Dear Valued Investors,
2018 was a bad year for Asia's stock markets, but Asia's markets are not the same as their economies, which for the most part remained unscathed. Not just unscathed but in fact remarkably resilient given the tightening monetary policy in the U.S. and China and the fractious political relationship between the two countries over trade. And although it is true that we are investing in the markets, not the economies, having a stable economic background is important as it underpins both the regions' currencies and the profits of the firms whose bonds and equities we hold.
So, why have the markets been so weak? Well, as I have mentioned, tighter money has been a big part of this. The tight money in the U.S. may well continue and there is an increasing risk that the U.S. Federal Reserve may tighten too far. Its job is complicated by low unemployment levels and corporate profits that are likely to struggle to maintain the growth rates of recent years. That is a headwind for all markets but it is surely going to have its biggest impact in the U.S. (Indeed, as I write this, Asia's markets have fallen just 6% in December as the Nasdaq has tumbled 14%.) Currencies such as Indonesia's rupiah seem to have stabilized. The Asian markets seem further along through this market downturn—and they are already showing good value for patient investors. Indeed, the dividend yield on a broad universe of Asia equities is higher than it has been for 90% of the past 15 years.
So, why is Asia further through this downturn and why does it seem so reasonably priced? Because the main reason for Asia's weakness was probably not the Fed, but the People's Bank of China. Tighter money in China has depressed nominal demand and also had a knock-on effect to other countries in the region, from Vietnam to Japan to Australia. Tighter money in China has not been a deliberate policy choice, but rather a side effect of trying to make the debt issues in local government finance vehicles both more transparent and easier to resolve. This is an important step for China and the fact that the government decided to tackle it while the global economy was still strong will likely be seen as wise in hindsight. The global economy may not be as strong in 2019, and the Chinese have taken the opportunity to deal with the issue while they still had it.
So, my best guess is that 2019 will be a year of moderate stimulus for the Asian region. I do not anticipate that China will try to loosen aggressively, not while the U.S. may still be tightening. But having dealt with the lion's share of the local government debt issue, it need no longer face the unintended consequences of that policy. Core inflation is likely to rise somewhat on the back of better monetary policy and that is likely to be good for profits.
Profit growth has certainly been disappointing in Asia over the last few years—slower than Europe, Latin America, and the U.S. (although Japan has done well). Why is this? Well, a Western-centric view of the world would likely put it down to superior standards of governance and regulation—that capitalist systems just work better than the ones in Asia. There is some truth to this. But the West is not as superior as it may think. For how superior can a system be that has allowed profits to grow so quickly on the back of squeezing wages and pumping up profits with one last, one-sided tax bill? Asia underwent a similar cycle in the 2000s but attitudes have changed since the global financial crisis of 2008. The first decade of the century was about “growth” and growth at almost any price—be it the environment or social cohesion. But then the Chinese emphasized not growth but “stability” as they sought to redistribute the gains from economic growth to labor and beyond their own borders to people in the rest of Asia. And now, they emphasize “quality” in order to share the growth equally between capital and labor and to achieve better standards of life, including environmental, social, and governance. The West, therefore, is not entirely superior to Asia in many of these respects. And it does seem to be the case that the leadership in the world may be pivoting from West to East.
How to take account of this in our investments and in our portfolios? First is to maintain our focus on domestic demand. This is not just about consumer stocks but all aspects of domestic demand—health care, capital goods and finance. And that will increasingly mean taking advantages of the profitable opportunities offered by the demands of citizens for “quality.” Now is certainly not the time to get defensive about Asia. That may seem the sensible thing to do and there are many trading the Asian equity and fixed income markets who, having shorter time horizons than we try to maintain, are focused on the potentially difficult weeks and months ahead. But, no, the opportunities that Asia offers are too varied and enticing in the long term and can be bought at relatively inexpensive prices, such that now is the time for portfolios to maintain their focus on growth—growth of the leading entrepreneurs and businesses in industries that we believe will prosper in Asia over the next few decades.
That remains our task as researchers and investors in the region and it is one that we tackle with great passion. We are, as always, privileged to be your Asia investment advisor.
Robert Horrocks, PhD
Chief Investment Officer
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