During a telephone call with a money manager over the weekend, I was surprised to hear of a new scenario making the rounds in investing circles. Some now believe that the Chinese economy’s forthcoming “hard landing” will be so jarring that it will bring the country’s gross domestic product growth down to 5 percent.
For now, let’s leave aside the thought of what this would mean for U.S. or EU economic growth. This latest speculation only adds to the litany of uncertainties facing the market. In 2011, investors have had to cope with inflation, high oil prices, collapsing earnings, the U.S.-debt-ceiling operetta, fears of a looming double-dip recession, the EU’s sovereign debt crisis and the potential demise of the euro.
Many of these concerns remain legitimate. But thus far, this laundry list of doomsday scenarios has failed to materialize in a way that truly damages the global economy, particularly in Asia.
Long-term readers of my advisory service, Global Investment Strategist, know that we often take a contrarian approach to the markets. We’ve advocated caution amid investor euphoria and highlighted buying opportunities when fear ruled the markets. For this reason we’ve been somewhat dismissive of the negative sentiment regarding the global economy. It’s not that we believe these fears to be wrong, but rather that we’re conscious that negative sentiment tends to feed upon itself, regardless of market or economic fundamentals.
It’s true that the markets are coming out of one of the worst quarters in some time – especially emerging markets. But this should be viewed as a favorable outcome for long-term investors. The fact that the markets are now discounting a total collapse of earnings growth in Asia, for example, represents a buying opportunity for investors who don’t believe we’re on the verge of a meltdown.
I’ve spent considerable time monitoring market sentiment. In my assessment, investors haven’t sold the markets because they believe that a financial apocalypse is nigh. Instead, they’ve been gripped by a short-term mentality that’s made it all but impossible to engage in clear, long-term thinking. Investors often claim to be in it for the long-term, but instead they react to short-term events. When the markets don’t oblige them with a favorable short-term performance, a bleak picture rapidly becomes all the more bleak.
Let’s return to long-term thinking. The current valuations found in Asia offer long-term investors an attractive entry point. As I noted in my article, "What a Strengthening Dollar Means for Asia," Asia as a whole trades at about 1.5 times book value, a compelling valuation so long as a new global financial crisis fails to materialize. By comparison, Asia traded at 0.9 times book value in 1998 after the Asian Financial Crisis, and at 1.3 times book amid the 2008 global financial crisis.
Global equities, as represented by the MSCI All-Country World Index, trade at about 12 times earnings and at 1.5 times book value. It’s true that global equities traded at 10 times earnings at their lowest point in 2008. But that was a truly frightening time for the financial system, comparable only to the bear market of the 1970s in which shares changed hands at eight times earnings.
I continue to forecast slow global growth and not a recession. I forecast relatively flat global aggregate earnings growth rather than an outright contraction in earnings. Given our base-case scenario, stocks are priced at a value, particularly stocks in emerging markets. In fact, Asia offers particularly compelling valuations. Asian markets have contracted more severely than developed markets. Yet Asian corporations boast the world’s strongest earnings growth potential and the region’s economies are in good shape.
It’s true that things may get worse before they get better. But attempting to identify the market’s bottom is usually an exercise in futility. On the other hand, getting into the markets too early may not yield the best risk-reward outcome.
But Asian markets have a knack for quickly rising and falling. In other words, if market valuations are at reasonably cheap levels, they will bounce back quickly should the economy avert a recession. There’s little point in waiting for valuations to drop even further. In times like these, investors should be looking for what to buy in Asia, rather than selling or shorting stocks.
I expect global GDP growth to clock in at about 3 percent this year and in 2012. Most of the growth will come from China and India while Europe and, to a lesser extent, the U.S. will drag global growth.
Don’t buy into the fear of an imminent collapse in Chinese economic growth. China’s economy will not collapse any time soon; the country will enjoy GDP growth of 8.5 percent to 9.5 percent in 2011 and 2012. It’s true that the Chinese market has performed poorly this year, but this has nothing to do with a potential economic collapse, or a hard landing. It’s the result of necessary government policies to slow growth without killing it.
China’s economy and policymakers face a number of challenges, but these do not add up to a hard landing. Consider the example of the country’s property market, which the government has sought to rationalize. Real estate sales have fallen substantially in China’s largest cities, and the danger of a real estate bubble in these cities may be growing. However, the population of Beijing and Shanghai–among the country’s top-tier real estate markets–represents only 1 percent of the country’s total population. If asset prices fall precipitously in these markets, the effect on the overall economy will not be pronounced. Furthermore, real estate sales in the country’s second- and third-tier cities remain robust and incomes continue to rise in these areas.
The major risk for China’s economy lies not within its borders, but is posed by a potential exogenous shock from the U.S. or EU. But absent such a development, the Chinese economy won’t experience anything remotely resembling a hard landing.
Finally, I want to highlight Japan as the country that remains the most attractively valued in the developed market. Analysts were quick to downgrade Japan and Japanese companies after the earthquake struck the country in March. But now analysts are rapidly upgrading their outlook for corporate earnings. The result is that the market has performed well even as the yen has strengthened, a situation that’s typically negative for the Japanese market.
Japan should be able to maintain this level of performance, though it would be wrong to expect the economy to race out of the gates. There are many good Japanese-related stocks right now and the country’s supply chain has recovered faster than expected from the earthquake and earnings will soon reflect this improving situation. The government is also in the process of drafting a supplementary budget of about USD155 billion that will be used in reconstruction.
Japan’s top-rated property analyst, Toshihiko Okino from UBS Securities, said that shares of large Japanese developers such as Mitsubishi Estate (MITEY.PK) will likely rebound in six months. However, global economic uncertainty will cause turbulence for the next two to three months. Mitsubishi Estate is one of the country’s most prestigious real estate companies, with land in some of the most coveted office areas in Tokyo. The company also has a very active residential business and runs six hotels in Japan.
There are indications that real estate prices in Japan were on the mend before the country was struck by a 9.0-magnitude earthquake in March. The government in 2009 began offering rebates and 10-year tax breaks to people who bought real estate before 2014. In 2009 the average real estate price fell 4.4 percent. The next year, prices fell by 3.7 percent and this year the average price dropped 3.4 percent as of July, according to data from the Ministry of Land, Infrastructure, Transport and Tourism. “Government incentives offered for home buyers have prompted people to start buying,” said Yutaka Iwaki, the director of the ministry’s price research division. “If we didn’t have the disaster, we might have seen more land points with increased or unchanged prices.”
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.