Diversification Into the Asian Markets

 |  Includes: AIA, EWH, EWJ, EWS, EWT, EWY
by: Randy Wu

Perhaps now may not be the best time to talk about future investments, as many bulls are still licking their wounds inflicted (as all animals are inclined to do so) from the recent battles fought across both sides of the Atlantic; the injured also include the bulls in the Pacific Asia region as a result of the fallout.

But the bulls must pick themselves up and prepare for a counter attack on the bears (who must have been laughing themselves silly for months now and repeating aloud ‘I told you the rally won’t last’) when that day comes, and that day may not be not be too far away perhaps later in the year or early next year. The attack on the bears will be broad-based and it will not be D-day invasion but more a slow process of pushing the bears over the hills (previous highs), and driving them across the rivers (resistance) and taking a breather and then resuming the attack.

A basic strategy in investments is to diversify so as to manage the specific risks (stocks) and systematic risks (markets) that are constantly present in the markets. Although the diversification of market risks have been expounded over the years, I suspect that it is largely the mutual funds and hedge funds who apply this strategy and possibly only a handful of large retail investors who have done so, whilst the rest do not do so for the following reasons:

  • Lack of resources in terms of capital, time and research.
  • A lack of knowledge of the foreign countries in economic terms and worries about the political environment, both internally and externally like the present Korean peninsula tension as a case in point.
  • A concern about the value of the currency of the country invested, which can be a real concern as seen in the 1997 Asian currency crisis where the value of certain currencies plunged by more than half in value.

Some financial sceptics may say that the global markets are so interconnected that when a crisis happens in one country it will spread like wildfire across oceans and continents and no country will escape unscathed and, as they would say, ‘there is no place to hide’.

And this is true, as it has been known for a long time now that when Wall Street coughs the rest of the world catches a cold. Whilst there is truth in the ‘contagion effect’, we must still attempt to diversify for the following reasons; one is that the impact of the financial crisis will be felt differently by the global markets in varying degrees, just as a tsunami will have a lesser force on countries that are located further away, and the other reason is that the markets will recover at a different pace as some will recover faster than the others and so will the stocks; so to try to focus on just a ‘few good stocks’ in one or two markets may not guarantee that you will pick the winners and you may miss the opportunity for some financial gains from the other markets as they make their move.

Positioning for the markets

We know by now that timing is everything in life, whether it is in our career, or in business and more so in investing and trading. It is often said that those who are successful that ‘they were in the right place at the right time’ which of course brings us to the next question which is ‘was it by chance or by design?’ We also know by now that things do not happen by accident or by chance and that aside from serendipity, everything in life happens by design and planning and that random events occupy less than 5% in the world of probability and mathematics, and this is so very true in investing and trading where prices are not random (95% of the time) but by design, engineering and deception.

But how do the successful people develop and hone their skills in ‘timing’? Well, studies showed that they do by simply positioning themselves for the event, which means preparing themselves for the event through research and acquiring the necessary knowledge and relevant skills, so that they will be ready for the higher position when it becomes available, or the business opportunity when it comes by, or the trade that comes along. And this is so true, because if we were to wait for the event to happen and then take the necessary actions it will be a case of too little, too late. So if you were to say to yourself that ‘I will look into the relevant markets when it has shown me that it has made its move’, then you will most likely be late in getting onboard the train and will have to pay a higher price or worse still miss the train as it has left the station. The question then is which markets do we position ourselves for? To find the answer, we will review the global markets and try to identify the countries which will recover more rapidly.

Western markets

The economic recovery in the America was coming along quite nicely when it was derailed in May this year as Greece announced that it will default on its loans, and that threw the financial markets into disarray once again, but the gale seems to have died down and the markets are getting back to its feet again. And although the growth recovery in America will resume, it will be slower as its exports to the eurozone will be impacted from the austerity programs that the countries are embarking on.

It will be a while for UK and the eurozone countries to get back on its feet as a number of them will have to reduce their debts; consequently the western markets may not be best place to leave all of your funds as the returns may be long in coming and the gains may not be very substantial. Therefore it is necessary to examine the other global markets and consider divesting some of your funds into any of the global markets that show potential for rapid recovery and progress.

Pacific Asia and East Asia countries

All the countries are largely export oriented and will be among the first to benefit when the economy begins to recover. Let us examine these countries a bit closer to try to identify which countries will lead the pack.

China (The Dragon)

China which is also experiencing slower economic growth as a result of her efforts to avoid a property bubble burst and fending off inflation, will also feel the impact of the slow recovery of the western markets as a large percentage of her exports are exported there. However, as it is still in the process of undergoing economic expansion, it will continue to be the engine of growth for many of the Pacific Asia and Asian countries. Whilst many countries are losing their economic purchasing power, China is gaining significant economic power and in fact is one of the largest buyer of US securities and as of late is becoming a major buyer of the Japanese bonds.

As China emerges from the shadows into the limelight, it is making a huge economic impact on the surrounding Asian countries as they are closely tied up with China’s economic growth in many areas such as suppliers of raw materials and machinery and expertise in capital funding; and in the process, many of the Asian countries had been enjoying high economic growth in the few years prior to 2008. This economic growth is still in its early stages seeing as it will take at least another two to three decades for China to become a developed country, so business opportunities will be plentiful for many years to come for the Asian countries including Japan.

Consequently China will continue to generate a high growth of 7% – 10% per annum for years to come and this means the other Asian countries, including Japan, will enjoy continued growth, too. However, it is a huge country and there is still widespread corruption among many of the provincial and state members in spite of strong actions taken by the Central government to wipe out corruption, even to the extent of executing some important officials found guilty of corruption. In addition, good company governance is still lacking, although the central government have taken strong measures to prevent insider trading and false declaration by companies. Those wishing to invest in China will find it necessary to subscribe to service providers for updated and accurate reports on the companies.

Asian Markets (The 4 Tigers)

Aside from China, the other Asian markets with possibilities of good economic growth are Hong Kong, Taiwan, South Korea and Singapore, aka ‘The 4 Tigers’. I believe that these economies will recover faster than the western countries and China for a number of reasons. One is that they are export-oriented countries so they would enjoy economic gains when the western countries recover, and also there is now a twin driving engine coming from China. Secondly, productivity is very high among these four countries as the people are extremely hard working and consequently the four countries would enjoy high GDP growth as the global recovery continues; and thirdly, none of these countries are burdened with debts.

Hong Kong – is a highly volatile market due to its close proximity to the China market. Many of the China stocks are listed on the HK exchange, and in turn many of the HK stocks are listed on the Shanghai exchange. Also, the HK market is the most liberal of the four markets with good liquidity and transparency.

Taiwan – has been doing well for many years now as their relationship with China has improved since the change in the ruling party in Taiwan. The present president has been reaching out to China to promote free trade between the two countries and Taiwan especially has increased its capital investments in China, and has also imported expertise to the mainland Chinese.

South Korea – the foremost leading 'Tiger' of the four countries in the areas of technology, manufacturing and automotive, it has done extremely well even in recent months in spite of tension in the peninsula which is unlikely to escalate as South Korea has referred the matter to UN instead of trying to resolve the matter itself.

Singapore – the smallest of the four but the most resilient and doing very well in exports, re-exports, tourism and in the financial business, currently competing with HK to became the financial hub in this region. In addition, Singapore enjoys a stable political environment internally and externally.

All the above mentioned countries enjoy a relatively stable currency, which is crucial for export-oriented countries.

Japan – Land of the Rising Sun

The question on everybody’s mind is probably ‘why Japan?’ as the country has been in an economic slump for the last 20 years or more. There are a number of reasons for my inclusion of Japan, which I shall outline below, but first a brief explanation of my choice to include Japan.

If the economy of country has been stagnant for a long time then for any improvement to take place there must be a catalyst that will trigger the change. And I think that this has finally happened as the long ruling LDP party has been replaced by the DPJ party, which has the peoples' interest at heart rather than just the corporations. Of course, there is no assurance that a change will take place, but the present PM Kan is taking great efforts to so by coming out with a number of policies, including adding stimulus to revive the economy, that seem to draw support and approval from the financial community.

Factors contributing to the economy’s growth:

  • Analysts in Japan have generally given PM Kan the thumbs up on some of the policies that he has introduced, saying that it will be good for the stock market, and added that “Kan is better than Hatoyama (previous PM) in terms of fiscal discipline.”
  • The BOJ (Bank of Japan) has come out of its shell and is now working closely with the ruling party, which is a big improvement because previously it had hardly said anything and did everything on its own; its relationship with the ruling party has been more than cordial, and much to the surprise of the analysts and financial community, it gone out of its way to make loans to small businesses. This will be a big boost as it will enable the bank to actively participate in the many small business ventures and projects that come about with the other Asian countries, which the ruling party is actively trying to cultivate.
  • A Bloomberg articles on Jul 1, 2010 by Keiko Ujikane reported that the ‘The Tankan index of sentiment climbed 15 points in June to plus 1, the Bank of Japan said in Tokyo today. The positive number, which exceeded all 22 forecasts in a Bloomberg News survey of economists, means optimists outnumber pessimists. The report contrasted with data this week showing higher unemployment, falling household spending and a drop in pay-checks’. This is a very encouraging as positive sentiments from the large manufacturers are a clear indication of increased GDP down the road.
  • Although Japan has also incurred huge debts over the years, the situation is slightly different from America as Japan’s debt are owed domestically and the present administration is taking steps to reduce the debts as quickly as possible (after witnessing the Greece situation). The administration is able to do it without too much difficulty as it is not burdened by costly social programs, and the Japanese people are very hardworking and frugal people who have no problem working longer hours and extending their retirement age, something they would actually prefer to spending the rest of their lives in retirement.

Whilst Japan does have other problems to resolve, like deflation and an aging population, its economic structure is still intact and it is still among the leaders in the latest technology, manufacturing, shipbuilding, heavy machinery and precision instruments. Its economic structure is still in place and it would therefore not take very long for the country to be dominant again in many of these areas, if it is able to get out of the slump. I believe that this will happen because if Japan misses this chance, it will be surpassed by the Dragon and the Tigers so rapidly that it will be left so far behind and may not get the chance again until the next financial crisis, which will surely happen as day turns into night. I have written extensively on Japan and not so much on the other Asian countries simply because it has been doing well and is expected to continuing doing so in future years.

How to position ourselves for the markets

Now that we know which markets to focus on, the next step is how to position ourselves for their anticipated growth. To do that in investing we need to have a good knowledge of the countries' fundamentals and political stability, as investments are for a long-term and it would be too costly to enter and exit the markets due to political instability. We also need to know the variables that contribute towards the economic growth of each country so that if any of the variables are missing down the road, we can properly question whether our reasons for continuing to invest in that country are still valid.

Once we are familiar with the macro factors, we will then zoom in on the micro factors - the market itself. To do that we need to have an intimate knowledge of the listed products and the instruments that are traded on the exchanges. We need to know the market volatility, the number of sectors that make up the stock indices and the type of products available for trading. We also need to know the type of instruments available for trading so that we will be able to choose the right instruments to trade.

How to invest in the Asian markets

There are a number of ways to go about it and much will depend on the resources available to investors in terms of finances, time and efforts; and in terms of expertise and risk appetites. For those with minimal expertise, time and a low risk appetite, they should consider a portfolio of mutual funds covering the Asian markets. For others with limited expertise and time, a portfolio of ETF may be a good alternative as the returns would be higher if investors are able to select the right ETFs for the different Asian countries. Those who have considerable expertise and time should try to own a portfolio of stocks of the different countries. Investors outside of the Asia region can consider buying ADRs and ETF that are available on US exchanges. A lot of information on these instruments is available on Seeking Alpha, written by a number of contributors.

Investors within the Asia Pacific and Asian regions, however, can consider buying selected blue chips from the manufacturing sectors, the heavy industry sectors, the raw materials sectors - including steel and metals - and the electrical appliance sector, which includes IT and precision instruments. For those with limited time and resources, it is best to subscribe to firms which provide reports and info on the stocks of the selected countries. For others, however, free financial data on the stocks are available on Reuters (stock section) and Bloomberg. Another alternative is to find a broking house with research on Asian stocks and work with a broking representative for the trades. It is usually best, when investing in stocks and ETF in foreign countries, that one pay for information and expertise and not try to save on the commission charges for longer-term investments.

I used to be an investor but turned to trading for some years now, which I find much more difficult to than investing. Presently I am focusing on the Japanese market, where I trade futures on the mini-Topix stock index and CFDs on the stocks, and my holding period is rather short - anywhere from three days to two weeks - as I am trading derivative instruments and therefore have to be extremely vigilant and not be exposed to the market for too long a period when the market is volatile. Those interested in learning how to trade the Japanese market can visit my site where more information is available.

In conclusion

Investors should not feel too depressed over the recent financial crisis, and should not be unduly alarmed and fearful of the many gloom and doom reports coming from the bearish soothsayers who are predicting dire consequences and advising everyone to avoid the markets altogether as the financial markets plunge to new lows and possibly into recession. One well known and reputable technician (Mr. Prechter) has predicted that the Dow may fall to 1,000 and 3,000 pts over the next five to seven years. Many of these forecasts are based on a combination of existing economic factors together with a projection of the charts with technical indicators overlay; yet one must remember that charts basically tell us what has happened and what is currently happening, but is unreliable in predicting what is going to happen in the longer-term, as future events will be heavily impacted by macro-economic factors and unexpected random crises like the recent ones that we had. However, to a certain extent the predictions based on the projections of the charts have about a 50% chance of happening, becoming a self-prophecy in itself.

And that is why the legendary Warren Buffet and his silent partner Charlie Munger, place little emphasis on charts and technical indicators but more on the macro-economic factors, the strength of the dollar and most importantly, the companies themselves; and this explains why they had sold puts amounting to billions of dollars on the major indexes to a group of hedgers who are predicting that the indexes will be below certain levels (for the Dow I believe that the level is 12,000, which is about the time that the contract was confirmed) by 2019 and, if they are right, then Berkshire will have to pay them $37 billion. But chances of that happening are low as it is a proven fact that option buyers have a low probability of winning and that option writers (sellers) have a high probability of winning, so the odds are 66% in Warren Buffet's favour and 33% in the favour of the option buyers. Coupled with the astuteness of economic prediction and the risk aversion of Mr. Munger, the probability of the major indexes falling to very low levels is very small. Since financial market predictions have proven to be only about 50% accurate, it is meaningless to go into a lengthy debate over who is right or wrong and it is also a futile effort to worry too much about the future.

Having said that, and having witnessed a similar financial situation during the 1997 Asian currency crisis, where many of the Asian economies were devastated, with a number of countries ready to default on their loans, the future looked really bleak for many of these countries; but through perseverance, determination and hard work (plus being frugal) many of these economies recovered and, in fact, some even came roaring back and surpassed their previous dire situation, all in less than seven years. I personally firmly believe that the current economic recovery will resume and get back on track, perhaps at a slower pace; looking back at the recovery of the Asian markets, I think it is safe to say that the present ’financial crisis too shall pass .... as surely as night turns into day’.

As the financial markets change their roles and positions, we the retail investors and traders will have to be flexible and recognize this shift, making the necessary adjustments mentally and financially. We have to change our thinking and investments strategies in order to avoid being caught in any future financial crisis, and not miss any opportunities for financial gains. With the economies of the Asian and East Asian countries coming into their own, we will have to position ourselves for the opportunities that may come our way.

Disclosure: I am only holding a long position on the mini Topix index in the Japanese market