Asia – January 1998

January 20, 1998

Dow Jones Average: 7873
S & P 500 Index: 979



The cascading economic crisis in Asia has stunned the public and the investment community. Everyone is wondering what happened to the “Asian Economic Miracle”. Over the past few months we have read countless articles about Asia and talked at length with experts on this region. We do not pretend to be experts ourselves in Asian matters, but we do have a few observations to share in this update.

It seems that Asia’s strengths have become weaknesses or at least masked underlying problems. People in Asia are known for saving a large portion of their income. These savings have fueled the economic boom in Asia, providing the capital for new factories and modern production equipment. A high savings rate would appear to be an unmitigated positive, but there has been a downside. The huge pool of savings overwhelmed the viable investment options. Banks and investors became less discriminating with their funds and started pouring money into marginal businesses and expensive real estate. Excessive property values and over-indebted, unprofitable companies are a big part of Asia’s current malaise.

Asians are also known for their strong work ethic, discipline, respect for authority, and individual sacrifice for the good of the group. While such personal qualities may constitute an employer’s dream, they are also easily exploited by corrupt politicians and ruling elites such as the Suharto family in Indonesia. Dissent may be messy, inefficient, and expensive, but without it abuses go unchecked and are more difficult to correct in the long run.

The social and business fabric is more tightly woven in Asia than in Western countries. Employees and employers form bonds that often last a lifetime. Banks and companies frequently go beyond the lender/borrower relationship and buy large stakes in each other. Government is intimately involved in business planning through such agencies as Japan’s powerful Ministry of Industry and Technology. While there are benefits from these supportive relationships, the entanglements that develop can be alarming. Financial reports from banks and industrial companies in Asia are opaque and complicated by Western standards. In such a tightly linked system problems spread more quickly, are harder to uncover, isolate, and cure.

The Western Nations through the IMF (International Monetary Fund) have moved into Asia to prevent the problem from spreading further. There is great concern about a domino effect taking down one company after another in Asia, leading to mass layoffs, severe recession in the region, and eventually worldwide economic decline. The current financial condition of many Asian banks and countries is dire, and requires an immediate cash infusion totalling tens of billions of dollars. A cash bailout is never a pleasant choice, because it effectively papers over the past mistakes and abuses of corrupt politicians, property speculators, and irresponsible banks.

The IMF hopes to exact some fundamental changes in return for the cash. The first change should be an opening of the books, an accurate accounting of bad loans, and disentanglement of banking and corporate relationships. Corruption and political influence is another area that needs to be addressed. Asians are a proud people and until very recently felt that their economy was superior to all others. We expect a lot of negotiating, posturing, and threats over the next few months and grudging change at best.


Current Strategy

The Asian crisis is affecting virtually every company that we follow. All exports to Asia are now earning less in terms of U.S. dollars. The possibility of severe recession in Asia is very real and yet to come. Even though Europe is the largest U.S. trading partner, a sharp falloff in demand from Asia will be noticeable. Growth rates for many U.S. companies may slip modestly due to Asia. The problem is that the stock market in the U.S. is priced at a level that requires decent profit growth rather than slippage.

It is not surprising that U.S. investors have moved money into bonds and safe, steady companies. Electric utilities have enjoyed a surge of popularity, Bell Companies are back in vogue, and medical stocks have soared to new heights. Worries about a tight labor market and inflation have been replaced by fears of deflation. We have moved money out of companies, such as Bankers Trust and Texas Industries, that may be vulnerable to events in Asia. We have invested proceeds in bonds and stocks such as MBIA, both beneficiaries of deflation and lower interest rates.

We are not intending to make wholesale changes in our clients’ portfolios. Our current list of key holdings includes the NY Times, Cisco, McGraw Hill, Helmerich & Payne, Travelers, MBIA, Intuit, Carlisle, and IBM. This premier group of companies, all purchased at low prices, continues to perform well in a challenging market environment. We are keeping a core group of stocks in each portfolio and building up cash reserves by selling less important holdings. If events in Asia create buying opportunities we will be ready to deploy the cash reserves.

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