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V. Anantha-Nageswaran

SINCE the beginning of the year we, at Credit Suisse, have been advising high net-worth individuals who open accounts with the bank to buy Australian and New Zealand dollar denominated bonds. The advice was tentative to begin with (`you cannot lose much with this bet') and grew louder (`we are bullish on AUD and NZD currencies') as weeks rolled by.

By the end of last week, the New Zealand dollar had advanced 19 per cent against the US dollar, and the Australian dollar had advanced about 12 per cent. Hence, it was logical to expect that traders would wish to lock-in profits resulting in the currencies paring their gains against the US dollar. Accordingly, we advised them about two weeks ago to lock-in their gains made on these two currencies (assuming they followed my advice!) and wait for slightly lower entry levels.

However, barely had the ink dried on that advice, both the currencies had come close to re-testing their one-year highs. One thing about the financial markets and about the 20th Century is the time compression of most phenomena in life. It takes only a fraction of what it took a cycle to be completed. It has made price movements more volatile. It is a phenomenon that extends beyond financial markets. It certainly has made for a more stressful and lower quality of life.

US investors wallow in denial

To be sure, our call on the AUD, NZD and gold consolidation and profit-taking was based on our hope that the US market would form a solid short-term bottom as it did in March and September 2001. Probably, we had bet too much on the rationality of US stock markets. Like kids who cannot wait to unwrap the new toy that their parents gifted them, investors waded into US stocks last Friday afternoon and pushed it higher until Monday close. In the next three days, the market had given back all its gains and closed below the levels of last Friday. Was all the hype all much ado about nothing? To this observer, it seems so.

As another (??) astute observer put it, financial newsletters in the US barely batted their eyelids when the Dow Jones plunged 200 over points earlier in the month on June 3. However, when it went up by 200 points on Monday, they were quick to raise their equity weightings. That shows the latent optimism. That is not healthy. It prevents markets from forming a bottom and staging meaningful rallies thereafter. Too bad for real investors. As long as denial continues, there is not much hope for US stocks. Therefore, instead of waiting for US stocks to settle, we have decided to remove our `consolidation' call on AUD, NZD and gold.

Be alert to take profits and buy on dips...

Nonetheless, as these assets begin to go into uncharted territory — AUD towards 60 US cents, NZD over 50 cents and gold over $325 per ounce — be prepared to take some profits and use volatility to buy back. However, if investors are not ready for such activism, then they have to settle back, accept the volatility and watch the assets scale new heights, as we believe they would. The sheer interest rate differential between these currencies — across the yield curve — and the US dollar would be supportive of them.

High interest rates do not work in favour of the currency when it is used as a defence against crumbling confidence but when it reflects a healthy economy and healthy appetite for credit. Such surely is the case with Australian interest rates now.

... as USD weakness is only beginning

The correction in the USD had just begun. Just as no one believed that the dollar could really rise when it began its long-awaited recovery in 1995, still there are lots of sceptics about how far it can drop. That is healthy. We need a two-way market. One argument in favour of the dollar is that other currencies do not inspire much confidence. That is largely true.

... despite European and Japanese stagnation

The French centre-right victory has given a semblance of hope to the country that economic liberalisation could occur faster now.

However, the face-off between Mr Schroeder and Mr Stoiber in Germany gives rise to a few concerns as Mr Stoiber's policy prescriptions sound more nationalistic rather than reformist. The EU summit over the weekend to deal with illegal immigration may not necessarily send the right signals to talent from other nations that seeks to relocate to improve its fortunes. Europe needs them as much as they need Europe. Reforms seem to have disappeared from Japanese lexicon. Tax law changes seem dead before they have arrived. The stock market is dropping with insider selling. Those who expected Japan to be a safe-haven from the turmoil in US equities seem utterly baffled. Even before the first quarter GDP growth figures came out of Japan, markets have concluded that it was unlikely to be repeated. International investors remain optimistic, however, as they bet perhaps that the Japanese government might undertake some price-supporting operations!

US turnaround is more dramatic

The reason the euro and the yen have brushed aside bad news is that, to an extent, the market had faced them before and digested them. It is the bad news in the US corporate sector — both in terms of diminishing prospects and rising scandals — and the persistence of trade and current account deficit in the face of an economic slowdown that is new information to the market. That is what is being priced in now and would continue to be the case.

First quarter current account figures and the trade deficit figures for April have both been on the wrong side of expectations. Somewhat unnoticed has been the budget balance for May that was deeper in the red than economists' anticipation. As the whole country is in the `red', it relies on foreigners to bridge the gap. If they resist, the currency has to drop to increase expected yield to foreigners. Simultaneously, the money that does not go to the US is now available for other regions of the world.

Test of strength for Asian revival story

Recently, we re-emphasised our bullishness on Asia with specific stock recommendations. Markets have, however, chosen to test the strength of our convictions. In the three days since we reiterated our bullish stance on Asia, Asian equity indices have generally declined. In the six months up to end-April 2002, Asian equities have appreciated even as US stocks plunged. However, it was not clear whether it was based on hopes of US economic recovery or of stock markets It could not have been the latter, as US stocks failed to continue their momentum into the New Year and yet, Asian stocks did not flinch. Therefore, the recent prolonged consolidation in Asian stocks (KOSPI is below 800 and the SET in Thailand is below 400) is attributed to rising concerns about the durability of the US economic recovery.

We have no reason, yet, to feel that the US economy is about to tip back into recession.

Such a possibility might arise in 2003 if stocks continue to head south for the rest of this year. If the housing market continues to hold up and if the credit market does not freeze, there is no reason to anticipate an economic contraction.

The Federal Reserve Bank of Chicago compiles its own national activity index and the index has staged a comeback from the depths of September. Even if it fails to improve further, its current reading is consistent with a national GDP growth rate of between 2 and 2.5 per cent.

Therefore, we still believe that the markets of South East Asia should be able to resume their uptrend once the current angst over the US recovery dissipates.

Therefore, we are not betting on a rate cut in the US as the next rate move. Therefore, we are not betting on the US Treasury yields at the long-end to decline further. Remember: the deteriorating fiscal deficit situation and remember the falling USD.

Latin America contagion does not spread to Asia

Argentina had managed to infect other countries in the hemisphere. Brazil, partly rattled by Argentina and partly by its domestic political dynamics, has seen its currency and bonds sell off. Last week, Uruguay floated its currency — a sensible decision instead of wasting precious foreign exchange reserves.

Asian bonds and currencies have barely stirred. Asian bond yield spreads (to the 10-year US Treasury note yield) remain (too) tight, as they have been in the last several months. Further, Asian currencies continue to strengthen against the US dollar.

For instance, the Brazilian real has lost 18 per cent this year against the US dollar while the Indonesian Rupiah had gained 21 per cent.

That bolsters our perception that the Asian domestic recovery play remains intact and reinforces our confidence on Asian equity story well.

(The author is the Regional Head of Investment C onsulting in Credit Suisse, Asia-Pacific. The views expressed are personal. Feedback may be sent to nageswar@singnet.com.sg)

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