The volatile pattern of stock market trading in recent months seems set to continue over the short term. The source of much of the weakness in share prices has been explained by the continuing crisis in Asia. The table showing forecasted GDP growth rates shows why investors are worried about Asia.
The disparity in economic growth between the Western developed countries and Asia could not be more stark. However, from an investment viewpoint it is important to bear in mind two important points. First, weak Asian economies and the prospect of an Asian recession are news that has been around for quite some time. Second, the Asia/Pacific region, including Japan, accounts for about one third of global GDP compared with the 50 per cent accounted for by Europe and North America combined.
Even as the Asian economies have continued to deteriorate North American and European economic growth has continued to accelerate. Furthermore, economic prospects in the West remain very healthy supported by low inflation and low interest rates.
The renewed worries concerning Asia have primarily affected the stock market through a reduction in expectations regarding corporate profits. Naturally, this downgrading has tended to focus on companies and sectors that have significant exposure to Asia. For example, in Britain the share prices of HSBC and Standard Chartered two banks heavily exposed to the Far East have fallen sharply in recent weeks.
In the Irish market the two share prices which have been hit hardest by Asian woes are those of Smurfit and Waterford Wedgwood. From their peak of 124p earlier this year Waterford's share price has fallen by almost 25 per cent.
The Smurfit share price has provided a roller-coaster ride of dizzying proportions. In the immediate aftermath of the merger announcement between Smurfit's US subsidiary
Jefferson Smurfit Corporation (JSC) and Stone Container Corporation, Smurfit Group shares rose as high as 290p.
Soon afterwards, as the news from Asia deteriorated, the stocks in the US paper sector, including that of JSC, declined as some companies issued profit warnings. Since their recent peak of 290p Smurfit shares are now more than 25 per cent lower.
While the deteriorating Asian situation will have a negative impact on both companies' businesses, the falls in their share prices may have been overdone. In Waterford Wedgwood's case, approximately 15 per cent of its turnover is accounted for by Asia. The US and Europe (excluding Britain) each account for around 30 per cent of sales with Britain and Ireland accounting for the balance.
Economic growth in the US and Europe remains healthy and therefore it should be the case that demand for luxury goods such as those produced by Waterford should continue to grow. Therefore, any downgrades in profit forecasts should be quite modest and the current weakness in the share price could well represent an attractive opportunity to invest in the company.
The situation with regard to Smurfit is somewhat more complicated. Although less than 10 per cent of Smurfit's turnover is accounted for by Far Eastern markets, it is in fact more exposed to Asian developments than Waterford. This is because the weakness in Asian economies has led to a fall-off in the demand for paper and packaging products. This drop in demand has been quickly transmitted into weaker prices for paper products.
The US paper industry had been confidently expecting to push through price increases before the summer. The onset of the current bout of Asian nerves has led to a deferral of any price rises to the autumn. Indeed, the risk that prices may decline has increased.
Smurfit's operational profits are highly leveraged to product prices so that small changes in prices lead to disproportionately large changes in profits. As long as the weakness in Asia is contained Smurfit's profits should rise sharply over the next 12 to 24 months and the share at current levels could well prove to be a very astute investment.
The most recent news from Asia provides some encouragement that the situation may be stabilising. Intervention from the Japanese and US central banks has temporarily halted the slide in the Yen. Furthermore, the Japanese authorities are working on setting up a "bridge bank" which would take over the banking sector's non-performing loans.
Once markets begin to take a more sanguine view of Japan's prospects the share prices of companies such as Waterford Wedgwood and Smurfit could well bounce quite sharply.
