As markets quake over the coronavirus and Trumpian chaos, losses in Japan and South Korea have been as savage as anywhere.
The Nikkei Stock Average is down 26% in the first 72 days of 2020. Korea’s Kospi Index has plunged 20%. Both drops are in the same neighborhood as Wall Street, where the Dow Jones Industrial Average is 25% in the red. The question, of course, is whether shares in Japanese and Korean companies might see even bigger losses.
After two years of trade-warring, Asian leaders dared to dream of a kinder, gentler 12 months ahead. At the very least, China, the region’s main customer, would catch its breath to restore growth and demand.
Instead, the Asia-led global coronavirus outbreak is being exacerbated by a perfect storm of unrelated policy moves.
Markets were already panicked over the surge in cases from Seoul to Rome to New York when an oil-price war erupted between Russia and Saudi Arabia. Then, on March 11, amateur-hour US President Donald Trump managed to bring the financial world to the precipice with an Oval Office address.
Trump made clear he had no plan to test more Americans, stabilize the economy or soothe investors. His vague European travel ban and pokes at China indicate a lack of coordinated response, perhaps through the Group of Seven.
Incredibly, European Central Bank President Christine Lagarde made things yet worse by failing to echo predecessor Mario Draghi’s commitment to do “whatever it takes” to avoid another global crisis.
Now markets are plunging the most since 2008 – or even 1987. Chatter about difficulty executing bond trades has punters experiencing flashbacks to the “Lehman Shock” days when credit markets seized up.
Adding to the déjà vu was the Federal Reserve racing to the rescue.
On March 12, it pumped more than US$1 trillion into money markets, an operation equivalent in size to Washington’s entire annual budget deficit. The Fed now seems just a stone’s throw away from resuming the quantitative-easing of the post-Lehman-Brothers collapse period.
As such, the turmoil hitting exchanges in Tokyo and Seoul is likely to get worse.
But there is one problem – the Japanese and South Korean economies entered 2020 on a weak footing. That’s especially true for Japan, where gross domestic product shrank 7.1%, year-on-year in the October-December period. Data since – including a 2.6% drop in exports in January – point toward recession. The January decline was the 14th consecutive monthly slide in overseas shipments.
South Korea, Asia’s No 4 economy, may contract in the current quarter, Governor Lee Ju-yeol said last month. The February-early March revival in Korea’s export engine won’t be enough to overcome fallout from its 7,800+ coronavirus cases. The blow to consumption, business confidence and tourism over time will hit Korea Inc hard.
Time to buy in?
What happens when the pandemic subsides? Then, bulls might be tempted to “buy the dip” in Tokyo and Seoul. Though coronavirus dislocations are real and potentially massive, markets could indeed be overreacting to the downside.
“In general, we tend to converge on the judgment that the recent wild selling of risk assets, and the collapse of bond yields to record lows, is disconnected from any plausible economic reality,” says Arthur Kroeber of Gavekal Research. “So the most likely course is that eventually, rationality will return and equity prices and bond yields will rebound to more justifiable levels.”
China, of course, has been stimulating early and often – massive fiscal pump-priming, central bank liquidity, tax cuts, business loans, local-government borrowing. In recent weeks, Beijing has been telegraphing a “V-shaped” recovery once global panic subsides. And, clearly, China has an impeccable track record of confounding the naysayers.
Yet even China’s crisis team will be hard-pressed to navigate current headwinds. Making coronavirus uncertainty all the greater is glaringly unsteady leadership from Tokyo to Washington.
Case in point: Trump’s market-shattering television address, which upped the odds that the world’s biggest economy will slide toward recession. This is all upending everything investors thought they know about 2020.
High debt, high risk
As Asia Times columnist David P. Goldman argued in a March 12 piece, typically safe and reliable US stocks with stable cash flows lost their footing in recent days. Over the last 10-years, ultra-low US rates allowed sectors from real estate to utilities to binge on cheap leverage. That is morphing one-time safe-haven sectors into no-go zones as investors pivot to a risk-off footing.
Might Japanese and Korean markets experience a similar dynamic?
First, neither market is glaringly cheap. On average, price-to-earnings ratios for Nikkei-listed companies is 15.4 times forward earnings. For the KOSPI, it’s 16 times. The DJIA is 15.1 So, not a big advantage for North Asian markets. What’s more, the p/e ratio for China’s CSI is just 13.8.
Debt levels relative to, say, the US make for complicated comparisons. Japan’s corporate debt-to-GDP ratio is 102.8% to Korea’s 95.6%. America’s is 74.4%, while Germany weighs in at 57.5%, Italy at 69.5% and Australia at 75.3%.
Granted, Japan and Korea stack up well to China’s 157%. But low interest rates have clearly had CEOs gorging on debt. These liabilities now become headwinds as global markets tank and growth slows.
Granted, Korea is a different beast. Given how hard it can be to discern where the Korean government ends and the private sector begins, the level of corporate debt is perhaps unsurprising. The big risk is near-record household IOUs. As of the end of September, outstanding debt held by households and small businesses was about $1.5 trillion, an increase of 4.5% from a year earlier.
Now let us add in the Trumpian wildcards – including a US recession. Then, would Trump ramp up his trade war again? He could make good on threats for a 25% tariff on imports of cars and auto parts, devastating supply chains on which Japan and Korea rely.
Hitting China anew is possible if Trump’s poor coronavirus response imperils his re-election in November. On March 11, US national security advisor Robert O’Brien seemed to debut Trump’s next line of attack when he said the “outbreak in Wuhan was covered up” which “probably cost the world community two months to respond.” And Trump talked of a pandemic “started in China.”
The risk is that this blame-China campaign leads to new sanctions. Or to an escalating tit-for-tat that increases the length of corporate blacklists, imperils press credentials and increases supply-chain uncertainty. Might Trump weaken the dollar to gain a trade advantage for manufacturers?
Thanks to cash-rich balance sheets, Japanese stocks are often termed cheap, says strategist Nicholas Smith of CLSA Asia-Pacific Markets. “Just cheap is not enough” though, he adds.
About “54% of Topix stocks are trading below book, but do they deserve to? In most cases, sadly, yes,” Smith says. “Even in the latest fiscal year only 43% of companies covered their cost of capital.”
Covering costs could get even harder as market chaos hits growth and, most importantly, consumption. Japan is already careening in reverse. Falling demand is one part trade war, one part fallout from higher sales taxes, one part coronavirus uncertainty. In February, sales of new automobiles plunged 10.3% from a year earlier, the fifth straight monthly decline.
The rest of 2020 will be plenty challenging for the rest of Asia, too. In recent days, markets from Indonesia to the Philippines to Thailand didn’t just turn bearish – they saw trading halted as sell-offs accelerated.
So much red ink on broker screens is giving investors fewer and fewer places to hide. It also gives punters betting on Japan and Korea fresh reasons for pause.