Asian Shares Move Cautiously Forward
The emerging markets, particularly Asian stock exchanges, will be increasingly decoupled from the US consumer and liquidity cycle

Asian shares were winners in 2006 despite higher oil prices, a depreciating dollar and the economic slowdown in the US. Sure, the Bank of Japan was the liquidity pump in the global financial markets and the end of Japanese deflation could mean higher call rates in the money markets in Tokyo. Valuations have risen across Asia, with a 34 multiple China and 25 multiple for India making an emerging Chindia bubble. Today, Asia is the epicentre of global economic growth. Earnings growth in Asia will increasingly be derived from consumption, the wealth effect from higher property prices and the sheer fund-raising scale of Asian private equity funds. The emerging markets, particularly Asian stock exchanges, will be increasingly decoupled from the US consumer and liquidity cycle.

At 16,900, the Nikkei does not have huge upside. However, I believe the Japanese yen is a steal at 120-117 and will rise as high as 105 against the dollar. This will hurt GDP growth and exports even as the Bank of Japan’s tight monetary policy crimps the housing and consumer economy. Besides, the Empire in the Rising Sun trades at 17 times earnings in 2007, an unjustified valuation premium to Wall Street (15x) and Europe (14x) for lower returns on equity and earnings growth. I believe total return in Japanese shares next year will be 10 per cent.

Pakistan performs
Pakistan has been one of the best performing stock markets since 2001, when Gen Musharraf made a foreign policy u-turn, abandoning the Taliban and allying with the US war on terror. This resulted in America writing off huge swathes of Pakistan’s $38 billion sovereign debt to the Paris Club, IMF and the Asian Development Bank.

Pakistan’s net interest burden shrank, remittances soared, a new government headed by ex-Citibanker Shaukat Aziz implemented structural reform, inflation plunged, central bank reserves soared from $1 billion to $13 billion. And, the Pakistani rupee, which had been a classic South Asian devaluation currency, soared in value to 57 against the US dollar, enabling Pakistan to borrow once again in the Eurobond market. However, Pakistan’s trade deficit, inflation and political instability are its Achilles heels. The Karachi stock market, which went on one of the longest secular bull runs in the emerging markets, from 1,800 to 11,000, is now overvalued as the State Bank tightens monetary policy, trade deficit balloons, inflation surges and the IMF warns of a devaluation of the Pakistani rupee. Pakistan is an unambiguous underweight for 2007.

Indian shares are trading at all times highs at 24 times earnings. The Sensex at 13,600 is priced to perfection at 5 times price to book value, even if corporate earnings grow at 17 per cent. The Reserve Bank gave an ominous signal of its tight money intentions with its unexpected increase in the CRR for Indian banks, promoting a sell-off of 900 points on the Sensex. India is expensive compared to other BRIC markets such as Brazil (1.9x book value, 12 times forward earnings), Russia (1.8x book value, 9 time’s earnings) and even Chinese H shares. It is time to underweight India. I would, however, buy telecom major Bharti Airtel on any weakness, preferably below Indian Rs 600. Bharti, with 29 million subscribers, is easily the most attractive growth story in India, already the world’s fifth largest cellular market with a mobile teledensity of 11 per cent, compared to China’s 34 per cent.

HK shares
Hong Kong/China shares have been a winner in 2006 as low interest rates, a liquidity tsunami and 10 per cent GDP growth in the Middle Kingdom continue to attract portfolio inflows. The Hang Seng is expensive at 19,000 but property bluechips are a better risk-reward play than HSBC, which will be an underperformer because it’s subprime consumer subsidiary, Household International, simply cannot avoid loan losses as the US housing bubble deflates. Meanwhile, HSBC net interest income is squeezed by the invented dollar yield curve. Banks in Indonesia, Thailand and Singapore have far more value than the trillion-dollar balance sheet HSBC, which is a global bank, not just an Asian bank. Stanchart offers far higher growth but at a much higher multiple and strategic stakes by the governments of Singapore and Dubai make a takeover bid prohibitively expensive. Chinese H shares offer greater value, with a 12,000 target not unthinkable.

A Hong Kong share worth owning is Hutchinson Telecom, which provides mobile services in Hong Kong, Thailand and India (80 per cent of revenues are from India). India’s teledensity will double in the next four years. Hutchinson Telecom is launching a growth initiative in Vietnam and Indonesia. On the whole, however, it is time to be cautious and not get caught in the trap of irrational exuberance.

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