Is the west still the best?

This is a question that regularly polarises opinion within the investment world, and there is no simple answer.  The high GDP growth rates in Asia and in particular China, when compared to the West have been attracting investors since the early 1990s. The recent economic slowdown experienced by western developed countries has only served to emphasise the growth differential. 

The Western world has had many issues to deal with during this period including the well publicised bursting of the housing bubble in the US and other European countries and the broader global financial crisis at the end of 2008. The resulting deleveraging process is still ongoing, and is why investors remain wary of investing in the banking and financial sectors.

However, after the pain, we are now seeing other sectors in the developed world emerging stronger with less debt laden balance sheets, tighter controls on costs and increased operational gearing, as company order books increase along with trade flows around the world. This leaner corporate landscape, combined with historically low valuations on a price to earnings basis and the low price to book value of many large capitalisation companies, gives a scenario where UK, US and European companies are offering attractive returns.

Where does Japan fit into the East versus West argument? Japan has been through its own banking crisis, again, driven by a property bubble, and has also been through the deleveraging process. On many measures, valuations are even more attractive than that of the Western world. However, there are two reasons why it may not be as attractive as it seems. The first is the amount of public debt and the second is the currency. The government debt to GDP ratio is over 200% but, given low interest rates in Japan, the cost of servicing that debt is relatively low. The currency has provided a natural hedge for overseas investors in recent years. When the markets went up, the yen tended to weaken and vice versa. Deflation is still a problem in Japan and the Bank of Japan is signalling that this must be tackled if the economy is to grow. If deflation is reversed, and one can hedge against the negative effects of weakening currency, then Japan might finally deliver.

Japan is also well positioned to benefit from the Asian growth story as the country has a lot of the cutting edge technology required by its rapidly developing neighbours. That development is continuing unabated with Chinese GDP growth at just under 12%. There are signs of asset bubbles appearing in the East similar to those experienced by western economies in the recent past, which nearly always end in disappointment for those who buy into the bubble. At least the Chinese authorities are taking steps through legislation to reduce the speculative house purchases that have been going on, combined with an explosion in lending, and it appears that they have learnt some lessons from the West.

Even if Asian markets suffer some form of set back, it may not be for long. Asia is destined to be the leader of global growth in the future and it certainly has the firepower to achieve this. Shanghai’s International Exposition, combined with the recent Olympics, is being used to showcase the opportunities China has to offer. This showcase is costing $59 billion, twice the cost of the 2008 Olympics and demonstrates the conviction with which they wish to advertise the potential of the country and region to the world.

Neighbouring countries are following China’s lead, but the markets are not without volatility and any investor must take this into account. With a long-term time horizon and the acceptance of some short term volatility, emerging markets, such as Asia, can produce excellent returns for your portfolio. The average bear market in the emerging markets has historically lasted 13 months and fallen 60% from its peak, but the average bull market has lasted 60 months with prices rising 400% from the trough.

So, in the West we see value in equity markets, and in the East we have opportunity for real growth, but with higher volatility. An active approach to investment management ensures that exposure between geographic regions remains flexible as opportunities arise and exposure can be adjusted according to the future risk/reward outlook.