One sneeze brought the house down in Asian markets. The discharge that triggered the spread of Sars ...
One sneeze brought the house down in Asian markets. The discharge that triggered the spread of Sars in March 2003 was enough to upset five years of company restructuring and de-leveraging. Before the hysteria caused by the virus, valuations in the region were cheap.
An emerging domestic credit cycle and domestic consumption were driving growth - on top of the impact of demand from China. The outbreak marked a low point for sentiment, particularly in Hong Kong and China. But the early containment of Sars and improving economic data from the US have contributed to rising confidence and, consequently, appetite for risk among investors. According to Lipper Hindsight, the benchmark MSCI AC Asia Pacific Free ex Japan index has risen by 26.9% during the six months to 30 September. So the good times are back, apparently.
The statement issued at the G7 meeting in September highlighted the need for Asian currencies to be more flexible. This latest catalyst for markets reflects the desire of the administrations in the US and Japan to see the Chinese renminbi (RMB), and regional currencies in general, appreciate. One consequence of G7 is a weaker US dollar, which is benefiting the markets in Hong Kong and China particularly - as the currencies effectively are tied to the dollar. The banks I visited last week in Hong Kong are revising up their expectations for loan growth next year, and there is evidence that bank credit is beginning to resume. We are also seeing activity in the property markets and consumer consumption across the region picking up - all of which should drive good GDPgrowth next year.
We have made few changes to our portfolio regarding asset allocation over the past six months but have concentrated instead on stock selection. We have been very overweight companies involved in consumer discretionary areas like cars and large-ticket consumer durables. We have also been overweight companies that produce basic materials and commodities.
Our stock screening process, which focuses on earnings expectations, has highlighted significant improvement in cyclical businesses. So in Australia we reduced our exposure to banks and added to BHP Steel, which has been one of the best performers in our portfolio due to demand for steel in China. And in Singapore we bought Chartered Semiconductor, which has worked well for us.
In Korea, industrial companies are also benefiting from Chinese demand and Asian trade. Shipbuilders" order books are full and expanding, steel and cement prices are rising, and these companies are operating at 100% utilisation. But they are not expanding, which has been a tradition with Korean companies, so their profits are coming through strongly and they are paying down debt and paying out dividends.
Overall corporate returns on capital seem to be improving, and structurally are still very cheap. So there is still re-rating potential in the Korean market. In the post-chaebol era, new sectors and companies are beginning to emerge. One example from our portfolio is Hana Tour Services, the largest outbound tour operator in Korea, which has doubled its market share in five years.
Employees own 27% of the company, which generates a 40% return on equity and is trading on a single-digit multiple. The outbound travel market is growing by 15-20% annually and the company has a 40% share of the wholesale market; the retail market is extremely fragmented. What we may see over the next five to 10 years is consolidation to two or three large operators - as in the UK - and Hana will be at the forefront of that.
Thailand still looks cheap, with strong growth of earnings - but we feel that the story is well developed. So we plan to reduce our exposure and take profits selectively. The government in Indonesia has brought fiscal accounts and the money supply under control, so the economy is "normalising". There is re-rating potential as interest rates come down, domestic consumption is recovering gradually, and the market is still cheap. So we are still very positive on Indonesia and it remains a core theme.
There are significant capital inflows to China as the currency has been undervalued, and the government is trying to maintain the RMB. We think that the authorities will recognise that the most effective way for them to manage the economy is to let the currency appreciate. While China is too big to ignore, it is important to remember that there are opportunities elsewhere in the region.
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