NEW YORK, 26 July 2004 — Are foreigners tiring of US assets? That’s a question bedeviling global investors looking at the recent data. It’s also of importance in Asia, which global investors tend to play as a warrant on global growth and where many regional economies are still highly dependent on exports to the US. Even as the dollar advanced last week after Fed chief Greenspan issued an optimistic view of the US economy, supporting the view that US interest rates will gradually march higher, investors in Asia at least were still looking askance at US assets.
Joe Quinlan, the chief market strategist at Banc of America Capital Management, believes that interest in US assets is moderating. In May, he observes, foreigners purchased a net $54.8 billion of US Treasuries, agencies, corporate bonds and stocks, well below the rate of previous months. Japan bought just $14.6 billion of Treasuries in May, versus $30 billion in March. By contrast, between September 2003 and March 2004, Japanese purchases of US Treasuries totaled $175 billion, more than it purchased in the previous seven years. Meanwhile, China has “faded away quietly” as a big source of capital inflows, Quinlan relates. In the first five months of this year, Chinese purchases of US assets totaled just $13 billion, down from $33.1 billion a year earlier.
Asian investors are torn. In the past, they’ve been keen on diversification and viewed the US as a safety net that was less risky than their capital tied up in businesses and properties at home. The thirst for yield has also pushed investors, particularly the Japanese, onto US shores. But across Asia lately, there are signs that investors are wearying of US assets, in part because of the uncertainty about the presidential election, but also because of the continued violence in Iraq and the high valuations perceived in US markets.
The issue is important because the US economy and US markets often lead Asia’s own. On an upswing, Asia’s more cyclical markets tend to outperform. On the downswing, however, these markets lag, as investors seek greater liquidity and more defensive names. “Ninety percent of the job of a country allocator is a cyclical call between Asia and Japan and the UK and the US,” says David Bowers, chief investment strategist at Merrill Lynch in London. And you can see how views about the US, therefore, distinctly bear on the outlook for Asian assets.
The US accounts for more than a third of the offshore holdings of the wealthy Asian clients of J.P. Morgan Private Bank in Singapore. “In the last few months, they’ve become concerned about the future,” says Kam Shing Kwang, the head of investment management, Southeast Asia, for the private bank. That’s a marked contrast to last year’s activity. Kwang isn’t disagreeing. US stocks, she says, are “fairly valued.” Indeed, J.P. Morgan is advising clients to focus on hedge funds and derivatives that protect on the downside.
The Asian clients of Citibank Private Bank have about 40 percent of their assets abroad and are ditching bonds for big caps and hedge funds.
Many clients own real estate abroad and are fretting about the cycle in the US. “Are they taking money off the table now?
No. But they’re cautious about making additional investments,” says Ravi Raju, head of investments for Asia Pacific and the Middle East for the private bank in Singapore.
Says Marko Dimitrijevic, president of Everest Capital, which runs a number of Asian and global hedge funds: “Asia ex-Japan is concerned about the US consumer, drawing a parallel to what happened in Asia in ‘97 when the region had budget and current-account deficits.” Tighter credit then “created havoc with their economies. Yet there’s little basis for that fear. The US advantage is that it’s the reserve currency.”
A restricted capital account means many Chinese investors don’t own US assets, at least officially. The sharp decline in purchases, however, might owe to the squeeze from higher oil prices. Speculation that the Chinese government will revalue the currency higher may also be keeping assets at home.
In fact, assets are being pulled back into the region as Asia piles up savings and governments get serious about developing fixed-income markets. And Asia has become the most stable engine of growth in the world, in some people’s opinion.
Asian families, of course, aren’t the biggest investors in US assets. Companies also are investing, as are the region’s central banks, which have bought dollars to depress their currencies and bolster exports, and which have reduced the risk of holding US assets as a result. If they reverse that view, the riskiness of US securities could jump sharply.
Right now, China may be willing to keep funding the US deficits. “If you believe as China does that it has long-term gains in terms of market share, technology transfer, and employment opportunities, then the cost of acquiring assets that may depreciate in value is fully justified,” says Mohamed El-Erian, the lead emerging markets investor at Pimco.
Japan is another story. Japanese consumption is surprisingly strong, Japan has boosted its own economic growth forecasts, and last week, the Nikkei newspaper even suggested the Bank of Japan is on the verge of raising interest rates. Thus, the dominant question in fund management at the moment is whether Japan, at last, is undergoing a standalone recovery that isn’t dependent on global growth. That’s up for debate of course. “Like it or not, the US still has a lot of traction, and Japan is still coming out of its funk,” points out Richard Horodeck, managing director at Drake Management, who has recently been marketing Drake’s hedge funds to Japanese institutions. In Horodeck’s view, “institutions are still very positive upbeat, interested and very focused” on the US.
That may be less true if Japan’s recovery gathers steam. Analysts like Banc of America’s Joe Quinlan believe that Japanese investors may at last have a reason to direct capital home. The central bank has led the way. Quinlan believes that Japan bought Treasuries heavily to cap yen appreciation. That policy probably ended when Japan’s economy remained surprisingly strong, even though China, a source of growth, has been trying to brake its economy. “Strip out the first quarter, and you see a deceleration in inflows,” says Quinlan. Similarly, global capital may gravitate to Japanese equities and other securities. US investors already have bought Japanese stocks hand over first.
Ultimately, that could spell trouble for US markets. Japan “is America’s banker,” says Quinlan. “They’re part and parcel of this extraordinarily low period of US interest rates. The more capital Japan sends to the United States, the greater the luxury and latitude Fed Chairman Alan Greenspan has.” A reversal of that position would truly spell trouble for US markets — and for Asia’s investors.
