Asian research: Worth the paper it's printed on?


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It's not just Asia's leaders that are in a state of denial. So too are the legions of economists and research analysts working at investment banks and brokerages across Asia. You might have expected some would have called the crisis that has crippled the region in the past six months. But whether because of political sensitivities or the sheer lack of talent in their ranks, Asian researchers failed to spot the impending crash. Steven Irvine reports.

When the world started to melt

What will go wrong next?
Asian banks: Now comes the real crisis
Peregrine's still flying
Hedge funds: You can run but you can't hide
Country Risk December 1997: It could be worse
Global Economic Projections: Overall Rankings

Asia's current economic woes have come as no surprise to Marc Faber. One of Asia's most famous bears, he has been forecasting doom for quite some time. Paul Krugman, an MIT professor of economics, is another who has long argued that the region has overstretched itself. But as Faber points out in a recent edition of his Gloom, Doom & Boom report, "when Krugman published his critical article about Asia's growth prospects, numerous articles by Asian fund managers and strategists countered that Krugman didn't know what he was talking about".

Now is Krugman's moment of vindication. People in the region had begun to argue, he says, that Asia was "not part of the same economic universe as the rest of us. Fundamentally the point is: Asia operates under the same rules."

With hindsight, it is easy to find examples of bank analysts who got it spectacularly wrong over Asia. The October 1996 edition of Deutsche Morgan Grenfell's Asia Overview, for example, states: "As with any cycle turning point, sentiment always overtakes reality. Stories of a terminal decline of the region's prospects are way overdone." It adds: "While current growth rates are likely to be disappointing this year and early next, the outlook for the second half of 1997 will be altogether more encouraging."

Not exactly. Growth-rate forecasts are now being rapidly revised downwards. In Thailand, the IMF has said GDP growth will be no more than 0.6% for 1997. This has left a good few pundits way off the mark. Morgan Stanley economist Tim Condon, for example, began the year with a forecast of 6.6%.

By far the most significant event of the year, and indeed the trigger for the whole crisis, was the decision to unpeg the Thai baht from the US dollar on July 2. In subsequent months it lost 48% of its value against the dollar. It was an event that economists might have been expected to predict well in advance. But even though the baht had been under pressure for more than a year, it is hard to find any research report that forecast the devaluation.

Thai brokerages took a singularly bullish view on their government's chances of beating the market. "We are certain that a baht devaluation is not possible," began a seven-page report written by Usara Wilaipich and Phongthorn Wrasai of Securities One on January 31. "Our analysis of the real effective exchange-rate index suggests that the baht has been undervalued, not overvalued, for the past 10 years. This confirms our view that a devaluation is unreasonable."

But it wasn't simply Thai brokers who got Thailand wrong. Barton Biggs, the Morgan Stanley strategist who was famous for going "maximum bullish" on Hong Kong for six weeks before changing his mind in 1993, produced a piece in January that was also, sadly, wrong-footed by events.

"Thailand, my beloved Thailand, is an economic, social and political mess," it began. "After almost a week there in empty hotels, breathing polluted air and talking with the most universally bearish and depressed businessmen, brokers and investors I have met anywhere, my conclusions are as follows: The locals are too bearish. Thailand's problems are cyclical, not secular. Thailand is not Mexico in late 1994. The macro-fundamentals are still pretty good. A fall in the SET [Stock Exchange of Thailand] index to around 700 would make me an aggressive buyer. On the numbers, Thailand qualifies for the Emu and looks healthier than Germany."

And now? With the SET index having plunged to a low of 445 - substantially down on its all-time high of 1789 - and a current-account deficit of $13 billion, Thailand is sinking into recession with corporate defaults on foreign-currency debts looming.

Bankers Trust was equally optimistic in January, writing that "Thailand's bubble is still releasing orchid-flavoured air, but the stock market seems fully deflated". It was reasonably bullish on the currency too: "The pressures on the currency are not overwhelming: Thailand's ratio of current-account deficit to foreign-exchange reserves is 40% compared to a staggering 450% for Mexico in 1994."

Other houses were also reluctant to predict the baht would devalue. Merrill Lynch's William Belchere and Miguel Cambronero wrote a piece in February entitled "Darkest before dawn" which stated: "We believe the Bank of Thailand will successfully defend the baht." SBC Warburg's Asian Adviser stated in March: "We are still of the view that Thailand will deflate rather than devalue."

Indeed, almost until it happened, the bulk of firms refused to acknowledge the possibility of the baht's devaluation. Just over a fortnight before the peg went, Warut Siwasariyanon wrote in ING Barings' Thai Strategy report: "Our view is that a voluntary devaluation of the baht will not take place in the short (six- to twelve-month) term." Siwasariyanon no longer works at ING Barings.

But surely the devaluation of the baht soon put a dampener on this mood of optimism? Well actually, no. Thailand, the analysts said, was different, and there would be no contagion to neighbouring countries. The Malaysian ringgit and Indonesian rupiah were made of stronger stuff than the baht.

ING Barings economist Daragh Maher, for example, commented on July 7, five days after the baht devalued: "Overall, the ability of the ringgit and the rupiah to weather the baht storm is encouraging. In particular, it may reflect the increased maturity of these markets as investors recognize their particular strengths and weaknesses. The broad brush so often used to paint south-east Asian economies may finally have been put to one side."

A week later, after the devaluation of the Philippine peso, he wrote: "This weakness in another Asean currency has intensified pressure on both the rupiah and ringgit. However, we maintain that the pressure on exchange rates and interest rates in Indonesia and Malaysia will not be long-term or destabilizing. The rupiah now stands at 2,435 to the dollar. The ringgit 2.50. Our year-end forecast for both the rupiah and ringgit remain unchanged at 2,450 and 2.50."

But by the end of October the two currencies were anything but stable. The rupiah had slid to Rp3,625, with the authorities in Jakarta giving up the fight. The ringgit plunged to M$3.40, much to the public ire of Malaysian prime minister Mahathir Mohamad. The rupiah had lost 52% since the beginning of the year, and the Malaysian currency 30%. The baht lost 48% in the same period.

The business of forecasting - never easy - became a minefield in 1997 as analysis was repeatedly overtaken by events. In Februrary, for example, Bankers Trust predicted that the Hang Seng index would reach 20,000 this year. By November it stood at half that level.

The number of wrong calls has provoked some soul-searching. In May ING Barings' star strategist, Alan Butler-Henderson, had maintained that export-driven Malaysia, Singapore, Thailand and the Philippines remained good strategic bets. By August he was at a loss to explain his confusion. "It would be nice to be able to report that my strategy thoughts of late-May had enjoyed their airing, but sadly that has not been the case. Much of the thrust of that forecasting has been awry." He continues: "I have run all the 'searches' I know to spot what element I am missing here - what it is that I can usefully incorporate into my mental model in order to refocus it correctly.

"A strategist who has been wrong-footed is placed under great pressure to right the wrong by turning and swimming with the tide. I am tempted to do just that - to say, maintain a hefty overweight in Hong Kong (and Wall Street) and continue to reduce exposure to the beleaguered centres in Asean. But I do earnestly question whether that is sensible." In October ING announced that Butler-Henderson will leave the bank at the end of the year. He plans to set up a consultancy in Cyprus.

Political sensitivities

Of course, it is easy to be wise after the event. But with so many pundits proved wrong by Asia's economic crisis, serious questions are now being asked about the quality of banks' Asian research. Had analysts become so used to selling the region's miracle that they could not contemplate its demise?

"All the economists here do trend analysis," says one banker. "They're not equipped to deal with structural changes. Plus, most of them have only been through bull markets."

Asian research has always fought the charge of mediocrity. At root is the cultural problem of writing research in a region where criticism is never greeted kindly. Loss of face arises when you say something negative. And certain subjects - like the prospect that the Thai baht would devalue - were almost taboo.

When Biggs advised clients to reduce their Hong Kong weightings to zero during the October crash it upset a number of political sensitivities. Wang Qishan, president of China Construction Bank, criticized Morgan Stanley for encouraging investors to desert the Hong Kong stock market. The public rebuke carried particular force. Morgan Stanley has a joint-venture investment bank in China: its partner is Construction Bank.

"I feel regret that Morgan Stanley's chief economist has made such statements which make everybody angry, and I feel angry too," Wang said. "They on the one hand reaped great benefits in China and Asia and on the other hand issue such statements." He added that the two companies had gone through pains to establish a good relationship, and hinted that ties could be damaged. Morgan Stanley's chairman for Asia-Pacific, Jack Wadsworth, issued an apology.

A similar situation occurred a couple of years ago when Dresdner Kleinwort Benson's London-based global strategist, Albert Edwards, referred to Malaysian economic policy as "noddynomics". Again, an apology followed. Taking a negative view is difficult. The first to go visibly bearish on Thailand was Jardine Fleming which found itself roundly condemned in Bangkok for encouraging foreign investors to sell Thai stocks. Andrew Houston, then based in Bangkok, had gone on what he calls an "apocalyptic" marketing trip around the US and Europe in June 1996 warning of the imminent dangers in the Thai economy. Then Daniel Fineman wrote a piece in October criticizing Thailand's overinvestment economy and comparing the situation with Japan in the late 1980s. Both pieces encouraged foreign investors to sell.

One Thai magazine, Hun Thai, started a campaign against two or three "redheaded devils" who were trying to bring the market down. In one article it decided they had shorted the market through Singapore, and were now marketing for their own benefit.

In Korea, top-ranked economist Stephen Marvin of SsanYong Securities wrote a bearish piece in October 1996 entitled "Still No Pulse". Its irreverent comments included the following: "President YS Kim has just decreed that the current-account deficit must halve next year. Normally, such a silly proclamation could be safely ignored, but 1997 is not a normal year - a presidential election is scheduled for autumn or early winter." The piece was only published in English and only distributed internationally. However, an enterprising Korean journalist got hold of a copy in Hong Kong and translated it.

A fracas ensued. "There's only one reason I'm here, it's because of Milton Kim," says Marvin, referring to SsanYong Securities' US-educated boss. "He's an enlightened guy. He hired me to turn the research around. He owns the company effectively. In other words, he's God. Everyone knows I pick up the phone and God answers. So people don't mess with me. He liked me for the right reasons and once he made that commitment he never backed down." Nor, says Marvin, did Kim censure him for his negative comments. In another report, "The Circus Comes to Town", Marvin advised investors to be wary of Korean stocks. "The director of the international broking department gave me a hard time. Without Kim I would have been muzzled."

Marvin's situation is quite unusual. And as Korea's first million-dollar analyst - poached from Jardine Fleming nearly four years ago - he is justifiably at the top of Asia's rather shallow pool of talent.

"It's a relatively immature market," says Jolyon Petch, Peregrine's director of research. "If you go to New York you will find 50- or 60-year-olds who have been following the same sector for years. Out here the average is three to five years and they've also jumped around a few sectors."

Mobility has indeed been high among the region's analysts. Jardine Fleming lost one team to SocGen-Crosby in Korea and another to Merrill Lynch in the Philippines. ING Barings lost a well-regarded team in Taiwan - again to Merrill Lynch. And along with this high mobility has gone high salaries. In one recent case a telecoms analyst was lured with a $1 million-a-year guaranteed package. Not bad for someone with three years' experience.

Petch, who was advised to leave Indonesia in 1992 for refusing to support an IPO, says investors are a big part of the problem. "With the exception of the US client base, investors can't tell the difference between the good and the bad. As long as you flood the client with numbers you're fine. I don't think they can distinguish between top-rate and mediocre analysts. So there's no pressure to improve."

Insiders have horror stories. "There is an expressway that goes between Zhejiang Province and Guangzhou that was listed early this year," comments one mainland-Chinese analyst. "Most of the analysts who cover it haven't even been to the province, let alone visited the company. I can name a few who don't even have the least idea where the province is. And this is almost one year into the listing."

Poor research also stems from the straitjacket put on analysts by their own firms. Economists face the fear of upsetting governments, which may result in their firms being barred from government business such as privatizations. Analysts fear the damage they can do to relationships with top Asian companies. They may therefore probe less than they should. "If you have an original story to tell you get attacked for it," says Andrew Houston, Jardine Fleming's chief strategist. "It's much simpler to take the easy path."

One of the very few economists to predict this year's crisis was Jim Walker of Credit Lyonnais Securities Asia. In his report "Asia Decoupling: it's life Jim but not as we know it", he commented presciently: "For most of the last 50 years Asia has been a dollar bloc. But times are changing and we are about to enter a new era for the region. Just as economies around the world are more inter-related through capital flows, so the appropriateness of being linked to a single currency is becoming questionable especially when economic growth rates diverge and institutions differ.

"We believe the economic conditions prevailing in the region at present will force a painful rethink of the dollar policy within the next two to three years. For governments and central banks that fail to address the problems which have been stored up over the last five years, in particular, of 'dollar-pegging', severe imbalances in their economic systems will be experienced. Under such circumstances, a Mexico in Asia is not outside the bounds of possibility."

This was published in 1995.

A different story in private

The reaction of one economist whose firm had been well and truly wrong on the baht is illuminating: "It was quite sensitive to call the devaluation of the baht. So while I was convinced the baht would devalue, I didn't publish it for political reasons. I'm not the type of economist that will try to stamp an economy into the ground. But I did call the devaluation in-house. And I will say in face-to-face discussions what I really think. I think that works better."

Another top analyst claims he had been bearish on Malaysia for at least a year but had never published a negative statement to that effect. "It's a country where you can't really print what you really think," he comments.

Top investors know how it works. "You develop a relationship with a handful of economists over the years. You call them up and ask: 'What's really going on? What do you really think? What are you hearing from central bank ABC?'" says Brian Lippey, who runs Tokai Asia.

This of course raises the question: why publish research at all? If the real information is given out during confidential one-on-one meetings and telephone calls, why bother printing watered-down opinions? Is it anything more than a costly waste of paper and resources?

To be fair, Asian research has developed from a very low base - and obviously still has a long way to go. But it needs to get better fast because good research is becoming all the more essential as Asia enters its post-miracle phase. "We're moving into an environment where careful balance-sheet analysis is going to be vital," says John Mulcahy, head of WI Carr Indosuez in Hong Kong. "Investors will reward research that can answer the basic question: is this company solvent?"

The question is: can Asia's researchers rise to this lofty challenge?