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Why we're only at start of powerful Asian bull market

Why we're only at start of powerful Asian bull market

With the MSCI Pacific ex Japan index rising nearly 20% year-to-date, Asia is outperforming most developed markets and many other emerging markets.

We expect this outperformance to only accelerate from here as investors re-appraise the risk-reward opportunity relative to developed markets, and realise that there are no valid grounds for considering Asia in the same asset class as markets such as South Africa, Russia and Brazil.

Since the financial crisis, investors have struggled to view Asia clearly, instead referring to it only as a component of emerging markets, or believing that by holding multinational companies they would pick up at least part of any economic turnaround.

Both approaches are flawed. Pairing Asia with non-Asian emerging markets dilutes the structural high-quality growth of a portfolio. For those trying to gain exposure via multinational companies, it is worth noting that in many consumer sectors the domestic Asian brands are easily outselling the multinationals.

In our conversations with clients, we often find ourselves addressing some key myths around investing in Asia.

Here are the big three:

Myth 1: Asia is NOT an emerging market

Asia’s outperformance of more cyclical and commodity dependent emerging markets such as Russia, South Africa and Brazil will endure for many more years.

In a world whose future will be dependent on knowledge and technology (not coal and copper), these emerging markets will struggle in comparison to economies such as .                                                

Although Asia dominated the weightings of the emerging market indices, the risks for investors emanated much more from non-Asian markets such as Russia, Brazil, Turkey and South Africa.

So when the US dollar began its ascent, funding became scarce for fast growing emerging markets with current account deficits, like Turkey and Eastern Europe, and commodity prices plunged, which was bad for Brazil, Russia and South Africa.

Emerging markets were sold off savagely, and so with it, Asia, despite the fact that this only served to improve the terms of trade for most Asian economies.

Asia is a region characterised by current account surpluses, but despite having some of the most efficient and, in many cases, skilled workforces in the world, Asia was sold off indiscriminately because of the ‘emerging market risk’ associated with non-Asian markets.

Myth 2: Investment in Asia is inherently riskier than developed markets

The question that should really be posed here is how does Asia compare to developed markets in terms of risk, and is the risk/return from developed markets superior to Asia?

To best frame this we should concern ourselves with the key macro drivers of economies and equity markets: the impact of political institutions, demographic trends, and financial risks posed by excessive debt.

Political risk comes in many forms. Changes in governments occur frequently throughout the world, primarily as a result of the democratic election process.

Here the risks for any nation are evident in the polarisation of the representative parties.

Polarisation can be devastating for economies as they either lurch between ideologies or remain gridlocked by partisan politics. Political institutions in Asia are primarily democratic (although the tenure and dominance of ruling parties in Singapore and Malaysia have certainly impeded the development of true opposition parties).

With the exception of Thailand, politics have not been a destabilising force in Asia. In the case of India, the most polarised of the political systems, the government has enacted sweeping reforms and made genuine, hard won gains.

Compare this to the dire state of the US and UK administrations and we think it would be fair to say that the Asian political environment presents no more risk than major developed markets.

Of similar importance, long-term investors must focus on risks arising from structural long-term challenges brought about by demographic change. For the developed world, .  In contrast, .

A closer look at the demographics reveals a vibrant and growing middle class, with greater financial resources propelling domestic consumption. The OECD forecasts that by 2030 Asia will represent 66% of the global middle-class population and 59% of middle-class consumption.

It is these factors that drove GDP growth of 6.7%, 6.2%, 6.7% and 7.1% in the Philippines, Vietnam, China and India respectively in 2016, while the BOJ, ECB and Federal Reserve continued expansionist policies to achieve growth of only 1%, 1.6% and 1.6% respectively.

The key issue behind the Asia crisis was not just one of leverage, but too much short-term foreign currency debt.

The good news is that Asia’s debt levels are now manageable. Foreign short-term loans represent low levels in absolute terms and also relative to non-Asian emerging markets.

Looking back at the response to the crisis two decades ago, there is much to admire in the hard road that many Asian economies took: they devalued their currencies and set about working towards exporting their nations back to prosperity.

In doing so they significantly improved the skills of their workforce as they moved up the value-chain, and engendered the efficient, hard working ethics that have driven successes in the last decade.

Myth 3: China dominates growth and their run has come to an end

Proclamations on the demise of China centre on the rise in China’s total debt, and the potential for credit issues from the decline in ‘old economy’ industries such as coal and steel.

However, these views conveniently ignore the booming contribution that the services sector and consumption are making to GDP growth.

In addition, these proclamations are also so out of date that to believe in them would have meant missing the significant turnaround in industrial profitability as a result of industry consolidation, supply-side discipline and now a healthy deleveraging for the entire economy.

Add in a solid rebound in exports (volumes and prices) and the momentum couldn’t be more different from two years ago.

There are huge structural growth drivers in China across a range of sectors such as travel, technology, consumption, wealth protection and health care. The services sector is growing fast.

Labour moving from low-end manufacturing into services is a healthy transition.

Returns on equity are rising from a combination of significant growth in high RoIC sectors such as technology and consumption, margin expansion thanks to benign commodity prices, and structural demand growth from a growing middle class.

This is in stark contrast to developed markets where after nine years of stimulatory (and in many cases experimental) monetary policy, the US, Japan and Europe have seen only muted cyclical growth whilst the liability of a rapidly ageing society with underfunded health and pension requirements grows ever larger.

Angus Coupland  (pictured) is portfolio manager of the CC Asia Alpha Fund.

 

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