Returning from my latest trip to Asia, I’m both exhilarated and perplexed.
Exhilarated because Asia is booming, and it’s a joy to see. Thailand, my main stop this time, is growing at 7 percent a year — twice as fast as the United States and about four times as fast as Europe. Inflation and interest rates are low, and the economy is well balanced between strong manufacturing exports and growing consumer demand. Entrepreneurship is rampant, and the people are smart and work hard.
Perplexed because, I’m afraid, the gap is growing between the energetic economies of Asia — notably China, India and the Tigers of Taiwan, Singapore, South Korea, Indonesia, Malaysia and Thailand — and the mature, complacent economies of the West, and I am not exactly sure what that means for investors.
At least one very intelligent and successful investor, however, is not confused at all. Byron R. Wien, the Morgan Stanley strategist, calls this person “The Smartest Man in Europe.” Wien won’t identify the man but wrote about him with respect and enthusiasm in a June 28 letter to clients.
The conclusion of The Smartest Man in Europe (let’s called him TSMIE) is this: “You should put your financial assets in Asia (50 percent), Europe (25 percent) and the U.S. (25 percent) and buy some gold and other commodities.”
Let that sink in. TSMIE thinks half of your stock holdings should be in firms based in Asia. Even an aggressive U.S. or European investor typically has no more than one-tenth of his portfolio in Asian shares.
My own view, repeated countless times, is that investors should assume that the world economy will grow pretty much as it has since World War II. Sure, some smaller nations will grow faster, but that’s no big reason to favor them. A smart portfolio, I have always said, focuses on U.S. companies. A little seasoning with international firms makes sense, but the flavor should not be overwhelming, or even very noticeable.
TSMIE disagrees strongly. First, he points out that while corporate “earnings are exceeding estimates by a large amount and substantial money is flowing into equity mutual funds . . . stocks refuse to budge.” That seems strange, says TSMIE, because, according to the conventional wisdom on Wall Street and in Washington, the economy is doing well.
Yes, it slowed after the attacks of 9/11, but “the Fed eased significantly, the government applied massive fiscal stimulus, business picked up, [and] inflation remained tame and interest rates stayed low.” Rates are rising a bit, but they are still very low. Growth is increasing, but “the stock market is going nowhere.”
What gives?
TSMIE’s premise is that “the market is smarter than all of us and knows something is wrong.” But what?
“The world,” TSMIE tells Wien, “is settling into three major blocs, and only one is especially interesting from an investment viewpoint.” The market, in short, is unhappy with the other two blocs from a long-run perspective. The future, contrary to what this column has been saying for years now, may not be like the past.
“The problems in Europe are well known,” says TSMIE. “The population is aging, the economy is mature. . . . People put living the good life ahead of working hard.” He goes on, “The American bloc isn’t much better. . . . The U.S. has grown soft. No politician can propose anything that involves sacrifice. . . . Your manufactured products are uncompetitive, and you don’t provide the necessary incentives to expand the knowledge-based industries where you have an advantage.
“The increasing cost of health care and retirement benefits will be a drag on U.S. profitability and will discourage investment. Litigation costs are a terrible drag.” TSMIE concedes that, as the dollar declines, U.S. products will become more competitive. He also respects our lead in biotechnology and nanotechnology, but he concludes, “The Western countries, including the U.S., have to face up to the fact that their standard of living will decline.”
Of course, we have heard such sentiments before — in the 1970s and ’80s, for example, when scholars, journalists and politicians warned of the rise of Japan and fall of America. That prediction was wrong, and this one may be, too, but I have to admit, the more I travel in Asia and look hard at where America is going, the more I believe Wien’s friend has a valid point.
“Asia,” says TSMIE, “is only beginning a long cycle of opportunity. . . . Both China and India have an educated population willing to work very hard for modest wages. Every year, China moves further along the curve of manufacturing sophistication. . . . Asian countries provide few health care benefits, and there is no plaintiff’s bar. . . . It is a free-wheeling business atmosphere, much as I imagine America was in the days of the Wild West.”
The problem with Asia for investors, however, is that, with the exception of Japan, the stock markets “are relatively undeveloped,” with widespread unfair trading practices and low liquidity.
This means that risks are high, but then so are rewards.
“Investors have come a long way in understanding the case for international investing over the years,” says Jeffrey Everett, president of Templeton Global Advisors, quoted on Forbes.com recently, “but one thing they’re still missing is the huge opportunity in picking individual stocks. There are huge inefficiencies that just aren’t here in the U.S.”
Picking Asian stocks is tough, especially in such high-growth markets as China and the Tigers. You have to put your trust in mutual fund managers, and there aren’t many with experience and strong track records. Certainly, the firm founded by the great global investor John Templeton is one. Templeton Dragon Fund Inc. (TDF), for example, is a closed-end fund that trades on the New York Stock Exchange and owns shares of firms based in Asian countries except Japan. It doubled in value in 2003 and has returned an annual average of 14 percent over the past five years.
In February, I wrote about Matthews International Capital Management, a firm that is based in San Francisco and runs eight funds that specialize in Asian stocks. Matthews China (MCHFX) has returned an annual average of 11 percent over the past five years, compared with a loss of 3 percent for the U.S. benchmark, the Standard & Poor’s 500-stock index. In February, the fund had only $88 million in assets; now it has $363 million.
Matthews Pacific Tiger (MAPTX) is larger and, in its 10th year, more venerable. Top holdings include Thai firms, Advanced Info Service PLC, a cellular provider, and Bangkok Bank. Also high on the list are three Singapore companies — Venture Corp., high-tech manufacturing; DBS Group Holdings Ltd., banking; and Fraser and Neave Ltd., a conglomerate with interests in beer, publishing and real estate. The fund has returned an annual average of 17 percent over the past three years, 7 percent over the past five.
Another U.S.-based money manager with Asian expertise is Guinness Atkinson, which runs Asia Focus (IASMX), which returned 64 percent in 2003, according to Morningstar, and China & Hong Kong (ICHKX), with annual average returns since 1999 of 5 percent.
Top holding by far in Asia Focus is Samsung Electronics, the superbly managed Korean high-tech company. The fund’s manager, Edmund Harriss, has about 4 percent of fund assets in each of two Hong Kong companies, Techtronic Industries Co., which makes power tools and appliances (including the Dirt Devil), and Denway Motors Ltd., a joint venture between a Chinese group and Japan’s Honda.
Last spring, Guinness Atkinson outlined the difficulties in investing in China, whose “A” shares may be purchased only by Chinese citizens. Hong Kong blue chips — which include pan-Asian firms such as conglomerate Hutchison Whampoa Ltd. and financial giant HSBC Holdings PLC, which is based in London and trades as well on the New York Stock Exchange under the symbol HBC — appear to be safest.
But the main point of the report was simple: “Since 1978, China has grown at a compound rate of more than 9 percent per year. Its economy today is eight times as large as when reforms were introduced.”
India, too, is growing like crazy, though the results of the recent national election cast doubt about the future. Still, China’s gross domestic product has grown at 10 percent over the past 12 months, India’s at 8 percent. Measured by “purchasing power parity” — that is, the buying power of local currency — China is the second-largest economy in the world after the United States, and India is fourth, ahead of Germany, France and Britain.
It’s not hard to see Asia surpassing the United States and Europe in economic power in the next two decades, and it would be foolish for investors to skimp on Asia — no matter how difficult it is to invest in companies outside Japan, which, by the way, I would include with the United States and Europe as potential areas of relative economic decline.
But put half your money in Asian stocks? That’s a little extreme. My suggestion is to start leaning East but to realize that, as even TSMIE admits, “the U.S. market . . . probably has one last run.” At least.
