East versus West
By:Donald Nott , Friday, November 19, 2004
Regular followers of our investment views will know that we are pretty downbeat about the long-term prospects for Western stockmarkets. Indeed, we have been calling for a long period in which they would do no better than move sideways. Looking ahead in the short term we remain positive on some equity markets, particularly those in Asia. Four years have passed since the Nasdaq Technology bubble burst and little has really changed. Share prices have recovered but there is little on our radar screens to suggest a new bull (positive) stockmarket. The economic picture has improved since Bush won the US presidential election, with a substantial increase of 337,000 new jobs having been created this October, and previous months’ figures also being adjusted upwards. However, the US current account deficit is way too large and needs to be addressed. I happened to be in Washington DC before and after the US election - a taxi driver who was surprisingly knowledgeable on economic affairs, and obviously a Republican, was pretty upbeat and said that ‘the cost of the Iraq war was just a spit in the ocean’. What is relevant however is that the budget deficit is currently increasing by US $1.25bn a day, and is being largely financed by China, Japan and other parts of Asia in their purchase of US Treasury Bonds, which has had the effect of maintaining Asia’s competitiveness in currency terms with the US. It is not all bad news, however; for one thing, profitable trading opportunities will occur as stockmarkets rise from the bottom of their trading range to the top. The past year or so has been a good example of this. For another, we believe that there is a good possibility that Asian stockmarkets may be the exception to the rule. In other words, whilst Western equity markets are trading sideways (our longer-term view) Asian equity stockmarkets might actually move higher. Many might consider this view a little controversial, particularly in the light of the old adage ‘when Wall Street sneezes the rest of the world’s stockmarkets catch a cold’. However, that is exactly what we now believe will happen. There are three arguments behind this view: fundamental, demographic and valuation. Any one of these might have been persuasive but taken together they make a compelling story. The Chinese economy has been growing strongly for over twenty years. It is now the sixth largest in the world and is starting to make its presence felt on the global stage. Nowhere is this more apparent than in the commodity markets, where demand emanating from China has pushed prices of oil, copper and steel, for example, to their highest levels for many years (the strength of the Australian and Canadian stockmarkets and their respective currencies has not gone unnoticed in this regard). Despite concerns of over-investment in certain areas we see little reason why the Chinese economy should not continue to do well for the foreseeable future. Ultimately, we expect Chinese inflation to lead to a revaluation of the Renminbi and a broad range of other Asian currencies. This will push down inflation in the East and up in the West thereby reinforcing the divergent performance of financial markets in the two regions. The demographic story is equally supportive of EAST versus WEST. The size of the working population of the West is going to shrink significantly over the next ten years relative to those of the young and old. This is unhelpful for Western financial markets in two ways - firstly, it will mean fewer savers channelling money into savings products and secondly, it will probably mean higher inflation. Let us consider this second point in more detail. Western governments faced with a shrinking tax base and increasing pension outlays may be forced to cut corners (borrow money, protectionism etc.), and both trends will imply higher inflation. Nonetheless, whilst dependency rates are rising in the West, they are also projected to fall in the East (a growing work force from a much younger population) with much more positive implications for inflation and stockmarkets. Value is a very important part in our investment process - if you buy assets that are fundamentally undervalued you will never go far wrong. In this regard Asian stockmarkets stand head and shoulders above their equivalents in the West. Not only are price-earnings multiples low in the region (relative to their own history as well as other markets around the world), but the economic prospects are so much better. It is not just about equities, though – Asian currencies are also incredibly cheap by international standards. It may be fanciful to think that Asian stockmarkets can resist the powerful pull of Wall Street, at least on a short-term basis, but we feel there is a strong case for saying that when Wall Street falls, Asia will fall by less and when Wall Street rises, Asia will really power ahead. Highs and lows may still correspond between two regions but while Western markets are trading sideways, Asian markets will register a series of higher lows and higher tops. The bottom line is that if capital growth is on the menu go East – not West. For the retired and cautious investors, steer clear of equities and stick to our selection of six of the best low-risk investments widely promoted on the Spanish Costas.
Regular followers of our investment views will know that we are pretty downbeat about the long-term prospects for Western stockmarkets. Indeed, we have been calling for a long period in which they would do no better than move sideways. Looking ahead in the short term we remain positive on some equity markets, particularly those in Asia. Four years have passed since the Nasdaq Technology bubble burst and little has really changed. Share prices have recovered but there is little on our radar screens to suggest a new bull (positive) stockmarket. The economic picture has improved since Bush won the US presidential election, with a substantial increase of 337,000 new jobs having been created this October, and previous months’ figures also being adjusted upwards. However, the US current account deficit is way too large and needs to be addressed. I happened to be in Washington DC before and after the US election - a taxi driver who was surprisingly knowledgeable on economic affairs, and obviously a Republican, was pretty upbeat and said that ‘the cost of the Iraq war was just a spit in the ocean’. What is relevant however is that the budget deficit is currently increasing by US $1.25bn a day, and is being largely financed by China, Japan and other parts of Asia in their purchase of US Treasury Bonds, which has had the effect of maintaining Asia’s competitiveness in currency terms with the US. It is not all bad news, however; for one thing, profitable trading opportunities will occur as stockmarkets rise from the bottom of their trading range to the top. The past year or so has been a good example of this. For another, we believe that there is a good possibility that Asian stockmarkets may be the exception to the rule. In other words, whilst Western equity markets are trading sideways (our longer-term view) Asian equity stockmarkets might actually move higher. Many might consider this view a little controversial, particularly in the light of the old adage ‘when Wall Street sneezes the rest of the world’s stockmarkets catch a cold’. However, that is exactly what we now believe will happen. There are three arguments behind this view: fundamental, demographic and valuation. Any one of these might have been persuasive but taken together they make a compelling story. The Chinese economy has been growing strongly for over twenty years. It is now the sixth largest in the world and is starting to make its presence felt on the global stage. Nowhere is this more apparent than in the commodity markets, where demand emanating from China has pushed prices of oil, copper and steel, for example, to their highest levels for many years (the strength of the Australian and Canadian stockmarkets and their respective currencies has not gone unnoticed in this regard). Despite concerns of over-investment in certain areas we see little reason why the Chinese economy should not continue to do well for the foreseeable future. Ultimately, we expect Chinese inflation to lead to a revaluation of the Renminbi and a broad range of other Asian currencies. This will push down inflation in the East and up in the West thereby reinforcing the divergent performance of financial markets in the two regions. The demographic story is equally supportive of EAST versus WEST. The size of the working population of the West is going to shrink significantly over the next ten years relative to those of the young and old. This is unhelpful for Western financial markets in two ways - firstly, it will mean fewer savers channelling money into savings products and secondly, it will probably mean higher inflation. 
