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Reuters Edge

Restocking revives Asia equities but where's demand?

HONG KONG (Reuters) - The factory floor of the world in Asia is feeling the benefit of a rapid restocking of global inventories, but that may give way to disappointingly modest end demand, a factor that will curb investors’ hunger for risk.

Asia ex-Japan stocks have rallied a blistering 45 percent plus since early March as Asia’s production lines started humming again.

But restocking bare shelves is quite different from meeting sustained demand and once inventories are replenished markets could face the uncertainty of an agonizingly slow and fragile global recovery making them vulnerable to a correction, analysts said.

“Markets are probably rallying because you are not going to see the end of the world, that the very depressed levels of production are not going to stay with us,” said Frederic Neumann, senior Asian economist with HSBC in Hong Kong.

“But at the same time that doesn’t mean you are going to see sustained strong profit growth on the back of restocking,” he said.

There are signs that replenishing global inventories could last through the middle of the year. Taiwan's Powerchip 5346.TWO has said it sees potential DRAM chip shortages and consumer goods exporter Li & Fung Ltd 0494.HK has said it expects increased orders from U.S. retailers.

As restocking winds down, government stimulus, tax cuts and consumer spending incentives in major economies will provide support, but markets will have to contend with continued uncertainty in the financial sector, U.S. consumer and business retrenchment and growing fiscal deficits.

Markets may not have factored this in just yet so could be overvalued.

Asia ex-Japan earnings estimates reflect healthy growth of 24 percent next year, data from profit-forecast tracker IBES showed, even though the global economy is in the worst recession since World War Two.

In the Philippines, a big exporter of technology equipment, a semiconductor and electronics industry representative said demand was slowly coming back. But even so, exports would still fall at best 20 percent this year.

RIDING THE INVENTORY CYCLE

As global inventory contraction slows, leading indicators and production gauges have risen, suggesting to Tim Rocks, Asia equity strategist with Macquarie Securities in Hong Kong, the largest restocking phase in living memory is underway.

South Korea has some of the most comprehensive inventory data in Asia outside Japan and it reflects a sharp rundown in inventories until recently when exports to China picked up.

The ratio of manufacturing inventories to the 12-month moving average of shipments fell precipitously from a seven-year high of 1.13 in November 2008 and only stabilized at 1.02 in March.

As an example of just how much the inventory cycle has been driving markets as opposed to a positive view on demand, commodities have lagged stocks throughout the comeback in risk-taking that has lasted so far two months.

The MSCI index of Asia Pacific stocks outside Japan .MIAPJ0000PUS bottomed on March 9 and has since surged about 45 percent, while the Reuters Jefferies CRB index .CRB, based on the prices of 19 commodities, has risen 17 percent.

Commodity inventories were not drawn down as sharply in the last six months as other sectors, so their upside has been limited relative to equities.

China’s stimulus spending has been a boon to exporters in Singapore, South Korea and Taiwan -- countries heavily leveraged to China’s markets. But since Chinese consumption only makes up about 5 percent of worldwide spending, its influence globally will be limited.

Khiem Do, chair of the Asia multi-asset group with Baring Asset Management in Hong Kong, said stimulus will likely help the U.S. economy grow 1 to 2 percent in 2010 from the depressed levels of this year. That should support Asia production, but again at relatively low levels.

That still leaves room for market disappointment after cyclical stocks in Asia led the two-month rally. So now might be time to take a look at defensive sectors again, Do said.

“Defensive sectors that last year were the key have year-to-date done very badly, like utilities and consumer staples. So if they have good earnings growth and have been sold down, it might be time to look at them again,” he said.

ASIA STOCKS TOO EXPENSIVE?

Markus Rosgen, Citigroup’s Asia-Pacific strategist, is skeptical about the recovery markets have priced in.

The decline in Asia ex-Japan export prices implies a return on equity of 8.4 percent, similar to the 1975 and 1983 downturns.

But price-to-book multiples paint a different picture and suggest equity valuations have room to fall. The ratio, currently above 1.5 times, only hit a low during the crisis of 1.1 times, holding above the 0.9 plumbed during the 1975 and 1983 periods.

Even if one argues that Asian balance sheets are healthier than 30 years ago, other measures of valuation flash caution.

Price-to-earnings 12-months forward for the three sectors that have led the equity rebound -- consumer discretionary, materials and technology -- have this month risen above the broad market for the first time during the crisis.

The more Asian stocks rise, the risk increases of a bigger corrective move lower, particularly if economic data are not able continually to exceed expectations. One sign to look for would be flagging new orders in global purchasing manager indexes.

“If the inventory channel is full and there is no final demand, I think the second half will be quite ugly for Asia. Not only will people have to deal with the numbers, they will have self-doubt that we will have a recovery at all,” he said.

Editing by Neil Fullick

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