Dear Valued Investors,
There has been quite a slew of good news coming out of Asia, recently—though you may not have noticed it, buried behind the trials and tribulations of President Donald Trump, GOP health care plans, and tax reform in the U.S.; Dutch elections, Brexit debates, Scottish independence and French presidential elections in Europe; and OPEC production flip-flops. Dominant news out of Asia has focused on North Korea’s perennial saber-rattling. But other things have been happening, too. First, the impeachment of South Korea’s president and the corruption indictment of Samsung’s heir seem to have given new impetus to South Korea’s reform agenda. In India, Prime Minister Narendra Modi, whose own reform program appeared to have hit some bumps with his demonetization policy late last year, reaffirmed his popularity with a landslide win in India’s state elections. In China, events have been noticeable for what hasn’t happened—massive capital flight hasn’t taken place as some feared; the U.S. did not overturn its long-held One China policy. And then there are the events that did occur: improved corporate results, hope for special dividends to be paid from some listed state-owned enterprises—all against a backdrop of markets that have risen 10.7% so far this year, according to the MSCI Asia Pacific Index.
I do not think that this has necessarily changed the average investor’s sentiment toward Asia. Through our global client base, I am privileged to meet a lot of smart investors throughout the year. And while sentiment has improved from where it was in early 2016, there is still much skepticism surrounding Asia. The bearishness with regards to China in the U.S. seemed to reach its peak in early 2016. But during my visits with European clients in 2015 and 2016, they also commonly reported being strongly underweight Asia—some at historically low weights. And whereas, the ground may have shifted a little more back toward Asia after the Brexit vote caused many to look at Europe’s own problems—problems that threatened to weaken the political and economic union and that, due to the political calendar this year, could extend across several quarters. The atmosphere is hardly exuberant!
Is this fair? This is always a dangerous question to ask, as it belies a certain feeling of injustice being dealt to our “home” markets. But it is true that Asia’s problems never seemed to be so bad when you speak with those who are actually living and working in Asia—or for that matter in other emerging economies such as in Latin America. Throughout all of the Western bearishness, investors in so-called emerging market economies were less likely to treat other emerging markets as risky just because of the name. These investors know how misleading the term “emerging” has become. Rather, they were able to focus on the long-term growth promise of the region.
Now in 2017, Asia’s markets have got off to a good start. This naturally brings them to people’s attention. And yet they still seem to be climbing a wall of worry. I think that in the U.S., people are still beguiled by the post-election rise in the market. Even with the weakening prospect of infrastructure spending and tax reform stymied by the GOP struggles with health care, the equity market remains mesmerized by the prospect of deregulation and the bond market is unfazed by federal reserve rate rises. The U.S. stock market, at 18.5X forward earnings (as of late March), is riding a wave of hope, just as Asia’s markets at 14.6X forward earnings, finally have some tangible achievements to rely on. Cyclically adjusted price-to-earnings ratios (where one looks at an average of multiple past year’s earnings) paint an even starker valuation discrepancy. This is due to the fact that earnings in Asia have been cyclically depressed (possibly by higher wages) for the past five years. The contrast with the U.S. is stark. Blue-collar workers, feeling disenfranchised by capitalism and rising corporate profit margins in a weak economy, swept Trump to power. In Asia, it has been the corporate world that has had to support faster wage growth and where the politicians—more assured of grass-roots support for capitalist growth—are able, as was China’s President Xi Jinping at Davos, to become one of the more ardent voices for globalism, trade and capitalist development.
The recent environment has not always been favorable to our portfolios. The rally that took place in commodity companies, on the back of hopes for infrastructure spending and global reflation, hurt relative performance. But we remain skeptical of this rally. It has already taken these companies to expensive valuations—and there is evidence of both stockpiling and renewed acceleration of production in some key commodities, just as hopes for large-scale Chinese (and to a lesser extent U.S.) infrastructure spend seem to be fading. The rotation amongst speculators from high-quality secular growth names to shorter-term cyclicals caused a severe divergence in performance between, for example energy and minerals stocks versus consumer staples and telecommunications businesses in the fourth quarter of 2016. However, for the moment, this seems to have played itself out.
Of course, changes in sentiment that bring the region back into favor may again ignite performance in some of the region’s cyclical sectors. But we remain committed to finding long-term growth in companies that will survive and grow sustainably over decades. Asia’s future lies in high-end manufacturing, the growth of consumer brands, the further development of financial markets, media, leisure and entertainment—the development of the digital world much more so than building roads, bridges, and dams. I note that the changes in environment in Asia, unlike the focus on tax cuts and fiscal spending in the US, are strategic and structural in nature. Better governance of both countries and corporates can add significant value to economies and markets over the long term. We believe that focusing on strong companies that will support Asia’s secular growth is the best way to think about core investments in the world’s most populous region.
Robert Horrocks, PhD
Chief Investment Officer
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