The recent sharp corrections to share prices in global stock markets have left investors feeling confused and vulnerable.
The problems originally stemmed from the U.S. subprime crisis, and fears are now growing the U.S. economy will slip into recession. As a result, the Dow Jones Index fell 6.1 percent to 12,650.36 in the first month of 2008. And pessimism quickly spread to other major markets.
The benchmark Taiwan index dived 985.15 points or around 11.6 percent, followed by the markets in Hong Kong, Korea, Singapore and India, where benchmark indices slumped around 14 percent in January. According to the S&P, these declines wiped an astonishing US$5.2 trillion off share price values in January alone.
Thus, the question investors are now asking is how much the Asian economy would be impacted by a U.S. recession. Is it true the Asian economy has largely decoupled from the U.S. economy? Or would the Asian economy also follow the U.S. economy down?
One theory suggests Asian emerging economies have broadened and deepened to a point where they are no longer so dependent on the U.S. for their source of growth.
This theory has gained traction recently -- especially after Asian equities shook off credit crunch concerns last summer to recover strongly and even reach all-time highs in October. However, it would be wrong to say the Asian markets do not follow Wall Street's lead: Recent data shows the correlation between Wall Street and Asian stock markets remains strong.
Admittedly, some economies in Asia would be more affected by a U.S. slowdown than others. The countries most affected are, unsurprisingly, those with a high percentage of exports to the U.S. As can be seen in the chart below, China and Japan are the two major exporters to the U.S.
China itself accounts for 39 percent of total U.S. imports from Asia and 16 percent of U.S. imports worldwide. As for Japan, its exports to the U.S. represent 19 percent of U.S. imports from Asia and 8 percent of its worldwide imports.
It is important to note the U.S. only accounts for a very small proportion of Indonesia's exports. Indonesia accounts for 2 percent of total U.S. imports from Asia, and the U.S. accounts for around 10 percent of Indonesia's exports.
As such, a slowdown in the U.S. economy should not have such a severe impact on the Indonesian economy. Nevertheless, despite this optimism, Indonesia's stock market has followed the regional stock markets down.
Will the market recover? This depends on the health of the domestic economy and developments in corporate earnings, we believe.
In regard to the economy, the main concern is inflation. Increases in the prices of food staples are the main driver of higher inflation. And as agricultural commodity prices have increased dramatically worldwide, prices of some staples at home may remain high.
At the same time, the high price of crude oil has forced the government to revise its 2008 state budget.
And since the government has pledged it will not increase fuel prices, it will need to more than double its fuel subsidy to Rp 102 trillion and up its electricity subsidy by 40 percent to Rp 43 trillion.
At the same time, it is also increasing food subsidies to Rp 20 trillion from Rp 7 trillion.
Nonetheless, inflation should ease in March when the harvest season arrives. And economic activity in the second quarter should be much stronger. Indeed, economic growth should still reach a healthy 6.3 percent for the full year, we estimate.
As for corporate earnings, the question is: Will they hold up?
Going into 2008, earnings momentum was strong -- and we recently upgraded our earnings estimates for 2008 by 15 percent since the beginning of 2007 to reach 22 percent growth.
It's early to say, but in regard to the 2007 results -- which have yet to be announced -- we suspect they will be mostly in line with expectations.
Thus, if the earnings growth does hold up, then Indonesia still looks attractive.
To conclude, there is no denying market volatility has increased tremendously recently. To position against volatility we suggest investors concentrate on sectors that are fundamentally strong and to invest in companies that have low debt levels.
The coal sector is particularly enticing. It offers investors opportunities to benefit from higher coal prices. Moreover, Indonesia is one of the major players in the coal market and easy shipment of coal allows coal miners to benefit from the favorable price trend.
The gas sector is another attractive sector. And there is a potential upside stemming from the huge discrepancy between the current gas selling price (US$5.5/mmbtu) and the equivalent price of subsidized diesel (US$13.5/mmbtu) based on an oil price assumption of US$90/barrel.
The agricultural sector, meanwhile, will benefit from the current high international prices. And besides higher demand for cooking oil, the increasing demand for biofuel will support the sector.
Finally, the banking sector is also worth looking at since the Indonesian banking sector is now in quite a healthy state. Indonesian banks do not have any subprime exposure.
Moreover, all the indicators such as NPLs (nonperforming loans), NIM (net interest margin), CAR (capital adequacy ratio) and LDR (loan-to-deposit ratio) suggest the sector has bright prospects.
The writer is an analyst at PT Danareksa Sekurities
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