[Mb-civic] Buttonwood The case for Asia

Wed Dec 8 17:39:40 PST 2004

Buttonwood 

The case for Asia

Dec 7th 2004 
>From The Economist Global Agenda

Foreign investors have been pouring money into Asian shares. For once, their
bets may pay off

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TO THE probable surprise of those who think of this column merely as a font
of scepticism, there are indeed a few markets for which Buttonwood holds a
warm affection. Take Asian stockmarkets. To the surprise of almost everyone
(including your columnist), most of them have actually gone up lately. True,
Japan has wobbled a bit in recent months, but the Nikkei aside, Asian
markets have generally recovered strongly since the sell-off in April and,
according to a widely watched index from Morgan Stanley, this week reached a
four-year high. A few of the more exotic destinations‹Karachi is one‹have
never been higher.

The region has been a magnet for foreign money, especially American money,
attracted by cheap stocks and heady growth‹since 2000, emerging economies
have grown two and a half times faster than rich ones‹and deterred from
investing at home by meagre bond yields and over-generous share valuations.
Flows into American mutual funds specialising in international equities have
jumped, according to EmergingPortfolio.com. So far this year, some $67
billion more has been invested in these funds. And an increasing proportion
of it has been popped into emerging markets. Flows into both international
funds and dedicated emerging-market funds jumped sharply in November.

 The Institute of International Finance expects Asia to attract almost half
of all private capital going to emerging markets this year, though it
expects its share to be below last year¹s. Although portfolio flows fell
sharply in April, when many investors fled, they have picked up smartly in
recent weeks. Money invested in Japan funds has risen by 57% so far this
year and, until recently at least, international investors were mostly
bullish on the prospects for Japanese shares.

 The contrarian in Buttonwood would take this as reason to sell. But just
because investors are wading into Asia does not necessarily make it wrong.
The problems of the American economy, and by extension its stockmarket, are
all too well known. Clearly, investors are underwhelmed by such arguments,
for the American stockmarket still accounts for just over half of the
world¹s stockmarket capitalisation. In contrast, Japan accounts for 9%, and
the rest of Asia just 3.5%. But even if you think that Japan is long past
its sell-by date, the region includes the fastest-growing economies on the
planet, and the most populous: Asia, after all, is home to 3.8 billion
people.

About 1.3 billion of these are, of course, in China, which also happens
directly to have accounted for about a quarter of world growth over the past
three years, measured in terms of purchasing-power parity, and a good deal
more indirectly, given how much Chinese imports have fuelled activity
elsewhere in Asia. Japanese exports to China are growing by anything up to
40% a year; its exports to America, in contrast, are shrinking. Intra-Asian
trade is growing by leaps and bounds.

 This raises four big questions. The first is: to what extent is Asia¹s
growth rigged by exports subsidised by cheap currencies? Quite a lot, is the
short answer. As Bank Credit Analyst, a research firm, points out, since
1992 emerging Asia's exports have grown 80% faster than consumption. Lack of
consumption, lots of savings and currencies quasi-pegged to the dollar‹in
China¹s case, fixed‹have resulted in huge current-account surpluses and
rapidly mounting foreign-exchange reserves. Asia¹s central banks have been
recycling these into US Treasury bonds.

Of late, many of these countries, with the exception of China, have let
their currencies rise against the dollar, perhaps for fear of an altogether
sharper and more unpleasant adjustment down the road. The yen has risen
especially fast. Of course, rising currencies raise questions about whether
heady growth rates will be sustainable; shares in exporters have suffered
somewhat. It is hard to say how much further Asian currencies will rise, how
much it will affect exports, or how long it will take for consumption to
take up the slack.

 Which brings up the second big question: how much will Asian growth benefit
investors? A big reason why emerging economies have not emerged is that
property rights are generally someone else¹s. And this is doubly true if you
are a foreign investor. Just ask any investor in China, which continues to
account for the bulk of foreign direct investment in Asia. Still, domestic
plays, though risky, are not without reward. Banks in Japan, a country where
outside investors are treated shoddily, are, in essence, a purely domestic
play. Although there was a sharp sell-off in April, shares in Japanese banks
are some three times higher than at their low in the spring of 2003, and the
rise has picked up pace in recent weeks.

 The third question concerns the sustainability of Chinese growth. The
country¹s investment boom was hugely helpful in pulling the rest of Asia out
of its slump in 2001. Were it to falter, so the rest of Asia would stumble;
and, for all its size, Japan would not be immune to such a shock. Still,
though investors were fearful earlier in the year that giddy growth would
lead to a hard landing, the signs are that, while China is slowing somewhat,
it is not headed for a fall. Inflation shows signs of dropping, and the
central bank may need to do little more than it has already done to cool the
economy.

The final question is about American markets. Were these to tumble, appetite
for risk would fall sharply, and Asian markets would suffer as much as those
anywhere‹probably more so, given their illiquidity and the extent to which
they have been propelled upwards by foreign money.

Still, that would seem to be as good a chance as any to buy. And at least
investors are somewhat protected by valuations. For all their recent rise,
Asian shares are still almost 40% below their 1994 peak. The cheapest market
in the region, South Korea, trades on a price-earnings ratio of seven, less
than half that of American shares. At the height of its stockmarket bubble,
Japan accounted for the same proportion of the world¹s stockmarket
capitalisation as America does today. Now you can buy the whole of Asia for
a quarter of that.

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