Briefing on the Asian economy and stock markets
The Asian economies have for several decades delivered faster economic growth rates than Western economies but their stock markets have been far more volatile. Though these growth rates are now receding, they are still expected to be much higher than in Western economies over the next decade. Asian stock markets experienced a major bull market high in the early 1990s before stabilising and then entering a major bear market with the Asian currency crisis in 1997-98. Many companies which had borrowed in dollars due to the underdevelopment of their national financial systems, found themselves in serious financial difficulties. This was a searing experience which still affects corporate and consumer attitudes across Asia today.
The dominant trend of the global economy over the next decade is the rebalancing of the world’s middle classes from the West to the East.
Western middle-class demographics are broadly stable, while those in Asia show the numbers more than tripling over the period from 2009 to 2020 – a hugely dramatic shift in both absolute terms and Asia’s relative share. Growth in Asian consumption will be the driving force in the world economy for the next 10 years.
In Asia, care is required to distinguish between economic performance and stock market performance. For example the Chinese economy has grown by more than 10% per annum over the last 20 years, but its stock market (as measured by the MSCI China Index in $) is little changed. This reflects factors such as state-owned companies prioritising employment and growth objectives rather than profit objectives, and family-owned companies not wishing to lose control of their companies. These problems can be overcome with careful research.
The near-death experience of many Asian governments, banks and consumers from the 1998 crisis is fresh in the minds of most people across the region, and underpins a culture of hard work, high savings and a reticence for using debt. This contrasts sharply with many Western economies today.
The Asian banking systems (excluding China) are in far better health than the Western banking systems. Their assets are heavily concentrated in loans to companies within the economies in which they operate, rather than the securitised US mortgage bonds and peripheral European bonds that have so badly damaged the balance sheets of the Western banks. Asian banks are well-capitalised and still have lower loan-to-deposit ratios than many Western banks - they are thus in a very good position to support and finance the future growth of the Asian economies.
The Chinese economy dominates the region, and is going through a major period of change. After 2008, China accepted that demand for its exports would be badly affected and so went on an enormous investment spending expansion for the next two years, hoping that when it was complete, it would be well positioned to benefit from recovering global demand. This recovery did not occur -instead its investment spending led to an increase in commodity prices and a house price boom in China. China was forced to tighten its monetary policy just as Western demand once again slackened off, and has undergone a slowdown in growth so that Q3 2012 saw growth of 7.4% below the official 7.5% target. Policy has now begun to reverse and move easier once again.
Asian governments have historically prioritised investment in industries with the potential to export over the needs of domestic consumers. Welfare systems are not generous, levels of taxation and government spending in these economies are relatively low and the size of budget deficits and total public debt as a share of the economy is much smaller than in the western economies.
The success of the Asian economies in recent decades has been built on manufactured exports to the West. There is a widespread understanding now that Western consumer demand will be much weaker in the future and that continued strong growth will increasingly depend on domestic consumer spending. Healthy government finances will permit tax cuts and stronger welfare systems, which should help to boost domestic consumption.
Rebalancing of the Asian economies will be good for the development of the local financial services industries - instead of merely providing loan finance for export companies, the banks are looking to provide other financial services to consumers. In the West, this phase of economic development in the 1980s and 1990s was extremely positive for growth generally and banking sector profits in particular.
The future for Asia
The largest segment of the world economy that has the willingness and the ability to spend money in the next decade is the Asian consumer. Companies and countries that meet the needs of these demanding consumers should see good profits growth.
The market valuations across the region offer additional upside potential for investors. On average, Asian companies have a similar Return on Equity to Western companies, but trade on lower P/E ratios and higher dividend yields. Balance sheets are conservatively financed and growth prospects both in absolute terms and relative to Western companies.
Corporate governance should improve. As economies grow and companies fund that growth from the stock markets, so the large holdings of government and family owners will get diluted. The influx of new shareholders should lead to demands for improved corporate governance towards Western standards, and provide further support to valuations.
With their attractive combination of powerful relative growth prospects, healthy financial systems and inexpensive valuations, Asian equity markets as a whole are likely to be the strongest regional performer amongst global stock markets over the rest of this decade. After a period of mild underperformance against the rest of the world since early 2011, as growth in the Chinese economy has disappointed investors, the region now looks poised to return to its position as the leading driver of global stock market performance.