Dear Valued Investors,
It seems that 2012 was a year in which Asia's markets rallied without much conviction. Investors appeared more concerned about chasing yield; growth in earnings was something that just happened whilst they were looking the other way. Bonds and dividend-paying stocks performed relatively well, whereas companies that retained capital for long-term growth struggled against investors' fears over 12-month GDP numbers. I readily agree that yield is a good thing to demand; we often argue that reasonable dividend yields can be a symptom of strong corporate governance and sustainable earnings growth. But reaching for high yields without thinking about growth or financial risk can be just as dangerous as blindly chasing high growth. I believe there are times when there is actually safety in growth!
I say this not just because of recent economic trends, but also because of the different approaches to government policy that emerged in the world over the past year. 2012 saw elections in Europe, the U.S., and across Asia. The results of these elections were also a product of the different economic environments across the globe. In heavily indebted countries, such as France and the U.S., elections were won on a platform of redistribution of wealth; taxation of productivity and investment; and encouragement of consumption. In Asia, where the fiscal position of most countries is much healthier, governments in favor of promoting profits and investment won or retained power.
It is perhaps not surprising that the consumption argument won elections for the West. In a depressed economy, more consumption may increase the circular flow of incomes and grow the economy. During the Great Depression of the 1930s, British economist John Maynard Keynes scorned the “purposive man” who pursued the accumulation of wealth over time at the expense of consumption in the present: “For him jam is not jam unless it is a case of jam tomorrow and never jam today.” But Keynes' “purposive man” is also the entrepreneur, the investor and the creator of long-term growth. In taxing him, policymakers risk permanently reducing investment. Despite this risk, the temptation to consume more today is often irresistible.
Much of Asia has a different view of Keynes’s purposive man. With the fiscal demons of temptation for the most part at bay, Asia continues to champion entrepreneurship and investment and to try to lure both to its shores. Tax rates on income are for the most part lower than the West and so, too, are corporate taxes and capital gains taxes, the latter of which are zero in Hong Kong and Singapore. China modified its visa laws to encourage the immigration of more foreign talent to help run and transform its businesses. In Asia, the purposive man is a hero not a Scrooge!
Asia's immediate challenge, therefore, is to facilitate investment. Such investment will still include physical infrastructure. However, it will probably focus increasingly on capital goods—the equipment and machinery necessary for improvements in manufacturing productivity and to produce a consistent quality of manufactured goods. In addition, investment in software and virtual infrastructure will increase in importance. IT spending across the region is likely to increase as wages rise, in order to get the most out of a more skilled labor force. Wages will continue to rise as people invest in their own education to reap the benefits of acquiring greater skills. Of all the challenges facing Asia, developing capital markets and the institutions to attract and grow capital are among the most important. As Asian governments continue to support and champion entrepreneurs, so Asian assets are likely to be in demand from both foreign and domestic investors. These are the channels by which Asia will allow the purposive man to accumulate wealth.
But What of Asia's Jam Tomorrow?
Asia will continue to build up its wealth. But the ultimate point of economic activity is still consumption, and for Asia that means the ability to enjoy a middle-class lifestyle. These changes are underway and will take time. They will probably take the form of more efficient use of natural resources to protect the environment; more money spent on leisure and the redevelopment of cities from production centers to consumption centers; and higher quality, modern housing. And, yes, Asia is also building welfare states: Indonesia wants universal health insurance by 2014; universal pensions a year later. China has set up its own welfare system; richer economies, such as South Korea, have had systems in place for some time. Yet, Asia's welfare systems are likely to be more efficient than in the West and also less generous. According to the Asian Development Bank, Asia’s spending on social welfare based on 2008 data averaged nearly 5% of GDP and ranges from approximately 2% in Indonesia, less than 5% in India and China; 8% in Korea and 16% in Japan. Data from the Organization for Economic Cooperation and Development, which measures public and private “social expenditure” suggests that governments in Europe and the U.S. spend between two and three times the amount than, for example, Korea.
I therefore remain confident that over the coming decade, Asia will retain its lead in terms of rates of investment and economic growth. Nevertheless, I also believe that our focus should remain on the long-term trends in Asian household and government consumption and the industries that are likely to benefit from the way Asia changes its patterns of consumption. In buoyant markets, there may be many short-term trades to make in distressed businesses—“cigar butt stocks” with “one last puff” in them. As tempting as these can be, trading on short-term market sentiment is not our way. We still believe in patience and we don’t want to end up holding a business that we wished we had never bought into. As we look to the year ahead, the most attractive opportunities seem to be in businesses in which the long-term growth is undervalued, or where the short-term cyclicality of the business has frightened investors seeking instant returns, even if the business has a strong competitive position in its industry.
Patience and delayed gratification, traits of the purposive man, remain key to long-run accumulation of wealth.
As always, we feel privileged to be your investment advisor for Asia and thank you for your support.
Robert Horrocks, PhD
Chief Investment Officer
Matthews International Capital Management, LLC
The views and information discussed in this commentary are as of December 31, 2012, are subject to change and may not reflect the writer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Statements of fact are from sources considered reliable, but the Investment Advisor makes no representation or guarantee as to their completeness or accuracy.