Article

Pacific shift - go east with your savings? - John Redwood comment

March 19, 2010

Over the ten years to February 2010 investors made a total return of 184% by investing in India and a stunning capital return of 725% by investing in China. In contrast they lost money over the decade as a whole by being in Japanese shares, made just 0.5% in the USA and scraped to a total return of 27% for the decade as a whole in UK shares.

This should not have happened. Investment professionals have long explained to investors that shares in the major markets like the USA, UK and Japan should always be a good long term investment. The theory went that because buying a share buys you participation in the growth of the economy you are investing in, and because dividends over the years rise, you should experience rising income and rising capital values over any longer term time period. An investor might expect to lose money for a year or two if they buy in when the market is high, but if they held on the theory was that they would make money over 5 or 10 years.

These figures showing poor performance of the major Stock markets have of course been heavily influenced by the Credit crunch and market collapse of 2008. However, they remain poor even after a full year of rapid recovery, when the main stock markets have advanced by more than 50% from their low points on February 9 2009.  Meanwhile, the leading Asian markets, which also experienced bad falls in 2008, have continued to provide good long term returns.

Investors need to ask themselves the simple question. Is it time to switch from successful Asia to America and Europe, or should we expect more of the same?

Japan is an important part of the argument when trying to answer this crucial question. From 1976 to 1990 investors in Japan made 740%, far outpacing the returns on the main western markets. For much of this period UK investors had little in Japan, usually reaching their peak levels of Investment around the end of the 1980s when the Japanese bubble burst. In the early part of the period investors were sceptical of Japan’s ability to recover from the damage of the war. Later investors kept asking themselves whether the share progress could be sustained, as it seemed too good to be true. As a result most UK investors missed out on a great stock market performance for a 14 year period.

It was not difficult to see this trend at the time for those prepared to challenge the common view. Japan advanced from low income levels and successful competition at the cheap end of the market in electrical and engineered products, to developing her own strong brands and technology in a wide range of automotive, electrical and consumer goods. Large Japanese companies with shares traded on the Stock Exchange spear headed Japan’s successful penetration and domination of crucial export markets. All an investor had to do was to identify this trend and stick with the shares.

In 1990 all this changed dramatically. By 1990 property and share values in Japan were way out of line with values elsewhere. The Japanese banking sector was overextended, advancing too much money to people and companies to pay too much for assets. Japan was poised to enter a period of population decline. The USA was on the verge of pioneering the digital and communications age, which Japan was less able to exploit. Japan entered a period of twenty years so far when its Stock market became a very poor performer. Today it is still 67% below its peak levels in 1990.

So we can rephrase the question. Are India and China now in bubble territory, like Japan in 1990? Is the west poised to take up the running after a great period for Indian and Chinese manufactures and service exports? Or are we still only part of the way through the surge in Asian economic success? Are India and China in the position of Japan say circa 1960?

The evidence points to the answer that rising Asia still has a long way to go and plenty of energy and industry to take it there. There are no signs yet that the world is tiring of Chinese manufactures, or that China is running out of ways of transferring more people from farm to factory. Most economists project growth rates of 5-10% for India and China going forwards, with China usually growing at the top end of that range. There are still many people to transfer form low income activities to higher income activities. There are still many more people to benefit from a better education. There is much to be done to boost domestic demand and make for the Chinese and Indian home markets, as well as more sectors for each exporting economy to take on and to win market share. China has become dominant in world textiles. She still has to provide a serious challenge to the world motor car market.

Meanwhile the evidence also points to slower growth in the west than the performance we have seen in the last ten years. The heavily indebted countries like the USA and UK are likely to produce a lower rate of progress in the next few years, because they have to pay off old debt and take on less new debt. They will have to save and export more, and consume and borrow less. The UK growth rate which has averaged 2.5% since 1945 may fall to 1.5% as the debt is repaid and the public deficit brought under control. The Euro area is also an area of relatively slow growth, with the added complexity like Japan of a falling working age population.

Investment in shares is investment in growth. The whole point of the idea is to buy a portfolio of stakes in companies where business can expand, so profits and dividends can rise. This should be easier to do in countries where growth rates are 5-10% than in countries where growth rates may be 1-2%. If all things are equal it is better to look east for growth and shares.

Of course at any given time the investor needs to ask are relative values of shares in the West and east sensible? Have markets fully taken into account the superior prospects for eastern growth? From month to month there may be times when it is discounted, but the long haul experience over the last decade and the Japanese experience over 16 years tells us that if the superior growth occurs it is never fully discounted.

The investor also needs to ask if there is any crisis that could hit the good prospects for growth in Asia, or lift the poorer prospects for growth in the West. Today both India and China are showing signs of overheating. There will need to be some reining in to control inflation. China remains a communist single party country prone to bouts of civil unrest. It is a very managed capitalism, so investors need to keep a weather eye on the government and its actions. Making overseas investors rich is not a number one priority for the administration.

Go east still looks like the correct strategic decision. Many western investors still have very little exposure to shares and property in fast growing Asia. There will always be tactical and currency issues to consider day by day, but history suggest that backing growth works.