The government may not be able to stop the TAIEX from falling below 4,000 for the first time in almost eight years as the economy's reliance on the semiconductor industry becomes a liability.
When the index slumped to within eight points of that level on Tuesday, the government started buying shares and directed local money managers to stop selling, traders said.
While the index gained 8 percent over the past three days, some investors doubt the rally will last because of the nation's dependence on making chips.
Taiwan now relies on the computer and telecommunications industry for almost a third of its exports, while one-fifth of the index comprises two chipmakers -- Taiwan Semiconductor Manufacturing Co (TSMC,
Falling chip prices threaten to put the brakes on Taiwan's economic growth and bank lending to a halt. Merrill Lynch & Co is forecasting 0.9 percent growth this year, a ninth of last year's rate.
"The economy is suffering from an over dependence on technology," said Bill Roden, who helps manage US$600 million at AXA Investment Managers UK Ltd. "Weak demand for products has led to a collapse in export growth. The resulting decline in corporate profits has not only hurt investor confidence but also hit unemployment and ultimately domestic consumption."
The value of the stock market has fallen 24 percent in US dollar terms in the past three months, fourth-worst in the world rankings behind Finland, Turkey and Argentina. While four government funds this month said they would invest NT$100 billion in stocks by year-end, that may not be enough.
Taiwan's individual investors, who make up about 90 percent of the stock market's turnover, are fleeing to the safety of government bonds, pushing the price of the NT$30 billion three-year up 3 percent this year. Trading in the government bond market has reached an average NT$200 billion a day -- more than two and a half times the turnover in the stock market.
Banks are also keeping a tight fist on concerns the economic slowdown will make it more difficult for companies to pay back their loans. Goldman Sachs Group Inc estimates banks' non-performing loans are as high as 15 percent of total loans, making them reluctant to lend. The government estimates the ratio is less than 6 percent.
"The nature of the stock market crash is a credit crunch," said Albert King, president of China Securities Investment Corp, which manages US$2.6 billion in investments. "People are putting their money into risk-free assets."
An average NT$76.3 billion of shares changed hands in the stock market this year, down about a third from last year. The lack of interest in stocks is starving companies of an avenue for funds and increasing the risk they will default on loans.
What's puzzling some analysts is why overseas investors continue to buy TSMC and UMC even as both warn sales will fall. The two accounted for 70 percent of foreign net purchases of Taiwan stocks in the first half of this year, according to ABN Amro Asia Ltd.
"That's remarkable when you consider the fundamentals of the businesses," said Christopher Wood, the global emerging markets strategist at ABN Amro. "TSMC and UMC are hugely expensive without a rebound in PC demand."
UMC trades at an estimated 88 times this year's estimated earnings per share while TSMC trades at 73 times. The TAIEX currently trades at 14 times.
A recovery in the stock market hinges on a rebound in chip demand. TSMC's profit all but vanished in the second quarter as makers of computers and mobile phone chips, its main customers, said sales will fall this year. Global chip demand may shrink 21 percent to US$139.2 billion, according to researcher IC Insights Inc.
"If we're taking the scenario the US economy will return to recovery grounds towards the latter part of this year, then the Taiwan market will also benefit as a result," said Kenny Tjan, who helps manage US$1 billion at Rothschild Asset Management in Singapore.
TSMC itself is optimistic and expects operating profit to improve in the third quarter. Even so, chairman Morris Chang (
"I don't think they'll make a profit" in the third quarter, said fund manager King, who holds TSMC. "They possibly will incur more depreciation costs."
TSMC has already paid the price for being over optimistic after expanding capacity by 80 percent last year. Profit fell 98 percent to NT$312 million in the second quarter largely because operating expenses doubled to NT$4.7 billion
"Fundamentals are clearly not looking great," said Emil Wolter, who helps manage US$3 billion in global emerging market investments at Pictet Asset Management Ltd in London. He's steering clear of TSMC.
That's bad news for TSMC and may be bad news for Taiwan.
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