The immediate outlook for Asia ex Japan equities may turn on today's low interest rate policies. In the short term we think these could drive markets higher; equally they may cause, along with massive increases in government borrowing, new and dangerous risks to build. That borrowing will have to be paid for through higher taxes. Yet private consumption and investment in developed countries continue to be very weak. Meanwhile low interest rates designed to get people spending again have only had the effect of forcing investors to seek yield, driving up equity and credit markets in an unsustainable and unhealthy fashion.
"Countries do not export goods and services for the sake of it"
Despite remaining cautious on developed countries, the picture in Asia is more positive. In fact, Asia will probably lead global growth for the foreseeable future, pulling other emerging markets along with it. If the West experiences a relapse, Asia will be affected. Regional economies still depend to a degree on demand from the West for their manufactured exports, as well as for inward fixed and portfolio investment.
Pressure is growing for the yuan to be revalued. For countries that do not have capital controls our expectation is that consumer price inflation will lead to monetary tightening anyway. Should prices rise because of stronger domestic demand, rather than supply side price changes, such developments will however be positive.
Indeed, we are firm believers that decoupling – the idea that increased domestic demand in Asia will be able to compensate for weakness in developed economies - can become a driver of growth in the next decade. Countries do not export goods and services for the sake of it but in order to pay for imports such as commodities and capital goods that are needed to grow domestic economies. As countries such as China Taiwan and Korea have increasingly been able to manufacture their own capital goods their need to export has decreased.
Asia's banking systems remain strong, having been rebuilt following the financial crisis of the late 90s. This has meant that in the face of slack demand from developed countries governments in the region have been able to boost local demand through domestic bank credit as well as public spending. Weakness in the West could also paradoxically be positive for Asian economies to the extent that they are not generally able to satisfy strong domestic demand and strong external demand simultaneously; there may be less pressure on commodity prices for which regional economies compete.
While equity markets and indeed most asset classes have been highly correlated in the last two years, we see 2010 as the year in which investors begin to differentiate between sectors and countries.
Company earnings growth has recovered recently helped by cost cutting and inventory restocking. Yet it remains difficult to ascertain how such one-off factors may have distorted returns. Thus, there is considerable margin for error in saying what happens next. In absolute terms valuations are no longer cheap but nor are they expensive. We think the region may deserve a higher premium, even after last year’s outperformance, reflecting fundamental strengths including low levels of corporate personal and government debt.
As we have argued, with the inherent imbalances in the global economy still not addressed and the risk of policy exit mistakes, the likelihood of a global correction appears to have been carried over from last year. If a correction does take place the bonus for investors who took the view that by mid-2009 local markets had already risen too quickly is that they should get a second chance.
Published in Professional Investor
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.