Asian stock markets show strength in adversity

Global stock markets are still well down for the year, despite a big rally since late March, but two trends in the regional performance figures stand out: America’s ongoing world leadership and resilience in Asia. America’s continued outperformance may be less of a shock, given the amount of money that Congress and the US Federal Reserve are throwing at the US economy in the face of the viral outbreak and the big role played by technology stocks in the stock market, but Asia will surprise many, especially as COVID-19’s origins lie in China.

Source: Refinitiv data. Local currency. Covers period to close on 21 April 2020

Asia is the second best performer in 2020 to date and although investors cannot pay bills with relative performance they might like to ponder the reasons behind this apparent resilience, especially as one powerful market force is currently working against not just Asia but all emerging markets and this is a strong dollar.

President Trump may regularly rail against what he sees as the negative implications of a bouncy buck but the greenback, as benchmarked by the DXY (‘Dixie’) trade-weighted index, is trading above 100 for the first time since spring 2017, just after the real estate magnate unexpectedly prevailed over Hillary Clinton in the race to the White House.

Source: Refinitiv data

Given the threat posed to the US economy by COVID-19, the Fed’s move to crank up QE-4 and the mammoth budget deficits that will quickly accrue as tax income falls and Congress’ fiscal stimulus programmes kick in, the dollar’s strength seems surprising. But the greenback is still the world’s reserve currency and this makes it a haven during times of market duress.

Dollar strength can therefore be a sign of concern for investors and there are two more tangible reasons for looking at a strong dollar with some concern.

First, a rising greenback is traditionally seen as harmful to demand for commodities. All major raw materials, except cocoa (which is traded in sterling) are priced in dollars, so if the US currency rises then that makes them more expensive to buy for those nations whose currency is not the dollar or is not pegged to it. Note how there seems to an inverse relationship between ‘Dixie’ and the Bloomberg Commodity Price index.

Source: Refinitiv data

Second, emerging equity markets do not appear to like a strong dollar either, judging by the inverse relationship which seems to exist between the DXY and MSCI Emerging Markets (EM) benchmarks. Dollar strength at the very least coincided with major swoons in EM, or at least periods of marked underperformance relative to developed markets, during 1995-2000 and 2012-15. Retreats in the greenback, by contrast, appeared to give impetus to emerging equity arenas in 2003-07, 2009-12 and 2017-18.

Source: Refinitiv data

This also makes sense, in that many emerging (and frontier) nations borrow in dollars and weakness in their currency relative to the American one makes it more expensive to pay the coupons and eventually repay the original loans. Zambia and Ecuador are already looking to restructure dollar debts while Argentina is still grappling with its $83 billion in foreign liabilities. The higher the buck bounces, the more uncomfortable those debts become as interest payment suck away cash that could otherwise be used for investment.

The past is clearly no guarantee for the future and China’s latest crackdown on pro-democracy movements in Hong Kong must be watched closely, as they could trigger a fresh cooling in relations between Beijing and the rest of the region, if not the world and its financial markets.

But the historic adverse relationship between the dollar and emerging markets may mean that Asia’s strong recent showing, at least on a relative basis, is all the more meritorious. There may be several factors behind it and investors might like to consider them, to see if they are an indication that the region is capable of contributing positively to diversified portfolios over the longer term.

• In the short term, Asia’s outperformance to date in 2020 may reflect nothing more than a view that the region was first in and first out when it comes to the viral outbreak.
• The strong relative showing, especially relative to other emerging markets, may be due in part to the region’s much lower reliance on commodity prices, relative to Eastern Europe (where Russia dominates) and Latin America. Oil’s collapse will do little damage and even help nations that are net importers of the black stuff, such as China, India, South Korea and Taiwan, at least when their economies start firing again.
• Given the experience of SARS in 2002-03, Asia may have been better prepared and equipped to deal with such a situation. Such readiness could serve the region – and investors in it – well over the longer term, too.

These articles are for information purposes only and are not a personal recommendation or advice.