Dear Valued Investors,
As an Englishman, it’s hard for me not to get sucked into the whole Brexit chaos. Let me say two things about it—first, the initial reaction was quite extreme; second, there has been a temptation for people to look again at Asia in light of the concerns around Europe. I’d like to pause for a breath a bit and examine whether Brexit really is a reason to reallocate to Asia.
The initial reaction to the Brexit vote was one of real concern—lower GDP in Britain over the long term, a hit to investment in the short term, and worries that political turmoil in Europe might hold back spending there too. Well, some of this was perhaps overdone. The sterling’s fall on the Brexit news has probably provided something of a boost to the U.K. economy. The likelihood that the U.S. Federal Reserve will now be much slower to raise rates, too, has also calmed stock markets and allowed them to bounce back. So, the initial shock seems to have been excessive and everything is back on an even keel, economically speaking. Or so it might seem.
Politics is a different matter. Who would be leader of the U.K.’s governing Conservative Party now? Dumb question. There is always someone ambitious enough to step up. But they would probably face a short premiership before having to call a general election; the possibility of having to implement a tight budget; and the difficulty of getting votes through Parliament to actually execute the separation from Europe—most members of Parliament are probably in favor of remaining. All this is complicated by the fact that it seems very difficult to me to meet the desires of the British electorate as expressed in the last two referenda—most recently Brexit, and what seems just a moment ago, the referendum on whether Scotland should remain part of the United Kingdom. For, if one thing seems sure in this mess, it is that if the U.K. does leave Europe, Scotland will want to remain a part of the E.U. and that means splitting from the U.K. So, a Great British “muddle-through” is called for. All of which will take a lot of negotiating as they muddle. In the meantime, populist and separatist movements in France, Spain and Greece may gain traction. Other nations, probably the Netherlands and France, might want to join in any separation Britain wins from European immigration policy (a key cause of the leave campaign). So, the political mess will likely churn on in Europe for some time. This could depress investment. It might depress stock market sentiment, so it is not to be ignored.
But is that, in and of itself, a reason to turn to Asia? I would say not. Asia has to build its own case for investment, outside of what is happening in Europe. It’s not good enough just to be a less bad choice. There are reasons to be cautious about Asia, to be sure. Credit cycles seem to be worsening everywhere—from China, to Thailand, to India, and everywhere in between. This leaves us somewhat concerned about the ability of the financial systems to support near-term growth and for those companies reliant on borrowing to continue to grow. Consequently, our portfolios are relatively light on banking stocks and we have a natural bias toward self-funding companies with secular, if not always spectacular, growth trajectories. These qualities do not come cheaply in today’s markets. But nor is Asia expensive relative to the rest of the world. There does appear to be a valuation argument in favor of Asia—the U.S. trades at 17x forward Earnings Per Share; Europe at 14.0; and Asia at 13.5x. It is true that such valuation differences disappear if we look at a sector like consumer staples where Europe, the U.S. and Asia seem to be trading at similar levels. But here, the chance of Asia producing better future growth relative to these two areas seems reasonably strong.
After all, productivity levels are still low, but still growing. Governments have a keen eye on increasing both the efficiency of financial systems (China and Vietnam being cases in point); as well as legal systems (again China and India); corporate governance systems (Japan and Korea); and overhauling government investment in infrastructure, such as in Indonesia. Everywhere one looks, governments are at least trying to do the right things. And the record pace and levels of Asian countries—in terms of savings, manufacturing exposure, openness to trade, productivity growth, and increasing political stability—continue to be prominent in a world where the political trends in other regions seem to be challenging this openness. Even as immigration and trade treaties become political controversies in the U.S. and Europe, China is looking to deal with its demographic issues by opening up vast new trade routes and stepping up its foreign direct investment into the rest of the Asia region. These are multi-year, even multi-decade plans that show a long-term commitment to embrace the forces of growth. And despite many Doomsday headlines about China’s growth and its currency, it still achieves rates of growth that are the envy of much of the world and an increasing share of global exports. Asia is not perfect by any means, but it seems to me to still be on the right track.
But no, Brexit itself is not a reason to turn your attention to Asia. There is a danger in trying to respond to short-term political events. Rather, we try to take a long-term view of the region. This remains a view centered on the growth in productivity of Asia’s workforce, the emergence of domestic corporate champions, and the improving institutions of investment—markets, legal infrastructure and corporate governance. Our portfolios at the moment express some skepticism about the credit cycle, but we can still find good value in companies that are seeking to protect themselves from industry competition, allocating capital efficiently, and sometimes even paying out dividends that, despite their superior growth, are at higher yields than you find on average in the U.S. and that are comparable to Europe.
Since 2008, the world has become dominated by breathless hyperbole and shock headlines. Better, I think, to put them to the side of your mind and focus on the fundamentals of growing businesses and macroeconomic reform. In these areas, despite all its problems, Asia is doing quite well. And that is reason enough to consider it as an investment opportunity—but no, not just because my fellow Brits threw a hissy fit.
Robert Horrocks, PhD
Chief Investment Officer
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