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Domestic disturbance

Changing consumer attitudes in Asia will be a key driver of the world economy

Aperception that the Far East is genuinely decoupling from the US may hold some credence economically but the financial markets disagree vehemently. It has been within Asia that damage has been greatest, with many indices giving up months of gains in a few trading days.

During turbulent times, it is customary (and prudent) to take a step back and review the big picture. Ultra-low credit spreads and a private equity-leveraged buyout boom have been key catalysts for Western markets but the underlying strength of Asia’s growth story precludes their need. Domestic demand in the region will be the key driver of the world economy in coming decades, based on demographics, rising household formation and a change in consumer attitudes to borrowing and consuming.

From our perspective, the market levels realised in Asia are nowhere close to peaking because the bull market started off a low base. The previous domestic boom in Asia and Japan produced massive asset price inflation followed by destructive asset deflation. This resulted in mass psychological trauma, evaporation of risk appetite and negative equity.

The degree to which risk aversion still lingers in Asia means much of the rally in equities in recent years has been driven by foreign investors. There remains a mass of low-risk liquidity in Asia that, if put to work, could trigger much more speculative conditions.

The rapidly growing mutual fund industry has the potential to increase equity ownership in Asia. This is also true of pension funds and, increasingly, policies are being put in place to achieve this, say, in Korea and China.

Another way of looking at this potential is through retail banking deposits in Asia. These remain large, reflecting the regional banking system’s low loan deposit rates. Yet in many countries, including Japan, Singapore, Taiwan, Thailand and China, bank interest rates paid on deposits remain desperately low.

The extremely conservative attitude of Asian governments to managing ballooning foreign exchange reserves is slowly changing. In recent years, it has been driven by the mercantilist instinct to hold down Asian currencies for as long as possible to monitor export-driven growth models. Interestingly, governments have begun to signal at least incremental change in the way these funds will be invested. This is likely to be positive for equities.

Most Asian currencies are trading at levels well below fair value on most valuation metrics. Most governments still generally follow the classic mercantilist economic development model, keeping the currency artificially cheap to foster the export side of the economy. The Chinese renminbi is perhaps at the forefront of this, with the currency allowed to appreciate gradually against the dollar. But pressure is intensifying for a more aggressive move. A stronger currency would alleviate many problems in the Chinese economy. Asian currencies are cheap and will probably remain so for some time to come.

China and increasingly India are at the forefront of most discussions about Asia while Japan has dropped off most investors’ radar screens. For an unhedged sterling investor, Japan has been a painful place for the last year or so. The Nikkei effectively went sideways over the period but the yen fell substantially, resulting in negative returns of around 20 per cent.

But it is not time to give up on Japan yet. Corporate Japan has never been healthier and valuations are getting more attractive. Japan has lagged due to ultra-low interest rates. Until its savers get a decent return on their money at home, it makes no sense to invest in Japan when potential returns are much higher elsewhere.

That said, increased market volatility could perhaps be the first sign that Asians are no longer willing to continue buying dollars regardless.

If this is the beginning of what would be a momentous change in the global economy, Asian currencies and domestic demand would significantly strengthen from here and perhaps begin to take up the strain from the over-indebted US consumer.

Jonathan Schiessl is investment manager of Ashburton’s Asia Pacific equity and Chindia equity funds


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