Stocks may well grind lower in weeks ahead

Window ledges are becoming crowded places around Asia these days as investors panic over stocks.

They shouldn?t. Remember that the Asian growth story remains intact and that 2010 is not 2008, when the MSCI Asia Pacific Index plunged more than 43% amid worries we would all be homeless by now. By comparison, the index dropped 6.9% during a decline of eight straight days this month.

No one is saying this will be an easy year — not with central bankers reacquainting themselves with the risks of inflation. Interest rates will rise, as they must given all the hot money sloshing around the globe. And Asian equities tend to take the first round of rate increases badly.

Yet there are three reasons to take a deep breath and step back from the brink.

One, Asia is still the most dynamic economic region. Sure, some of the 34% rebound in the MSCI index in 2009 reflected asset bubbles. That?s inevitable when monetary authorities in Frankfurt, London, Tokyo and Washington slash rates toward zero.

There?s a reason money rushed to Asia. Reforms following the 1997 Asian crisis positioned the region well for the last 18 months of turmoil. These efforts were rewarded not just because traders were looking to make a quick buck. They made Asia the markets of choice because this is where the energy is.

Losing streak

Yesterday?s rally may have been a case in point. It snapped the longest losing streak since 2004 and offered a respite from the stampede out of the stock market. The sell-off may resume, though, and might get worse before it gets better. Think of it as a correction, not a bear market.

We?re talking about Asia, ex-Japan, of course. Japan?s deflation is accelerating, consumption is stagnant, and Standard and Poor?s threatens to lower the nation?s AA credit rating.

The crisis at Toyota Motor Corp. is another blow to Japanese stocks. Perhaps no corporate name is more emblematic of Japan?s impressive post-World War II revival than the world?s largest carmaker. Yesterday its stock fell almost 4% amid concerns its reputation for quality may be permanently tarnished by recent recalls. Toyota shares have shed 12% in the previous week.

Nothing that has happened in the last few weeks changes ex- Japan Asia?s outlook. Remember, as Niall MacLeod, Hong Kong- based strategist at UBS AG, points out, Asia typically responds badly at first to interest-rate increases, especially in the 40 days around when they begin.

Least ugly

The process is just beginning, meaning that stocks may well grind lower in the weeks ahead. But Asia is still the least-ugly region in the stock-market beauty contest at the moment.

Two, policy makers are addressing the bubbles of 2009. Since the collapse of Lehman Brothers Holdings Inc. in September 2008, the Group of 20 nations has spent more than $2.2 trillion trying to restore growth.

Efforts are afoot to take back some of the fiscal and monetary stimulus, and that?s healthy. China, where banks have begun restricting new loans, is responding to a push by regulators to contain credit after a surge in lending.

Investors such as Mark Mobius, chairman of Templeton Asset Management in Singapore, have a point when they argue that such steps may benefit China?s economy. At a minimum, they will reduce overheating risks and make markets more stable.

Good-news story

This is really a good-news story for Asia. Money isn?t about to get tighter so much as it?s about to become less loose. The trick is not to go too far. Central bankers from South Korea to India need to act forcefully, yet wisely.

The key is for Asia to avoid replays of 1994 and 2004, when monetary tightening devastated asset markets. It won?t be easy for policy makers and it won?t always be pretty for investors, yet less liquidity will serve markets well over time. And besides, valuations in Asia are cheaper now than on January 1.

Three, the US won?t steal Asia?s thunder. One reason Asian markets stumbled in recent weeks is that there is more optimism the US economy will recover markedly.

Normally, such perceptions would be great news for Asia?s export-dependent economies. After the sheer financial chaos of 2008 and 2009, though, many international investors are anxious to pile their money into the most developed economies. While better US growth can be good for Asia, it reduces the relative attraction of emerging-market stocks.

The US won?t be a major competitor for Asia?s stock money for some time. More likely, the US will muddle along this year, limiting corporate profits and restraining wage growth.

That?s hardly a comforting scenario for the world economy. Yet Asian markets have proven over the last year that they can stand their ground as the U.S. limps along.

Don?t forget that Asia also benefits from 10% growth in China, 6% in India and a general sense of dynamism that?s lacking in the US and Europe. In a rather ugly world economy, Asia still looks pretty good.

(The author is a Bloomberg News columnist. The opinions expressed are his own.)