Asia Will Lead the Developed Markets Over the Next Few Years

While the recent stock market rally may seem to signal that the worst is past, a look at the big picture tells us otherwise. Look at the following obstacles, and you will know what I mean.

1. The economy is deleveraging. Not long ago, we were leveraging up. Growth was fueled by debt and was further boosted by the multiplier effect. For every dollar borrowed, the economy expanded by several dollars. Economic expansion thus went on steroids. Now, the reverse is happening. Consumers and businesses are reducing debt. And for every dollar of debt reduction, a few dollars are withdrawn from the economy. Therefore, we are now in a hangover state in which activities will shrink, putting pressure on revenues.
2. Leverage magnified profit margins in the recent past. Now that leverage is in reverse, profit margins and the bottom-line will contract.
3. The cost of borrowing is going up. So again, profit margins and the bottom-line will be under pressure.
4. It took the world about the last 20 to 30 years to leverage up. It will take much longer than a year or two to unwind the leverage.
5. Taxes in the U.S. are going up. Higher taxes will further impede economic growth and will also erode profit margins.
6. As borrowing costs rise, investors will begin to discount stocks at higher rates, meaning that stock PE ratio, and therefore stock valuation, will fall.

So you see, three important stock drivers, namely top-line, bottle-line, and PE ratios, are all fighting an uphill battle at least for the foreseeable future. Given these challenges, it is hard to be overly optimistic about stocks. More importantly, after the recent surge, broad markets in the developed world appear to be at or close to fair value. To find attractive stocks, I believe Asia is a better place to look because the fundamentals there are stronger than those in the developed world. These fundamentals are outlined here:

1. The banks in Asia are not as exposed to the bad debts as U.S. and European banks are. As a result, Asian banks will able to resume normal lending much faster than their developed world counterparts.
2. Asian economy is growing faster than the developed economies.
3. The balance sheet of Asian consumers is healthier than those in the U.S. and in Europe. Therefore, consumer deleveraging, and its effects, in the former market will be less pronounced than in the latter markets.
4. China has US$2 trillion of foreign reserve, a budget surplus, and a trade surplus. So China has the firepower to spend itself out of trouble and lift Asia along. The U.S. is opposite. It has large national debt, budget deficits, and trade deficits. It is having trouble borrowing from overseas, so it is printing huge sums of money to save itself. Common sense tells us that governments cannot print money indefinitely. If they keep doing it, sooner or later, the dollar will crash and the consequences will be tragic.
5. Asian stocks have fallen harder than the developed markets have. And even after the recent run-up, many Asian markets remain cheap. For example, the Singapore Straits Times Index and the Hong Kong Hang Seng Index are at levels close to their levels in the early 1990’s, before the Asian financial crisis.

In summary, I believe that a recovery of the world economy and stock markets will be slow and bumpy. However, I believe that Asia economies and stocks will lead the developed markets for the next few years.

Disclosure: Long TDF, no positions in IVV, EFA, EWH, EWJ, EWS, EWT.

Comments

[Joseph Sherman:]

Asian economy is growing faster than the developed economies. - This is the main point.

Apr 12 08:32 AM

[Alphameister:]

Great job, Steven. You've nailed it!! While I continue to find excellent investment and trading opportunities within the relatively inefficient small-cap and micro-cap sectors of US markets, I am much more bullish and sanguine about my diversified holdings of stocks in emerging markets, most especially China.

Apr 12 01:41 PM

[RiskReturnO...:]

Taiwan market (EWT) has large upside potential, as it can benefit from five super-powerful macro trends:

1. Rebound in China (FXI);
2. Opening up of tourism by Chinese residents brining some much needed Chinese RMB;
3. Rebound in US technology spending (QQQQ is outperfoming SPY by quite a bit);
4. Undervalued NT$ currency (rush to US$ and JPYen as safe havens punished Taiwan and Korea currencies unfairly last six months);
5. Once in a lifetime removal of political risk -- Taiwanese banks opening shop in China, expanded direct flights / shipping; reduction of trade barriers; talks of softening military stance by China; ... imagine where the market might be if there are steps taken toward some sort of Peace Treaty with China ...

To me, it seems EWT offers the best risk-reward among the Asia Pacific region, as these macro themes play over of the next few years.

Apr 12 02:05 PM

[LR European:]

"many Asian markets remain cheap. For example, the Singapore Straits Times Index and the Hong Kong Hang Seng Index are at levels close to their levels in the early 1990’s, before the Asian financial crisis."

Were Asian markets cheap before the crisis? (Were US housing stocks cheap before the subprime crisis?)

A shame you don't give numbers for these levels. Valuations at pre crisis levels suggests either fair or expensive, not cheap. Actually, my assumption before reading the article was that Asia was cheap - you make me less sure.

As for the rest of the article.... excellent points, clearly conveyed. Thank you.

Apr 12 03:11 PM

[Mutual Fund...:]

Good information. For a few weeks now I have been saying that China would lead the way out of this global economic crisis with Latin America to follow.....

Doug T........The mutual fund guy
www.mutualfundwealth.com/

Apr 12 10:09 PM

[ArtfulDodger:]

Stephen Yu:

You're right. It must be so. Thanks.

Apr 13 02:04 PM

[anarchist:]

like RiskReturnOptimizer I like EWT. No matter who lead the world out of recession Taiwan will benefit. Jim Rogers gave an interview some months ago and listed several stock in Taiwan he was interested in. I bought about four of them, added a little here and there and I wish to hell I had put more in as they pay a nice dividend and are up at least 50% in stock price. EWT is the easy way to invest in Taiwan and pays a nice dividend.

Apr 14 07:13 PM