Don’t Overreact to Taper-Talk Turmoil in Asia 

Neil Dwane 

 

8/29/2013 

Neil Dwane, CIO Equity Europe, provides a European perspective on the strong long-term growth prospects for Asia ex-Japan: Volatility and outflows provide an opportunity to find good values.

Summary

Emerging markets have been severely impacted by “taper talk” from the US Federal Reserve and the ensuing “tantrums” have seen investors withdrawing record sums from Asia in particular. In addition to this, the recent chemical attacks in Syria and the response from the West have led to a “risk-off” environment returning among investors in the last few days, and have worsened the sell-off in emerging markets.
Despite the negative sentiment, we believe the longer-term opportunities and prospects for Asia in particular remain clear and compelling. However, the halo from China has lifted all boats in the region. Now, as China rebalances, the local and regional challenge is for the surrounding Asian economies to refocus on their own domestic improvement policies. With reliance on trade and related mercantile policies, Asia remains vulnerable to tapped-out Western consumers and a rejuvenated Japan. All of this should encourage Asian policymakers to step further forward, with more supportive economic and political policies, as is well described in the book “From Third World to First” by Lee Kuan Yew.
Flattering the domestic growth of many Asian economies has also been a tsunami of investment activity, estimated to have exceeded USD 5 trillion over the last decade. With the US Federal Reserve in tapering mode, Asia is now seeing that it will have to fight for access to global capital, rather than being seen as the default home for investors. Moreover, investor over-positioning toward global emerging markets in both bonds and equities may mean that further outflows and volatility will occur; this may challenge policymakers and central bankers to respond constructively and prudently – Asia is not where it was in 1997/98 when there was excessive domestic debt, borrowed in foreign currencies.
The challenges are obvious but Asia has the people, the guile and the wherewithal to offer good longer-term returns as the “taper tantrums” subside and the direction of policy globally becomes clearer later this year.

Tempted to overreact to taper tantrum turmoil in emerging markets? Think again …

At a critical time for emerging markets and Asia in particular, as it is impacted by slowing Chinese economic growth and short-term events, I spent a week in Asia this summer to view developments there first hand as a European investor. Bearing in mind that our European equity portfolios invest in many world-class European companies that have successfully expanded into Asia and other emerging markets, it is critical for us as European investors to follow developments in these markets and economies, enabling us to assess the possible impact on companies closer to home.

Since then, emerging markets have been severely impacted by “taper talk” from the US Federal Reserve and the ensuing “tantrums” have seen investors withdrawing record sums from Asia in particular. While the ending of quantitative easing – and the record flows of money it helped drive into emerging markets – was always going to negatively impact these markets (much to the concern of their central banks), I came away from Asia convinced that the region has the talent, drive and determination to continue to deliver relatively strong rates of economic growth going forward. We believe that investors should view current events as an opportunity to review their exposure to emerging markets and may well be rewarded by pockets of good value increasingly opening up.

I was deeply impressed by the pace and enthusiasm with which Asians are living the new dream of economic growth and transformation, reflected in the incredible continuing pipeline of infrastructure projects and building developments. The Asian talent pool remains deep and highly industrious, with many Asian countries putting explicit economic strategies in place to move up the value curve from low-cost manufacturing to higher value added and service business. Europe and other sclerotic developed societies – in particular the less well-educated within Western societies – will continue to “feel the heat” of competition from Asia. In Europe, we are seeing the direct result of this inability to compete and adapt, directly reflected in record high youth unemployment levels – a longer-term challenge I have previously addressed.

Intra-regional Asian trade now accounts for 25 per cent of regional gross domestic product (GDP) but Asia remains very beholden to Western consumption patterns. Obviously much of this trade is closely correlated to economic activity in China, as many economies are major counterparties for specific commodities with China. Thus, what I found interesting was that the further away from China one was, the more nervous people were of major shifts within the Chinese economy. It was easy to deduce that much of the strong economic progress the region has delivered was not solely domestic reorganization and rejuvenation, but all about the “halo from China’s meteoric growth” of the last 20 years.

South-East Asia

One sees similar patterns appearing across South-East Asia, as all the countries try to move from the lower-margin global industry segments towards the higher value-added areas.

For Malaysia, which has a low middle-income population of 28 million, this will require a decade of planned spending of about USD 400 billion and championing projects like Iskandar, near Singapore.
In Singapore, there is a move to become the “Switzerland of the East” for private and wealth management, although they will have to enforce higher compliance and transparency guidelines. Reliance on trade, both regional and international, will need to be rebalanced, but domestic markets are likely to remain tightly regulated and protected from global competition.
In Indonesia and Vietnam, both less well developed, politics and regulation will play key roles in how and at what speed their economies develop. Indonesia’s elections in 2014 will be worth watching as over 50 per cent of the population of 242 million is under 30 – and as such is increasingly likely to vote for change in order to meet the ambitious goal of quadrupling the economy by 2030. While Vietnam offers low labour costs and a well-educated workforce, politics and corruption remain entrenched and the economy is dominated by the national oil company. However, its route to economic development could follow either the Chinese or Korean models, with Japan already a big inward investor.
India was rarely mentioned positively during my stay. However, optimism remains that, when India finally breaks out of political deadlock and inertia, its potential is enormous, boosted by its almost unique demographic tailwind.

Hong Kong and Shanghai

Hong Kong and Shanghai have become true world cities. As such, both are suffering from the financially repressive policies at work globally which are encouraging huge investment in very high-priced residential real estate, as in London and New York. Indeed, recent moves by policymakers have been designed to cool the ever-rising prices. This might lead to prices in Hong Kong falling approximately 20 per cent over the next year or so. China’s growth has pumped over USD 4 trillion into the region over the last 10 years, and thus the reliance and closeness of all economies requires a strong affinity with China. Hong Kong has followed its major corporates by investing in China and has become, with Macau, a major destination for Chinese tourism. 

China

After a slow and deliberate transition, China is set on a better quality growth path, to which it will take time to adjust. It has declared war on formalism, bureaucracy, hedonism and extravagance, and clearly now wants to share its economic prowess across more of its population. As a magnet for global foreign direct investment over the past decade, China has found itself creating great wealth – but harnessed to US interest rate policy, much of this wealth has either sought to leave the country for diversification or sought higher returns through aggressive wealth-management products. The events of late June showed that, going forward, policy will only tolerate socially useful investment which benefits Greater China. Many in Shanghai were perplexed as to why this change in policy had been so long in coming, but its arrival, together with the trial of Bo Xilai, shows a new determination to act for the good of all Chinese. Worryingly as well, much of the growth in China since the global financial crisis has been fuelled by credit. This challenges additional economic restructuring as China moves from investment and exports toward consumption, which needs higher remuneration and thus less global competitiveness.

Conclusion

Here in Europe it’s clear that, at a time when capital is fleeing emerging markets and negative sentiment has the upper hand, many investors see this as a fitting opportunity to review their allocation to emerging markets and to Asia in particular. However, as a European investor, I believe that, in line with the management of many of the most successful European companies, investors should not necessarily seek to pull out of the region, but use market corrections to review current investments and make sure that they are invested in the best growth opportunities in the Asian economies. The longer and deeper the correction, the more that attractive opportunities and good value will open up in many markets. At this point in time, the challenges may have grown – and fear of increased conflict in Syria has worsened the situation again in the last few days – but Asia has the people, the guile and the wherewithal to offer good longer-term returns as the “taper tantrums” subside and the direction of policy globally becomes clearer later this year.



Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance.

Source of all data (unless otherwise stated): Allianz Global Investors, as at August 2013.

Gross domestic product (GDP) is the value of all final goods and services produced in a specific country. It is the broadest measure of economic activity and the principal indicator of economic performance.

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 

Allianz Global Investors Distributors LLC, 1633 Broadway, New York NY, 10019-7585, us.allianzgi.com, 1-800-926-4456.

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