Driving the selloff are fears of global recession, worries about the fragility of the financial system and a cash crunch for some investors that led to forced selling.
The fall in Asian markets means they have now priced in all but a major shock to the global economy, and to some analysts appear cheap.
"The way markets are trading, people are anticipating some kind of falling off the cliff," says Wendy Liu, head of China research for Royal Bank of Scotland in Hong Kong. Ms. Liu sees no cliff. "These valuations don't come every year," she says.
Hong Kong's Hang Seng Index is down 23% this year, including a 12% drop in the past month, compared with 8% and 3%, respectively, for the Standard & Poor's 500-stock index in the U.S. The MSCI AC Asia ex Japan index, which tracks all Asia markets outside of Japan, is down 24% this year. Stocks in Eastern Europe and Latin America have also been hit.
The recent surge in the dollar means losses for U.S. investors were worse. The dollar has risen 7% against the Singapore dollar in the past month and 10% against the Korean won.
Markets, as they normally do, have acted ahead of the economic data, which are just starting to reflect a global slowdown. On Friday, Taiwan reported that exports in September grew modestly from the year before, but the government warned that trade momentum will likely tail off in coming months on the dour outlook in Europe and the U.S. There have been signs of similar reports of slowdowns in other important exporters including Singapore, considered a bellwether for global trade.
South Korean electronics giant Samsung Electronics Co. said Friday it expects to report a 14% decline from a year earlier in third-quarter operating profit, as the world's largest maker of flat panels and computer chips saw weak demand in those categories.
Still, Asia's economies are growing strongly, and until recently central banks were raising interest rates to combat inflation. The trend of rate increases has likely ended in most economies. Last week Australia joined Indonesia in signaling rate cuts could be coming.
"Markets in Asia are telling you there is going to be global recession," says Markus Rosgen, head of Asia Pacific Equity Strategy at Citigroup in Hong Kong. Based on price-to-book and trailing price-to-earnings ratios, stocks are pricing in a 33% drop in corporate earnings, he estimates. On average in Asia over the past 36 years, earnings drop 38% during global recessions.
That means markets could fall further should a recession prove particularly harsh. But if it's a mild slowdown, as many expect, there is substantial room for gains.
Behind the bull case is the expectation that Asian countries have the fiscal and monetary firepower to stimulate their economies. Adding to the optimism is the view that the region is somewhat less dependent on exports than in the past, though most dismiss the idea that economies and financial markets have "decoupled" from the West.
Late last week, the view that the slowdown would be mild took over, and Asian markets rallied strongly; the Hang Seng finished Friday up 9.5% from its Tuesday low.
The Hong Kong market has been a focus of investor concern. Shares of Chinese companies account for 70% of its trading volume, and there have been fears that relatively high inflation in China would prevent the government from stimulating the economy. A string of accounting scandals involving Chinese companies has added pressure, as have expectations of lower demand for exports.
Another factor hurting Hong Kong is that it's a deep and liquid market in a region where most stock exchanges are tiny by comparison. When investors can't sell assets fast enough in places such as the Philippines or Indonesia, they instead hedge their exposure by shorting Hong Kong.
"Hong Kong just gets it in the neck," says Citigroup's Mr. Rosgen.
The bad news has made valuations for Hong Kong stocks appetizing, says Haitong Securities strategist Edward Huang. Last Tuesday, when the Hang Seng finished at 16250, its lowest close since May 2009, the one-year trailing price-to-earnings ratio of the index was 7.49, its lowest level since the Asian financial crisis in the 1990s, when it hit seven.
Even after the late-week rebound, the ratio is less than eight—still a bargain, Mr. Huang says. Over the past 16 years, in weeks when the market traded at less than 9.47 times earnings, the total return over the following year has averaged 50%. Stocks have been lower a year later only 7% of the time.
One factor that could push stocks lower, at least temporarily, is liquidity. The recent selloff was driven in part by a scramble for dollars in global markets, which forced some investors to sell assets.
"The degree of selloff in emerging-market debt and equities and currencies suggests there is something more than a concern about slowing economies at play here," says Ewen Cameron Watt, portfolio manager and strategist at BlackRock in London. He says the dollar-liquidity squeeze by European banks turned investors into forced sellers. Another leg down in the European crisis would likely mean even more market pain in Asia and other emerging markets.
"In liquidation sales, things get cheap," he says.(Asia Wallstreet Edition)
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