Key points are:

• Chinese GDP growth will downshift, averaging 6%-7.5% for the next five years as net exports and investment are reaching their limits.
• In Asia, Japan is perhaps the economy closest to the “T-junction” described in PIMCO’s global secular outlook: The destination of Japan’s journey looks increasingly uncertain, with multiple potential outcomes that could stabilize or destabilize the global economy and markets.
• We expect the New Normal to arrive in the Australian economy and markets as the intensity of Chinese policy stimulus subsides and domestic growth outside the mining sector remains subdued.

To read the PIMCO report, click here.

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But with the Federal Government’s White Paper calling for closer ties between Australia and Asia in the ‘Asian century’, one global investment manager says that the paper simply reinforces his view that investing directly into Asia can provide significant upside for investors, particularly as markets in the US and Europe start to recover.

Craig Mowll, CEO of Certitude Global Investments, says there is no reason to suppose that Asia’s rapid growth over the past 60 years will not continue as GDP for the region is expected to double by 2030. 

“The three ‘R’s that underpin growth in China; railways, roads and real estate, are still growing as urbanisation continues.  And, as the White Paper identifies, an increasingly wealthy and mobile middle class will continue to fuel domestic demand. Asia will soon be the world’s largest producer of goods and services,” he says.

Mr Mowll went on to say that he has been surprised by the fact that investors are seemingly fixated on the fact that China has not managed to deliver double digit growth this year.

“Even with growth figures of 6.5 – 7.5% for China this year, Asia is looking a whole lot better than the US, which will be lucky to achieve 2 – 3%, or Europe which is going backwards.”

But the situation is set to improve, he says.

“Current commitments by the ECB and the program of quantitative easing in the US mean that growth rates in these developed markets are likely to stabilise going forward, and that is good news for Asia.”

That’s good news because, with the globalisation of world production, emerging markets like Asia receive significant benefits when demand in developed countries increases, and they also receive the associated increased demand from their own region.

“Emerging markets have been heavily discounted in the past year, in part due to economic woes in the major developed economies. But positioning your portfolio for the next phase is critical. Asia is a high beta play on the developed markets – in times of growth, it will receive a disproportionate benefit.”

Mr Mowll concluded by saying that closer ties mean investors should consider investing in Asia directly.  “Many Australian investors believe they are accessing the Asian growth story through domestic equities, but they really aren’t getting the most out of the opportunity, particularly considering the challenges we face playing out in the resources sector. Investing directly can provide a greater increase to returns,” he said.

“Now, more than ever, is a great time to invest in Asia.”

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“Asia as a safe haven is a novel concept for anyone who remembers the region’s own devastating financial crisis in the late 1990s,” says Tom Stevenson, Investment Director at Fidelity Worldwide Investment.

“But confidence is growing in the ASEAN region of 600 million people, with a fast-expanding middle class driving consumption and economic growth.

“The International Monetary Fund recently downgraded growth for the ASEAN region, showing it cannot completely buck a slowing global recovery. But it has still pencilled in 6.1% growth next year, compared with 0.7% for the euro area and 2.3% for the US.

“ASEAN should not be underestimated. With a combined stock market capitalisation of more than US$2 trillion and trade with China expected to top $500bn by 2015, the region is grabbing the attention of increasing numbers of investors. In the first half of this year, almost as much money flowed into ASEAN funds as flowed out of China. Having been the first investments to be liquidated in an emergency, they are taking on the characteristics of a port in the storm.

“Many of the region’s attractions are familiar to China bulls. Rapid urbanisation and infrastructure build tell a similar story, for example, as do the robust government finances that make a high level of public investment possible. But there are differences, too. China’s one-child policy is leading to a rapid ageing of its population, but in South-east Asia more than 40% of the population is under 25, putting the region in a demographic sweet spot.

“The ASEAN region is extremely diverse, however, so it is not possible to generalise beyond the obvious themes of higher consumption and investment. Vietnam and Singapore share membership of the economic organisation, but little else. Some of the region’s countries are rich in natural resources that others lack. Inflation is a problem in some places and not in others. Local knowledge is key.

“One of the most interesting markets in the region is Thailand, and not just because it might be the best way to tap into the opening up of Burma. Thailand’s stock market has risen by 16pc so far this year, beating all the other main indices in Asia.

“In part that reflects a quicker than expected recovery from last year’s floods. But it is also a consequence of a raft of pro-stimulus policies from the country’s populist government, including a 40% rise in the minimum wage and a sharp reduction in corporation tax from 30% to 23%, with 20% in the pipeline for next year.

“Foreign investment is pouring into Thailand, with Japanese car makers seeing the country as a safe destination for companies seeking to escape the high yen and energy shortages following the Tohoku earthquake.

“The government is playing its part, too, spending heavily on dams and flood defences as well as rail and road projects to help promote the country as a distribution hub for the region, linking China with frontier markets such as Cambodia. “

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity Worldwide Investment. Prior to making an investment decision, retail investors should seek advice from their financial advisers. Investors should also obtain and consider the Product Disclosure Statements (“PDS”) for any Fidelity fund mentioned in this document. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading from our website at www.fidelity.com.au. This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless stated otherwise.  2012 FIL Responsible Entity (Australia) Limited.  Fidelity, Fidelity Worldwide Investment and the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited.

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“The objective of this new plan, called OMT (Outright Monetary Transactions) is expected to provide Sovereign states with benefits similar to those provided to European Banks via the Long-Term Refinancing Operations (LTRO) announced last year – lower funding costs, and improved availability of funds.

“High bond rates make it almost impossible for the heavily indebted sovereign states to deleverage, as the heavily indebted sovereign states need to issue more debt in order to pay the high interest cost. This initiative will still leave parts of Europe with low growth, high unemployment and continuing need to de-leverage but the announcement of the new plan has effectively boosted market sentiment, and provided a solution to the continuing refinancing requirements of certain sovereign states.”

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“Markets reacted negatively to a wide range of disappointing macroeconomic data in May, and we believe that there will be more negative data to come,” says Jason Pidcock, manager of the Newton Asian Income Fund from Newton, part of BNY Mellon Asset Management.

“For this reason, we are likely to maintain our relatively cautious outlook for the rest of the year, despite the increasing number of high-quality companies available at attractive valuations.

“We are particularly aware of the problems in China, where the efforts of 2009 and 2010 to stimulate growth are beginning to have an adverse impact upon the economy; our Chinese exposure is very selective,” he adds.

“There’s no doubt that a significant economic slowdown in China would affect the whole region but we do not expect growth to collapse.”

Pidcock continues, “Growth remains strong and we expect this to continue. Furthermore, we believe that the concerns over China’s economic growth are broadly priced into markets and we would describe our view of the country as cautious rather bearish.

“We think that its economy is likely to plateau from here, with GDP numbers unlikely to fall below 7%. The economy is in the process of rebalancing and this might not happen quickly or smoothly. As such, further interest rate cuts and fiscal stimulus are likely, although these measures are unlikely to be as aggressive as they were in 2008.”

Look South East…
“We are more optimistic about much of South East Asia and countries such as The Philippines, Thailand, Singapore and Malaysia. Indeed, this view was reinforced on a recent Newton visit to the region; growth in these areas seems to be holding up well, with Thailand and The Philippines, in particular, benefiting from falling commodity prices.

“Though dependent upon these lower costs, we would expect these countries to be relatively immune to a Chinese slowdown, in part, because they have not undergone a credit boom so there is no reliance upon rising property prices to fuel growth but also because they still boast robust domestic consumption,” Pidcock adds.

3 July 2012

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This concept of urbanisation is certainly nothing new to most investors and financial advisers. History has taught us that each developing economy has gone through this process over the last few centuries. The urbanisation process undertaken by Great Britain in the 1800s and the United States in the 1900s played a significant role in turning them into the world’s leading economies.

Asia, the region which contributed greatly to the global economy in the last two decades, especially post the 2008 financial crisis, is the next frontier in urbanization. However, the scale of growth this time around is unprecedented.  Between 1950 and 2010, Asia’s urban population nearly tripled from 15 percent to more than 40 percent.

Focusing specifically on China, as at January 2012, over half the population of the 1.35 billion people is now residing in urban areas. This means that over 600 million people are still in rural areas, which will be developed over the next few decades. This is something that should never be underestimated.

One major benefit that urbanization brings is the potential consumption power. Based on a forecast by the United Nations, China’s urban population will increase by 216 million from 2012 to 2025. For India and Indonesia, the combined increase in the urban population is expected to be greater than 400 million. With more migration into urban areas, there will be significant increases in the demand for properties and household products.

Furthermore, by 2020, the Asia Pacific region is forecasted to have over 50 percent of the world’s middle class population. The rising disposable incomes and wealth levels will encourage the pursuance of higher living standards. While external demand remains gloomy, the rapid urbanization in Asia is highly likely to unearth great potential in domestic consumption.

However, the greatest benefit of urbanization, as in the case of the US and Britain, is productivity. As the population moves off the land and into factories or the service sectors, the multiple gains in productivity are significant. This has already been proven by the US that the urban population is up to 50 percent more productive than the rural population.

Therefore by moving from farming to manufacturing, the multiple gains for China will increase and continuing to grow as further efficiencies evolve. This in turn will generate more economic growth and convert China’s industries from working harder to working smarter.

It has also been well documented that urbanisation can positively impact the evolution and economic growth of a country towards an industrialised economy. To create a completely industrialised economy, it requires the creation of three areas: free education, free base level healthcare and a government social security/pension safety net.

Education has been seen as one of the most important factors in economic development. Higher literacy rates can strengthen the productivity of labour forces – one of the key engines for economic growth. In most of the rural areas in Asia, a large number of people are still struggling with the issues associated with poverty and can hardly afford education. Therefore it is necessary for policy makers to support those areas with free education. Since 1998, the Chinese government has tripled its share of GDP that is devoted to education.

There is now a 9-year complimentary education provided in both rural and urban areas. On the 29th of July 2010, China’s Ministry of Education released guidelines for reforming and developing the educational system in the next 10 years. This program covers almost every level of education (from kindergarten to university), especially in rural areas. Providing education to the children of urban migrants has also been marked on the ministry’s agenda.

Secondly, a sound healthcare system can help sustain or increase productivity in order to support the supply of labour forces. It can also reduce the financial burden on households brought about by medical services. As part of its $4 trillion yuan stimulus package in 2008, China invested a large proportion of it into creating a universal healthcare system. Their aim was to have the entire population covered by the universal healthcare system by 2020. Moreover, it is also aimed at addressing the disparities between rural and urban dwellers. Those in the cities are healthier and live longer compared to those in the rural areas. 

The World Bank adds that bankruptcy caused by medical expenses is common in rural China. A free basic health care system means that those who normally cannot afford basic health services, such as rural dwellers and low income earners, can gain access to basic health care. This will at least give them something that is normally available to those in the middle income bracket and above.

Thirdly, a government social security system is also necessary in maintaining a basic standard of living, slowing the widening gap between the rich and poor and maintaining an income stream after retirement. Currently the pension system coverage rate in Asia is still underdeveloped, with the Asian Development Bank indicating that the coverage rate for the working-age population (those from the age of 15 to 64) ranges from 13.2 percent for Vietnam to 58 percent for Singapore.

In comparison, the rate for developed countries is around 90 percent. On a brighter note, the Chinese government has reformed and enhanced its social security system. The government has introduced compulsory superannuation at a level of 10 percent for urban workers and created a government base retirement pension. In addition, during the 2012 National People’s Congress, Premier Wen Jiabao announced that a full coverage of the pension system for both rural and urban populations is expected to be achieved this year – 2012.

For the rest of Asia, the situation is not too different. The way the urbanisation roadmap for Asia will be unfolding is through the government providing incentives to reduce the gap between the rich and the poor, and trying to create the largest proportion of its population as the middle class. While this complete urbanisation is still a work in progress, governments will slowly roll out similar programs to boost the standard of living. With a strong middle class population; consistent, steady, and most importantly, sustainable growth is possible.

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Singh’s alliance has since cracked under corruption scandals. The results of recent state elections will only make it harder for him to unify his political partners and push through the reforms that India’s slowing economy needs.

The results of month-long elections showed that the Congress party performed poorly in three of the five state polls. The most disappointing result was in northern state of Uttar Pradesh, India’s most populous state that, as home to more than 200 million people, is considered to be the political battleground state. Congress was banking on boosting its holding of 22 seats in the 403-seat assembly to at least 80 seats to enable it to form a coalition at state level with the socialist Samajwadi Party so it could cement this party’s support at federal level.

Even though Congress’ bid for power was headed by Rahul Gandhi of the Nehru-Gandhi dynasty that has dominated Indian politics since independence in 1947, the Samajwadi Party won a comfortable majority in the state from the tainted Bahujan Sarnaj Party (whose leader is fond of building statues of herself) – gaining at least 220 of the 403 seats. Congress only won at least 28 seats, to come fourth in a state that sends most MPs to the Lok Sabha, as India’s lower house of parliament is called.

The result follows a bleak 2011 for Congress at a national level and portends poorly for the next general elections in 2014, especially now its hoped-for prime minister Gandhi failed to win over voters. Numerous corruption scandals over the past 12 months or so have scuttled the government’s reform drive as smaller coalition partners have splintered off and thwarted any significant changes.

The most glaring reform defeat was Congress’ announcement last year that India would allow foreign department store owners such as Walmart to set up in India. This decision, which didn’t require the passing of any laws, was overturned within days after Congress’ coalition partners, opposition parties and state governments objected to a move that is seen as threatening the family-run stores prevalent throughout India. Other stalled reforms include attempts to clarify land acquisition, strengthen anti-corruption measures and overhaul insurance and investment management.

Investor verdict
Congress was hoping that a strong performance across the five states would pressure its rebelling federal coalition partners or prompt its outside supporters such as the Samajwadi Party to push on with reforms. Better results may have also improved the morale and determination of Singh’s rattled-looking government.

Even if a Congress-led coalition holds onto power in 2014 (and Congress has ruled India for most of the post-independence era), it’s now more likely to be a far more unwieldy coalition than the one that so excited investors in 2009. The Congress-led coalition that ruled India from 2004 to 2009 was a disjointed coalition that included Communist MPs.

Investors were disappointed with the state election results. “We view the election results as negative for economic reforms and the markets, though a key uncertainty has been lifted,” said Goldman Sachs in a report on the election.  “We think the results will not provide the political space for the government or the confidence to carry through unpopular reforms.”

Congress did win a majority in the northeastern state of Manipur and in the Himalayan state of Uttarakhand, but it fizzled in the northern state of Punjab (won by the incumbent alliance of the Shrimoni Akali Dal and Hindu-based Bharatiya Janata Party) and in the western state of Goa (won from Congress by the Bharatiya Janata Party).

Congress has much work to do to spark another rally in shares.

 This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity Worldwide Investment. This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs.  You should consider these matters before acting on the information.  You also should consider the Product Disclosure Statements (“PDS”) for respective Fidelity products before making a decision whether to acquire or hold the product.  The relevant PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading from our website at www.fidelity.com.au. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Details about Fidelity Australia’s provision of financial services to retail clients are set out in our Financial Services Guide, a copy of which can be downloaded from our website at www.fidelity.com.au. © 2012 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity Worldwide Investment and the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited.

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“We think it will,” says David Urquhart, Portfolio Manager for the Fidelity Asia Fund. “The Organization for Economic Co-operation (OECD) forecasts the Asian region to grow around 7% in 2012.

According to the Chinese zodiac, 2012 is the Year of the Dragon – an auspicious symbol of good fortune and power.

Mr Urquhart notes Asian markets have historically performed well once they dropped to the current inexpensive valuations of 10.3x price to earnings ratio (P/E) and 1.5x trailing book value. “Over the past 20 years when P/Es have been this low we have seen rallies on average of 16% or higher over 12 months, 92% of the time, according to studies by Goldman Sachs and Citi.

“Although Asia is not immune to the slowdown in the West, the region is proving more resilient to a global economic downturn than in the past. One reason is that the region is significantly less reliant on the West than previously, with over half of Asia’s exports now being traded within the region.”

Mr Urquhart says one reason he is optimistic about Asian equities is that the region’s demographics continue to be very favourable for investors.  The labour force is forecast to grow at 1.5% a year for the next 10 years, compared to Europe and the US which are growing at just 0.3%. “The region’s steadily rising labour force will provide a source of higher growth. As people enter the labour market they become economically productive, rather than being a drain on an economy. More people will be able to earn and therefore spend, buying goods and services that companies provide.

“The rising labour force is also adding to the growing middle class in Asia, which is expected to almost double to over a billion people in the next five years. China is expected to report the biggest absolute increase, while India and Indonesia will have stronger percentage growth.”

Another positive for the region is that while most Western economies have a negative current account balance, most Asian nations have a positive one (with the notable exception of India).

“This provides another reason for optimism about Asia, as the West slows, is that policymakers in the region still have more growth-supportive options at their disposal than their developed market peers,” says Mr Urquhart. “Asian economies still have the ability to use both monetary and fiscal policy to help stimulate domestic demand, while in the West high levels of government debt have made Fiscal policy tools unavailable. Most Asian central banks have been tightening their monetary policies in the past few quarters so they now have flexibility to relax interest rates and credit policy in case of a severe economic slowdown outside their borders.

“It is similar, with foreign exchange (FX) reserves. Asia accounts for 63% of global FX reserves, with China accounting for half of these at the end of 2010. “Asia still has the capacity to lend and borrow. This will help corporates in the region.

“Corporate debt levels are the lowest they have been since 1981 at 25.8% debt/equity. They have been building increasingly large reserves of cash and significantly de-leveraging their balance sheets following the Asian Financial Crisis in 1997 and the Global Financial Crisis in 2008. Strong balance sheets, cash flow and rates of return have put Asian companies in great shape. Though some companies will do better than others in this kind of environment.”

Mr Urquhart points out that “there are several other factors that will further contribute to Asia’s growth this Chinese new year – including increasing participation rates in tertiary education, rising labour skills, increasing urbanisation, developing credit markets and so on.  All these should further underpin the growth opportunities of companies and their share prices in the region.

“Overall, Asia’s healthy financial system, robust domestic demand, low debt levels, high savings rates and the emergence of China as an anchor of growth for the region will continue to be supportive of multi-year growth in the region.

“By being in better economic shape we expect Asian equity markets – which are currently following the lead of US markets – have greater upside when global markets do improve.”

What countries will provide the best market returns?
“I have returned to a slight overweight to China, as the government in Beijing should start to loosen monetary and fiscal policy there as inflation concerns reduce and growth slows in response to the slowing global economy. This should help the growth of local companies.

“I also like Indonesia and Thailand, as we have identified some great businesses there with great growth potential.

“This is key, as while the region as a whole is one of the strongest in the world it is important to identify, from the bottom-up, those companies that are going to deliver earnings per share growth stronger than the market anticipates and currently at very attractive valuations. These stocks should perform well over the next few years even in the challenging macro environment.”

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity Worldwide Investment. This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs.  You should consider these matters before acting on the information.  You also should consider the Product Disclosure Statements (“PDS”) for respective Fidelity products before making a decision whether to acquire or hold the product.  The relevant PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading from our website at www.fidelity.com.au. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Details about Fidelity Australia’s provision of financial services to retail clients are set out in our Financial Services Guide, a copy of which can be downloaded from our website at www.fidelity.com.au. © 2012 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity Worldwide Investment and the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited.

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Mr Ford says Asia will emerge stronger from the current financial storm – at least relative to the developed world – as there is a heavy price to pay for all the bail outs, recapitalisations and fiscal stimuli that have taken place in the developed world.

Cash-rich companies in Asia, ex-Japan are sitting on around $US1 trillion in cash and are also looking to deploy these funds by finding quality merger and acquisition targets with attractive valuations.

Strong balance sheets and a reduction in capital expenditure are also behind the build-up of corporate cash reserves, he said. “People don’t tend to associate income with Asia, but we are seeing a growing trend of Asian corporates undertaking share buybacks, special dividend payments and even M&A activity,” Mr Ford said.

He said the dividend income growth story would continue for some time and that dividend payouts were not associated just with infrastructure stocks. “We are seeing airlines, heavy industrials, and Taiwanese technology, media and telecommunications companies paying healthy dividends, as well as what you would expect from typical defensive stocks such as banks.”

In contrast to the West, Asia is in good fiscal shape on the sovereign, household and corporate front. According to the International Monetary Fund, the G20 advanced economies had a debt-to-GDP ratio of more than 100% in 2010. This figure is projected to rise to 125% by 2015. 
However, public debt levels are around one-third of GDP in Asia ex-Japan and are projected to decline to less than one-fifth by 2015. 

On consumer spending, Asian households can afford to spend more given the very low levels of household debt. 

Demographic factors and high savings rates will come down over time as the Asian population becomes increasingly middle class. This means that spending will accelerate in the future, translating into structurally higher levels of economic growth, particularly relative to those of developed world economies where households are necessarily focused on debt repayment.   

On the corporate front, Asian companies with healthy balance sheets are in a strong position to weather the current market volatility and reward shareholders with higher dividend payments and share buybacks.  The cash-payout ratios are set to increase further from 12% in 1998 to a prospective average of 32% estimated for 2011-12.

“This is significant because it shows us how strong corporate balance sheets are and how strong profits and cashflow are in Asian companies. It also shows a marked change in attitudes to good corporate governance and concern for shareholders’ interests,” Mr Ford said.

“This focus on shareholder value – coupled with robust balance sheets and healthy profits – means that over time an increasing proportion of total return from investing in Asian equities will come from dividend income and share buybacks rather than purely capital gain. In an environment so full of uncertainty, the well-covered yields in Asia are likely to become increasingly valued by investors,” he added. 

These are long-term strategies and a reflection of Asian companies getting more sophisticated and wanting to provide more value to shareholders.

Despite the current market turmoil, Mr Ford said Asia was the key winner out of the situation. “Companies in Asia remain healthy. The fundamentals are in good shape and foreign investors will once again look to this part of the world for growth and further income.”

“The bull case for Asia is not just about growth – it is about better governance, better balance sheets, better profits and cashflows, and therefore, attractive yields. Yet, Asian valuations have often remained at a discount to developed markets despite all of this,” Mr Ford said.

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