The US Federal Reserve has turned on the taps, announcing last week that it would buy 600 billion USD worth of bonds supposedly to support the weak US economy. Personally, I think the US economy is doing fine. As our recent research report titled “US: On Track To Record-High Economic Output in 2011” shows, advance estimates show that 3Q economic growth was an annualized 2%. With the US economy expecting to grow between 2.5% to 3% in 2010 and another 2.4% in 2011, the economic output of US is now expecting to hit record levels by next year.
The main reason why there is so much hand wringing in the US, to the extent that the Fed has now turned on the taps again, is because of the unemployment rate, which is still at 9.6%. Otherwise, corporate America is actually doing great, and its companies are going to be seeing overall earnings at an all time high next year.
Nevertheless, the buying of bonds by the Federal Reserve, termed “Quantitative Easing” has unleashed a new flood of liquidity which has found its way into the market. Thus, commodity prices, emerging market bonds, emerging market equities have all seen a boost since last week’s announcement. Not all of this is simply liquidity flowing from the US into emerging markets. Emerging markets, including in particular Asia, has many other factors making it a good buy right now, including reasonable valuations, very strong earnings growth, and the entire region is basically shifting to a higher gear economically with China leading the way.
But things like strong corporate earnings, valuations and mega trends take time to happen, and some of it gradually takes place over a period of time. Asia did not suddenly wake up today and decided to become an economic powerhouse, nor did its companies suddenly overnight start to make lots of money. Now however, the Federal Reserve’s announcement has acted as the trigger, the catalyst that has unleashed the flood gates. Previously, even investors here in Asia were cautious, despite the many signs that Asia as a whole, was growing at a red hot pace.
Now, with last week’s announcement, the excess flood of money will also serve to bring about a relooking at where markets stand today, and based on fundamentals, there is much to like about Asia. This doesn’t mean just close your eyes and buy any Asian unit trust, or commodities fund, or resources fund blindly. Investors still need to be disciplined, and maintain a diversified portfolio and approach to investing. In the short term though, the flood of liquidity is going to continue to drive equity markets and commodity markets up, and after that, the strong fundamentals at least in Asian economies will help drive it Asian markets even further.
Ultimately though, will QE2 work? I don’t think so. Not in the sense that this round of QE is going to magically restore the US economy, in particular bring back jobs. But it will certainly result in a surge of liquidity that just happens to be the trigger that I believe will continue to propel Asian markets into this next phase of bull run we are seeing. In the medium term, it will also weaken the US dollar and cause commodity prices to move up even more.
Oil prices have now surged to over 88 USD per barrel as of 5 November, as a result of the Fed’s announcement and the surge of liquidity arising from it. Inflation and asset bubbles are a source of concern in Asia, and rising oil prices will heighten such concerns. It will remain to be seen if Asian governments take further steps to keep inflation in check. Also, higher oil prices will result in higher costs for Asia, which imports a lot of oil. If the US dollar continues to weaken, oil prices are likely to continue to trend higher. Certain pockets of assets, be it property, etc may also be subject to increased speculation arising from the excess liquidity, and if an asset bubble develops, then in time, it will eventually burst. Thankfully, we are not quite there yet, and based on many Asian government’s actions recently, we are trying to control the amount of hot money sloshing into Asia, so with luck, perhaps asset bubbles can be contained, or even avoided.
In the end, as with all markets, what goes up must come down. So, keep an eye out on overall stock valuations. These are the biggest indicators. We are not quite there yet, but when stocks in general all start to sell for 20 times or higher PE ratios, when all caution is being thrown aside and when everyone is queuing to jump into them, then its time to get a lot more cautious. The good news is that we are not at that stage yet, since most Asian markets are still off their all time highs. So in the meantime, enjoy the ride!
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