Asian shares have been hard hit by the global financial crisis and subsequent global recession. However, at a time when the medium term outlook for US, European and Japanese shares is fraught with uncertainty, there are good reasons to believe Asia ex-Japan shares will perform well over the next 5 to 10 years, says Shane Oliver, Sydney-based head of investment strategy and chief economist as AMP Capital Investors.
From their 2007 highs to their recent lows Asia ex-Japan shares have fallen around 60% and this is worse than the more than 50% falls in US, World and Australian shares. Unlike the 1997-98 Asian crisis, the slump in local shares has not been of Asia's own making, however.
As Oliver notes, Asia did not have major structural or cyclical imbalances of the sort that led to the Asian crisis -- current accounts were in reasonable shape, foreign exchange reserves were high, inflation was up but largely driven by the commodity boom (as was the case elsewhere), and shares were not particularly overvalued.
"Asian shares have been dragged down by the global financial crisis which has seen foreign investors exit and their export-oriented cyclical economies hit hard," Oliver says. "The outlook for Asian growth is bleak over the year ahead thanks to the slump in their export markets."
Many Asian countries literally saw their exports fall off a cliff late last year, he notes, with declines of 20% to 30% typical over the year to December. Singapore, Hong Kong, South Korea and Taiwan are in recession or close to it. Growth looks like being pretty soft in China and India compared to year-ago levels.
Asian share markets are usually high beta, moving in an outsized fashion compared to US shares since their economies are more cyclical and their share markets seem more influenced by foreign capital, which rushes in during the good times and rapidly retreats in the bad, Oliver says. He notes that the relative underperformance of Asian shares over the last 18 months is not particularly unusual for a global bear market. But the relative outperformance of Asian shares versus global shares since 2001 is still intact.
Oliver cites some reasons why investors should to be overweight Asian shares strategically.
First, Asian countries do not suffer from the consumer indebtedness and deleveraging that is now causing big problems in most Anglo countries (particularly the US, UK and New Zealand and potentially in Australia and Canada).
Second, the Asian financial system is not impaired like the US financial system which is going through a gut wrenching adjustment from a huge dependence on credit markets back to a system more dependent on banks. Asia's financial system never became as dependent on credit markets and its banks are far less exposed to the toxic debt now causing big losses for US and European banks.
Third, Asian countries are highly dynamic and clearly focussed on achieving Western per capita income levels. This contrasts with Europe and Japan which are constrained by a lack of dynamism reflecting more rigid economies.
Fourth, Asia generally benefits from more favourable demographics. Asia along with most other emerging markets, save for Eastern Europe, is projected to have faster population growth and a lower dependency ratio -- or the ratio of children and retirees to working age people -- than in developed countries. This contributes to a faster potential growth rate in the labour force and hence faster potential economic growth overall. China is an obvious exception but it still has a large underutilised rural workforce it can draw on.
Fifth, Asian equities are now back to trading on a similar valuation to global shares. After trading on a higher forward PE ratio than global shares they are now back to being in line.