we believe improving domestic consumption will be able to take up some of the slack from a slowing export sector, and this leaves us confident that Asia can continue to grow strongly even in the face of a US economic slowdown. The exception to this would be Australia, where a property and consumer lending bubble lead us to expect that the economy will slow next year, potentially exposing some of the excesses of the last three years.

Our investment policy remains largely unchanged. Funds are focussed on domestic consumer plays in the region, particularly banks and selected retail plays. Funds remain underweight industrials and exporters where we believe the pressure from rising raw material, labour and energy costs combined with a slowing global economy could lead to significant earnings disappointments. We continue to focus on those companies with sensible and improving capital management, and in particular are finding improvements in the Taiwanese corporate sector and the telecoms sector in this area. Overall, we are of the view that Asian equities will continue to trade in a relatively tight trading range with the headwinds of uncertainty over the global economy and China, being offset by reasonable valuations and solid regional growth.

Hong Kong/China

The Hong Kong market lost -0.53% (local terms), underperforming the regional index. China was the worst performing market in the region as the Bank of China raised interest rates for the first time in nine years, in acknowledgment that administrative measures were not having the desired effect in slowing the economy. The 1-year lending rate will increase by 0.27% to 5.58%.

Hong Kong's September CPI rose 0.7% as retailers increased prices due to increased demand from the tourism boom, falling unemployment and a property rebound. August retail sales rose 5.9% YoY. The unemployment rate remained stable at 6.8% in September as visitors from mainland China boosted hiring in hotels, restaurants and stores. Hong Kong's September exports rose 14% YoY to HK$179.7bn whilst imports increased 15% YoY to HK$186.2bn.

In China, 3Q GDP growth slowed to 9.1% YoY. September CPI increased 5.2% YoY whilst retail sales rose 14% YoY. September exports and imports slowed rising a smaller 33% YoY (38% in August) and 22% YoY (36% in August) respectively.

Chinese insurers will now be allowed to invest an additional 5% of its total assets directly in the domestic stock market. Previously, they were limited to invest only 15% of their assets in stocks through funds and 20% in corporate bonds. China Shipping's 3Q profit rose by 64.4% YoY to 466m yuan as demand for oil and coal boosted revenue. Sales rose 23% YoY to 1.63bn yuan. The company also boosted net income by cutting costs and increasing capacity by putting new ships to use.

Korea

The MSCI Korea lost -0.84% in local terms but a stronger Won helped to bring its US$ performance to close to 2%. The strong Won and failing product prices depressed the IT sector whilst banks outperformed on good quarterly results.

Consumer confidence rebounded in September after the Government scrapped sales taxes last month on projection TVs, golf clubs and other luxury goods. September industrial production gained 9.3% YoY, led by autos and mobile phones. The business confidence index reached a five-month high on expectations that consumer spending will continue to rebound. The September unemployment rate fell 0.1% to 3.5%.

Samsung Electronics' 3Q profit growth slowed as semiconductor and flat screen prices slumped. The company's 3Q net income rose 46% YoY to 2.69 trillion won. Kookmin Bank recorded a 3Q net income of 375bn won compared with a 341bn won loss a year ago. The bank cut won-denominated loans by 600bn won to 125.2 trillion won at the end of September and set aside 754bn won of provisions in 3Q, compared to 920bn won in the same period last year. Former Seoul Bank Chief Kang Chung Won will replace Kim Jung Tae, who was forced to step down by regulators.

LG Petrochemical's 3Q profit more than doubled to 74bn won and sales rose 61% to 487bn won due to demand from China's increased usage of raw materials used in making plastics. Hyundai Motor's 3Q profit rose 49% YoY to 450bn won spurred by demand in the US and Europe for both the Sonata and Santa Fe models. However, domestic sales fell 5.1%.

Taiwan

Taiwan recorded another month of losses, down almost -2% in local terms. Given the November MSCI re-weighting, fund managers have opted for banks (consolidation story) and high-yielding telecoms. The IT sector underperformed again.

The Financial Supervisory Commission has requested fund managers to set aside fee income as a provision against losses expected from forced redemption from bond funds. Bond funds have surged to NT$2.4 trillion buoyed by unwritten guarantees of yields exceeding bank deposit rates. Government bonds slumped in early October after the central bank increased its benchmark interest rate for the first time in four years to curb inflation caused by record oil prices.

The Taiwan Government plans to reduce the number of financial holding companies in half to seven over two years such that each of the top three dominates at least 10% of the market. September's unemployment rate fell to 4.35% (4.4% in August). September CPI rose 2.8% YoY due to increased food costs as heavy rains damaged crops. September exports rose 19% YoY to US$15bn. Imports increased 29% YoY to US$14.2bn.

Fubon Financial plans to acquire more banks once it formerly merges its two banking units in January 2005. TSMC recorded a fifth consecutive month of record sales. September sales increased NT$23.3bn from NT$18.9bn last year.

Taiwan Cellular recorded a 46% YoY rise in 3Q profit to NT$5.7bn. The company's earnings were boosted by focussing on higher revenue users. Unwinding of cross-shareholdings helped to improve efficiencies.

Malaysia

Malaysian equities rose 1.35% in October. Amid surging oil prices, the Government raised retail fuel prices for the second time this year to reduce the country's fuel subsidies which have more than doubled to 13.9bn ringgit this year.

Malaysia's CPI rose 1.6% YoY in September due to increased taxes on cigarettes and alcohol. Industrial production grew 10.6% YoY in August due to surging oil and gas exports and strong electronics shipments. August exports surged 24% YoY to 41.4bn due to surging crude oil prices and US and Asian demand for semiconductors and other electronics. Imports rose 29% YoY to 38.4bn ringgit, led by gains in intermediate capital goods and consumption goods imports.

Telekom Malaysia is hoping to regain its top position in the country's mobile market in three years. The company also plans to make acquisitions abroad where sales have grown faster than domestically.

Thailand

The Thai equity market was amongst the worst performing markets in the region, down -1.6% in local terms amidst another round of monetary tightening, rising oil prices and escalating political tensions in the South. Banks and Telecoms outperformed.

The Bank of Thailand raised its 14-day repurchase rate by 25 basis points to 1.75%, the second rate hike in two months in an effort to curb inflation fuelled by higher oil prices. The Government is also expected to cease gasoline price subsidies from October onwards which has cost the Government 40.5bn baht since January.

September's CPI rose to 3.6% YoY (3.1% in August), affected by higher prices for fuel. Consumer confidence fell to 91.1 in September on expectations that surging crude oil prices, the bird flu and social unrest in South Thailand will slow economic growth.

Bangkok Bank reported a 30% rise in 3Q profit to 4.63bn baht, the largest quarterly profit in seven years, prompting the Bank's first dividend payment since the 1997 Asian financial crisis. A half-year dividend of 0.75 baht per share will be paid. Siam Cement's 3Q net income more than doubled to 11.99bn baht from 4.86bn baht as the company benefited from high oil prices and increased demand from China.

Indonesia

Indonesia was again one of the region's best performing markets as Susilo's presidential election win boosted investor sentiment. Impressive quarterly results from banks helped the sector to outperform.

The Energy and Mineral Resources Minister will propose to the President a continual reduction in fuel subsidies to lower the budget deficit. Indonesia is likely to spend 59 trillion rupiah on fuel subsidies this year, enough to bridge the budget deficit 2.3 times over. The Government plans to impose a tax on the interest income earned form government bonds which may deter investors from investing in this asset class.

September CPI slowed, rising 6.3% YoY (6.7% in August). On the external front, August exports rose 17% YoY helped by higher crude oil prices and increased shipments of commodities to India and China. Imports grew 44%.

PT Telekomunikasi Indonesia plans to expand its telephone networks next year. The company is expecting demand to increase as the new government attracts more investment. PT Telekomunikasi may invest half the money to almost triple capacity for fixed-line subscribers, including a fixed-wireless service.

India

The Indian equity market continued to perform strongly in October driven mostly by the software sector which produced excellent quarterly results. Indirect tax revenues for the 6 months to September rose 9.5% YoY to Rs 696bn, boosted by accelerating industrial production and oil imports. The Government has decided against an increase in petrol and diesel prices and deferred its decision to cut the duty on crude.

Taking advantage of an increase in foreign exchange reserves (up US$119bn for the week ended Oct 8), the Government plans to prepay Rs280bn of external debt from Russia. Industrial production rose 7.9% YoY in August. Inflation slowed to 7.1% easing pressure on the central bank to raise interest rates.

Source: Schroder Investment Management.

All returns are quoted in US$ in this article.