By David Sterman
The unfolding events in Japan are distressing and saddening. We all hope that the social, environmental and economic impact of the recent earthquake will prove to be not as bad as is currently feared. In times like this, one can become a bit squeamish talking about investing. The sheer notion of profiting while others are suffering is unseemly, yet you have to separate your humanitarian side from your investment logic. So when major global events have an effect on stocks -- positively or negatively -- a rational course is essential.
I've been trying to look out several years to identify what major thematic changes will take place in Asia as Japan rebuilds its economy. More than likely, the country's manufacturing base will be smaller in five or 10 years. Not only is a wide swath of the northern part of Honshu (the main Island) facing potentially major environmental challenges, but Japan's fiscal response to the crisis will alter the value of its currency. And that will make Japan the highest-cost country in the region -- by far.
Japan is a heavily-indebted nation. Its total government debt exceeds even that of the United States -- as a percentage of GDP. (The situation is dire in Japan because of a rapidly-aging population due to declining fertility rates and restrictive immigration policies.) The cost of rebuilding will likely be at least $100 billion -- and could end up being five times that much. The reduced economic activity also threatens to increase already-large budget deficits as well.
To meet these costs, Japan will have no choice but to sell its considerable amount of foreign holdings. For example, Japan owns nearly $1 trillion of U.S. government bonds. It took that route to keep the yen from getting too strong. That option has now ended.
Before long, expect to hear about rising sales of U.S. bonds, and as those funds are repatriated back home, expect the yen to surge to new all-time highs against the dollar and other currencies. When that happens, Japanese companies will have no choice but to start moving their manufacturing base offshore more, just as the United States has done for the past 20 years. If that scenario plays out, I spot a clear beneficiary: Vietnam.
Stumbling toward growth
Vietnam has been the unheralded success story of Southeast Asia throughout much of the past two decades. Per-capita income has risen sharply, the country's infrastructure has received heavy investments, and foreign multinationals are increasingly setting up shop. Companies such as Intel (INTC) now count on Vietnam as a major part of their Asia strategy.
After a torrid growth phase, the past two years have proven far more challenging. Inflation has bubbled up, the government is running budget deficits due to deficient tax collections, and rigid polices form central planners are creating bureaucratic hurdles. The latter two issues are now being addressed and the inflation scare is likely to cool once commodity prices recede.
Make no mistake: the cost of doing business in Vietnam is quite low. Wages are below levels seen in China (and the gap could widen -- economists expect China's currency to slowly strengthen and Vietnam's currency to weaken). That would be of no help if it was hard to get goods to ports, but any tourist coming back from Vietnam can tell you about the clear positive effect of the infrastructure investments.
The pattern repeats
In the past six decades, a clear pattern has emerged in Asia. A low-cost country trains lots of engineers and then starts to make increasingly sophisticated products, triggering rising standards of living. That's what happened in Japan in the 1950s through the 1980s, and then in Korea in the 1990s and 2000s. Korea picked up a lot of business simply because Japan had become a more expensive place to do business. Korea is now fast on its way to being a world-class economy, as are Malaysia and Indonesia. (Economists think those two countries should be seen in the same light as the BRIC countries -- Brazil, Russia, India and China.)
As these Asian economies ripen, they start to become less competitive in terms of basic manufacturing. That's where Vietnam comes in. The country is now positioned to act as Japan did 40 years ago and Korea did 20 years ago. In 2010, foreign direct investment in Vietnam rose by 140% compared with 2008, according to the United Nations Conference on Trade and Development. Vietnam's industrial production has risen at least 10% in four of the past five years and is expected to rise a healthy 14.5% in 2011, according to the World Bank.
It's now increasingly likely that the impact of the earthquake in Japan will be the shifting of more production offshore. To be sure, several countries will benefit, but Vietnam will be a prime beneficiary. Equally important, Vietnam's markets stalled in 2010 while neighboring stock markets rallied. The Vietnam Fund (VNM), an exchange-traded fund that holds a basket of Vietnamese stocks, is just above its 52-week low. The fund focuses on Vietnamese oil plays, construction firms, banks and chemicals.
An interview last fall in the International Business Times summed it up best. Doug Clayton, an executive at fund manager of Leopard Capital noted that: "Vietnam is around four decades behind South Korea and Taiwan and two decades behind China, but may be on a similar trajectory because its people share that passion for self-advancement. Vietnam also has a lot of things going for it, which will make following the track easier now, such as having these richer countries in its neighborhood." That's why I view Vietnam as one of the most compelling emerging economies for the next 10 years.