Wall Street seems to have already anointed China the growth story of the 21st century. But what fund investors really want to know is how their Asia ex-Japan funds will fare in 2005.
Asian funds were up 13.2% in 2004, just slightly above the
returns of 10.9%, according to Morningstar. While emerging markets investors might have been expecting steeper returns last year considering the hype surrounding China, they should not forget that Asia ex-Japan funds were coming off a year in which they gained a hefty 53%.
Edmund Harriss, portfolio manager of the $31 million
Guinness Atkinson Asia Focus fund, expects Asian stocks to do very well in the coming year as China continues to replace Japan as the main engine for growth in the region. He is also looking for China to revalue its currency sometime in 2005 as its economy moves toward greater liberalization under the World Trade Organization.
asked Harriss about his forecast for the region and what investors can expect in 2005 from Asian stocks.
What are your projections for the Asia ex-Japan region in 2005?
The highest growth phase in Asia is now behind us, but the region is still expected to post growth of 6% in 2005 vs. an estimated 7.5% in 2004. Macro-economic growth momentum is slowing and this has already started to show up in the region's export numbers, which are coming down from an average growth of 24% in 2004 to an estimated 13% in 2005.
The overall prospect for Asia is one of steady growth and low inflation. The bias for Asian currencies is for them to appreciate, as they have been doing in recent months. The banking sector across Asia is significantly underleveraged and thus we are at the early stages of a renewed credit cycle. With current accounts in surplus, foreign exchange reserves at record highs in a number of cases and low levels of foreign and corporate debt, Asia is looking very stable. The key risks to the outlook are a sudden and sustained rise in energy prices, a collapse in U.S. demand -- and the U.S. dollar -- and a hard landing in China, which we view as very unlikely.
How is China's growth affecting some of the smaller countries in the region?
China is the main economic growth driver for the region, and thus all countries are affected to a greater or lesser extent by changes in China's growth profile. China accounts for between 9% and 15% of smaller Asian countries' total trade and accounts for 21% of Korean and 24% of Taiwanese trade. In some cases these countries are supplying raw materials, but in most cases they are providing components for final assembly by export manufacturers in China.
Slower growth in China would have an impact on these satellite countries, but we need to look at the picture a little more closely. China's overall economy is seeing a slowdown in investment and particularly in construction, but private enterprise including export manufacturing and consumption continues to be strong. Therefore, the main story is not what is happening in China, but instead what is happening to global demand and what affect that will have on demand for Asian goods.
China seems to have usurped Japan's role as the center of activity in Asia. What is the state of the relationship between Japan and the rest of Asia?
Japan continues to be an important investor in the region, but its economy has not been a key driver of the region in the way that China has become in the last few years. Japan's economy is, however, showing signs of a sustainable recovery. Consumption is still very weak, but corporate profitability is improving, as are investment and hiring. China's growth has, in fact, given Japan a boost, through its imports of capital goods. In 2005 regional growth ex-Japan is expected to be 6%, while including Japan the number comes at around 4%.
What do you expect from chipmakers and electronics manufacturers in the region?
The technology sector has been dragged down by a slowdown in global information technology spending that is expected to continue at least into the middle of 2005. PC growth is lackluster and there is a lack of drivers to boost the replacement cycle. Components such as DRAMs and LCD panels are dogged by increased capacity, and even the independent foundries are beginning to suffer from structural changes in the industry.
Nevertheless there are bright spots. First, consumer electronics will still see strong demand growth. Second, demand for notebook PCs is still a growth area and it appears that the market among suppliers is consolidating. Third, technology stocks are trading at or close to trough valuations and are ready to perk up at the first signs of good news, which is likely to come in the second or third quarter of 2005.
Will the region continue to drive commodity prices higher?
Commodity prices will continue to be underpinned by industrialization in China. However, we should be clear the demand is for natural resources such as copper, iron, oil and alumina rather than industrial commodities such as steel. China's impact on the commodities markets will be at the margin and will be cyclical. Consequently, I would expect prices to be structurally higher, but that China will be the key marginal factor driving swings in the prices.
If raw materials prices keep moving higher, could inflation be a potential problem?
Inflation in Asia is incredibly mild at present, with headline CPI growth well below that of 1995 pre-Asian crisis levels. China's CPI in 1995 was running at 17% while Hong Kong's was 9%, Korea's 4.5% and Taiwan's 3.7%. In 2004 inflation in China was 4.5%, Hong Kong minus-0.2%, Korea 3.1% and Taiwan 1.9%. China's inflation was the only area, except Indonesia, with rising inflation, but that peaked at 5.3%, while core inflation has barely moved from 1%.
What is the current state of domestic growth? Can the Asian consumer start replacing the weary American consumer?
That's a very good question. Asian growth is still largely determined by external demand and exports. The consumer has not properly recovered from the Asian crisis and is not yet ready to take over from the U.S. That is not to say I do not think anything will change. I absolutely believe that consumption growth in Asia will come through, but not in the next 12 months -- simply because there is no sign of it happening yet.
However, I do expect that Asian firms will start to invest again and I do expect consumers will begin spending again. As I have mentioned above, the banking sectors across Asia are liquid and underleveraged. They have the capacity to fuel growth when -- not if -- it starts.
What stocks do you like the most? Why?
I like stocks that exhibit four key qualities: First, a high and rising return on investment over time; second, rising revisions to earnings forecasts; third, value; fourth, a positive price trend. Stocks that I like in Hong Kong/China include
. In Singapore, we like
Neptune Orient Lines
In Taiwan, our favorites are
High Tech Computer
. And in Thailand and Korea we like
Advanced Info Services
How is the weak U.S. dollar affecting Asia? Will China revalue in 2005?
The weak dollar is a problem for exporters in Asia, and since Asian economies are still dependent upon export growth while private consumption remains so weak, Asian banks have intervened to prevent their currencies from rising too sharply -- although they have risen and levels of intervention have fallen. As a result, there is a great deal of liquidity sloshing around, foreign reserves are increasing and with currencies tending to rise, there is little need for any sharp rises in interest rates.
In the past, Asia has followed U.S. rate moves very closely, but recently the premium of local rates over U.S. rates has narrowed and in some cases is at a discount. The dollar has not yet fallen to levels that cause severe pain to Asia, and for the present there is no sign of Asian central banks bailing out of the currency.
China is quite likely to make some moves on its currency in 2005. The need to move away from a peg is recognized by China, although for rather different reasons than the anticompetitive arguments being touted. As China's economy moves toward greater liberalization under WTO and moves toward an opening of the capital account, the economy will become more vulnerable to external shocks from capital flows. A more flexible currency to absorb those is clearly desirable and this is what governs Chinese thinking.
It should also be noted that with the economy running at a cyclical peak, with low inflation, and a current account surplus and $540 billion in reserves, there could hardly be a better time to break from the peg. The question is whether they will move by a conservative 3%-5% or whether a more substantial move is in the offing. Interestingly, Chinese proponents of a more substantial move are gaining ground. What is clear is that if pressure is applied by markets or governments on China to move, it will not happen. They will choose a quiet moment when no one is expecting it.
We saw a successful furniture dumping case vs. China in the U.S., and there have also been textile tariff cases. How much of a problem is China backlash?
China is more sensitive than many might realize to the effect of its own competitiveness on the rest of the world. One of the arguments against a revaluation was that it would hurt the export sector, which has been the job creator and economic driver in China since 1995. However, they also know that doing nothing and allowing a protectionist agenda to gain momentum could prove far more harmful. They are aware that even leading proponents of free markets in the U.S. are wondering whether free trade with Asia is desirable.
They also note that in addition to the point you made, antidumping cases from the U.S., Europe and even India are running at record highs. The threat of a backlash is real. It was instructive to see that ahead of the removal of textile quotas on Jan. 1, China imposed its own export tariffs on certain textile goods. These were low but were an acknowledgement of the problem.
We've covered quite a bit of ground. Is there anything I forgot to ask you?
The message I would leave you with is that Asia is at a point where it has regained its balance following the Asian crisis. The banking systems are working and are able and willing to lend. The macro-economic data show a region with trade surpluses, broad fiscal balances and low inflation. The global cycle has peaked and exports are slowing but growth is still expected to be 6% in 2005. Moving into 2006 the global cycle is expected to pick up and Asia, with its lack of excesses and substantial reserves of liquidity and savings, still looks like a good bet.