Sectors decouple, not markets

By R M Cutler

MONTREAL - A relatively broad-based advance on Asian exchanges is being cut short by new fears of a developed-world recession.

The original upward movement surprised investment professionals who had expected continued weakness on the basis of forecasts of economic slowdowns in the developed market economies of Western Europe and North America in particular. It began in Asia at the end of last week. Equities in the Japanese markets in particular advanced 3% on Wednesday, February 13, due primarily to growth in Japan's GDP. Manic-depressively, however, they slid back on the 14th and spent the Friday flat.

These movements, confirmed by the Mumbai-based BSE 30 Sensex, occurred only secondarily in response to developed-country (in particular US) economic data. They were driven by endogenous Asian macro-economic developments. The 2% decline in the Nikkei on Tuesday this week, for example, was caused by investors locking in profits from previous days, even as Japan Government Bonds tracked US treasuries to the downside.

The Nikkei may be moved by the Dow Jones averages, and sometimes it can create a feedback downdraft when esoteric parameters calculated and tracked by computer buy and sell programs exceptionally exceed the ranges for which quantitative analysts have programmed them. But also the ever-increasing program-driven trading can create counterintuitive moves.

This may be why, for example, the New York averages unaccountably began to drive higher around noon on Wednesday 20th, about two hours before the release of the Federal Open Market Committee minutes from January. It may be one reason why East Asian markets were buoyed, against expectations, several days over the past week when foreigners entered them late in the day to buy futures.

Throughout the week it was energy and raw materials - oil and metals in particular - that generally drove most world equity markets higher, and these sectors continued to rally even as others, such as financials, began to show signs of weakness towards the end of the current week. Specialists who a week ago were saying that they expected gold to consolidate from $910 down to the $830 round before moving higher, are ending the current week expecting it to rise from its present $940 to over $1,000 before falling. Platinum and palladium soared.

Oil and gas stocks across the broad, from exploration and production to integrated companies, advanced strongly, seemingly ignoring fears of a recession that would decrease demand.

Much ink has been spilt over the question of "decoupling" of Asian from American equity markets. One view holds that Asian demand can drive Asian markets in the event of a US recession. Another view is that if Europe is less badly hit than America, then Asia can withstand a US recession because demand for consumer goods produced in Asia will remain relatively strong. A third view is that other economies cannot decouple from trends in the US.

All these views make the error of taking a national view. Although central banks remain undeniably influential in their ability to affect short and medium evolution in national equity markets, it is economic sectors that drive the aggregate national equity index averages.

The Australian market, for example, began to decouple from the American one at the beginning of the present decade. The trends may be similar, and the volatility of the Australian All Ordinaries index may be slightly greater than that of the Standard & Poor's 500, but it is up about 80% since the beginning of 2001, while the S&P 500 is up only just over 20%.

If the Australian index is adjusted for appreciation of the Australian dollar over this time, then it is up 145% over the US market, ie, worth nearly two and a half times as much. The Canadian market is also up about 80% since the beginning of 2001 in absolute terms, and the Canadian dollar is up 50% over the US dollar since then, making the advance of the Toronto-based S&P/TSE Composite comparable to Australia's in currency-adjusted terms.

Can it be a coincidence that Australia and Canada were not only less heavily tech-laden than the US exchanges but also more heavily based in the "real economy" of energy and metals? Can it be a coincidence that, although financials in both countries have indeed taken hits with the subprime liquidity crisis, nevertheless the two countries are much less dependent upon performance by companies in the financial sector, as a percentage of aggregate corporate profits, than is the case in the United States?

National markets still matter, and governments can still be more important than their central banks. Witness, for example, the purchase by the Chinese state aluminum company Chinalco of 9% of Rio Tinto's listed shares on February 1, a move intended to prevent the Australian mining company BHP Billiton from acquiring the Rio Tinto group in what would have been the second largest takeover in history. But this is precisely in the natural resources sector, which rather makes the point that an integrated view of international sectors may in some cases supercede and give a more comprehensive perspective than national markets all taken together.

R M Cutler http://www.robertcutler.org is a Canadian international affairs analyst.