The Shift From West to East

There are no permanent changes because change itself is permanent. It behooves the industrialist to research and the investor to be vigilant – Ralph L. Woods

Wise words as those above provide investors an approach for today’s global economic landscape. Western industrialized economies, once viewed as the engines of global economic growth, are still struggling to recover from the latest economic crisis and subsequent recession. In contrast, Asian economies have continued growing and are now surpassing more developed and stagnant, Western economies as the new drivers of the global marketplace. Asia has attracted investors with a growing middle class and rising consumption. Asian now also is home to new generation of investors who have benefited from rising wages and a powerful export-driven economy.

Long-term trends in the East remain intact; the growing population will drive growth over the foreseeable future. Asian economies are projected to expand through continued development of infrastructure and industrialization, a rising middle-class consumer society and increased production and export of natural resources. The region’s growing population is expected to account for 40% of global consumer spending by 2030, while per capita output (excluding Japan) is predicted to rise 48% over the next five years compared with 18% in Western economies. Investment banks are now calling the key economies in Asia the new “safe havens” for portfolio investments.

As investors look to capitalize on Asia’s growth, they must determine what type of exposure they want within the many diverse economies that make up the region. Asia, as a regional body, is composed of several “blocs” of countries that have matured economically at varying speeds, and are at different stages of “emerging.” Within Asia, there are tiers of emerging markets as well as frontier markets, resulting in various levels of growth and also varying degrees of economic risk for investors.

China is undoubtedly the locomotive behind Asian growth. As part of the BRIC economies, China has experienced rapid double-digit growth over the past hree decades, fueled by exports and manufacturing. Through an investment-driven growth model, China has emerged as the most influential developing economy worldwide, but also on a regional level, where it has defined Asia’s regional integration and growth by both absorbing capital goods from other emerging Asian economies as part its manufacturing production chain and to satisfy growing domestic demand.

While China’s growth has been resilient since 2008, it has not been immune from the global slowdown as growth is still dependent on now-anemic developed countries. The Asian Development Bank estimated that 71% of manufactured exports are for markets outside Asia. This non-Asian export dependence has been a factor for the recent slowdown in growth over the past seven quarters, which has led the World Bank to revise its growth forecasts from 8.6% to 8.1% for 2013. This slowdown in growth has led to some uncertainty amongst investors who have adjusted allocations accordingly.

Other developed markets within Asia referred to commonly as the Four Asian Tigers, which includes Hong Kong, Singapore, South Korea and Taiwan, are perceived as relatively less risky for investors looking for Asian exposure. These economies experienced rapid growth into the twenty-first century, resulting in high-income populations and rapid industrialization. What has set these economies apart from other economies within Asia is specialization in areas of competitive advantage such as finance and information technology, which make these economies less dependent on Chinese growth and domestic policies.

The countries of Southeast Asia, which make up the political and economic organization of ASEAN (Indonesia, Malaysia, Philippines, Singapore, Thailand, Brunei, Myanmar, Cambodia, Laos, and Vietnam), are in the early stages of “emergence” or in some cases viewed as frontier markets. These economies have just set out on the path to economic and social progress, and because of this, offer very compelling growth prospects. Southeast Asia has been able to sustain robust growth in 2012 and the OECD projects the region to average 5.5% growth from 2013 to 2017. This growth comes mainly from low-cost manufacturing, youthful populations, and low debt.

While the growth opportunities are compelling, these economies still face considerable challenges such as a lack of infrastructure, heavy reliance on low-wage manufacturing, political conflicts, and China’s pursuit of vertical integration within its own production process. Investors comfortable with these risks can find these markets intriguing in an increasingly risk-on/risk-off world, where emerging and especially frontier markets offer diversification and lower correlation to developed market movements. Furthermore, inefficient markets within these economies offer unique opportunities for fund managers to find unique and profitable bargains.

As Asia continues to accelerate the shift of the global economic center of gravity through sustained growth and the development of consumer economies, investors will continue to seek exposure to the region for diversification and returns. An even more dynamic and stronger Asia can evolve as steps are taken for greater economic integration towards a single market that would allow for the free flow of investments, goods and capital. Although it is evident that Asia is now the driver of world economic growth, it is also clear that the region must focus on strengthening domestic markets through specialization, innovation, and investment.

Author: Chris Davies

Posted in: Asia , China , economics , frontier markets , FXI