Rajiv Jain, managing director for international equities at Vontobel Asset Management in New York, thinks most Asian equities are grossly overpriced. The $5 billion Vontobel invests in global equities outside of the United States, and Jain reckons plenty of European multinationals offer much better deals for equity investors.
He cites the case of Taiwan's Hon Hai Precision as typical of what's on offer. One of the region's most respected companies, Hon Hai's gross margins have deteriorated over recent years from 6% to 3.5%, while operating margins have been halved to around 2%. Jain can't fathom why it's trading at 20x 2010 earnings when its major customers are the likes of Dell and Apple, ultimately linking Hon Hai's fate to America's stricken consumers. And worse, companies like Hon Hai have no pricing power.
Plenty of equity managers in the US like the tech story, but not Jain. He relates a story of how trauma companies can't meet expected sales, or how doctors in hard-hit parts of the US such as Florida are losing patients because more people can't meet their co-pay. If Americans can't pay for vital things like healthcare, then it's unrealistic to expect them to buy more iPods.
It's in Asia where this disconnect from reality is reflected most extremely in stock valuations, Jain says. The notion that Chinese domestic demand is going to rescue the region is a fiction. "Chinese domestic consumption is less than that of the UK," Jain notes. "An increase there isn't going to move the needle."
Worse, it's in China where the greatest overcapacity exists in areas such as steel and cement. China's infrastructure spending programme is good at boosting GDP figures by adding capacity, but does nothing to help corporate profitability.
Jain is sceptical about the ability of government stimulus programmes to ultimately boost corporate earnings. "We don't trust any government. Why do investors have such confidence in Beijing? Chinese steel companies are being instructed to produce more and not lay off workers, at a time when capacity utilisation rates are at their lowest in 50 years."
Too many investors are mesmerised by the Asian growth story, but Jain calculates that over the long term, Chinese corporate earnings growth rates have been about the same as America's -- yet Chinese stocks are priced for something far more ambitious. Jain says the past few years were a bubble and have clouded investors' expectations about growth in China and other Asian markets. The argument that Asian corporate balance sheets are strong is fine for bondholders but doesn't equate to earnings growth.
Similarly he believes prices in most commodities are also way overbaked -- although capacity remains tight in oil and gas.
There are some attractive names in emerging markets, Jain says. He likes consumer staple companies in India such as Nestle or Hindustan Lever, or utilities in Brazil. But these are often multinationals.
What Vontobel likes are stable European multinationals that exhibit visible earnings growth for durable franchises. There are some companies that perform well in recessions but at present are not priced as such, including British American Tobacco, Imperial Tobacco and Diageo.
These companies offer 9-11x earnings, 5-6% dividend yields, reasonable growth, little leverage on the balance sheet, and pricing power. They are usually planning to buy back their own stock.
Take the example of Diageo, the UK-based beverage and food conglomerate. A weak pound makes it even more attractive to dollar-based investors, but Jain is more interested in its Johnny Walker unit. Whisky is cheap to produce; sales in America are up; the company is planning price hikes in some markets. Diageo is selling at 10x earnings with a 5.5% dividend yield, and has stated its intention to buy back stock. Its Red Label was launched in 1805. The product hasn't changed. "It's a durable franchise that is now priced attractively," says Jain. "It's got 25% operating margins in the US, compared with Hon Hai's 2%."
He'll take the whisky.