Asian financial markets will continue to expand and evolve, so investors should strategically allocate a portion of their portfolio to Asia ex-Japan, argues UBS director and equity analyst Patrick Ho.
Although prices have rallied substantially in the past few years, current valuations of Asian equities are not expensive since price-earnings ratios are within historical ranges and earnings have increased rapidly, says Ho who contributed to the research.
The report notes that urbanisation, increasing affluence, and AsiaÆs dominance as a global supplier of goods and services are three trends that have the potential to contribute to strong regional economic and earnings growth and should lead to increasing investment opportunities.
Increased affluence and heightened infrastructure spending will support durable goods and services consumption throughout Asia, and there will be increasing spending on discretionary items like information technology products and transportation, it states.
Ho and his research colleagues give a generally positive outlook for economic growth in the region. ChinaÆs GDP growth, they project, will remain at the current 9% to 10% level in the next several years and will slow to around 7% between 2011 and 2015.
However, ôcompared with the world average of 4%-5%, [a 7% growth rate] is already an achievement,ö they argue.
IndiaÆs economy is also poised to grow strongly, but manufacturing activity will likely make up a greater proportion of overall economic output, according to Ho. The economies of South Korea, Taiwan, Singapore and Hong Kong are expected to experience more moderate growth of between 4% and 5%, whereas some newly emerging Asian economies are poised to achieve high single-digit rates of economic growth. Japan, due to its aging population and high debt burdens, will likely see growth capped at no more than 1.5% on average during the next decade.
This type of economic and financial backdrop in Asia is likely to produce sub-par returns for global bonds, global equity returns closer to their long-term average (following the exceptional returns seen since 2003) and the potential for well-supported commodity markets, the UBS team argues.
Asian equity markets are growing rapidly, even though the growth is driven more by initial public offerings than share price increases, Ho says. ôAsian equity markets account for 5% of the worldÆs total market capitalisation now. The proportion is going to increase in the futureö he notes.
As for global equities, the report argues that growth in profitability is related to increased economic interaction with emerging Asia. Nonetheless, having benefited from a structural boost to margins and earnings, global equities are unlikely to experience as favourable a situation in the coming years as profit margins are unlikely to expand and provide further support.
Also, ôwith Asian countries less likely to continue providing disinflationary impulses to the world economy, liquidity will most likely not remain as supportive of risky assets.ö
However, AsiaÆs industrialisation and urbanisation trends will create a positive environment for commodities through the end of the current decade, the report projects. Global demand for commodities is also expected to remain robust, while supply constraints are unlikely to be relaxed anytime soon.
The rapid urbanisation process is a driving force for infrastructure development in the region and has the potential to boost revenues of domestic companies engaged in engineering, construction, and building materials, UBS says. These companies are likely to enjoy higher earnings growth assuming their margins are kept stable, while other industries in the supply chain such as power and water utilities; energy and natural resource providers; and supporting industries like transportation, logistics and telecommunications should also benefit in the long run.
Citing an estimate by the Economist Intelligence Unit that China will catch up or overtake the US in terms of purchasing power within many key segments by 2010, the research also projected that AsiaÆs emerging and newly industrialised markets, particularly China and India, will provide significant growth opportunities in the consumer goods and retailing segments over the next decade.
While the retail markets in industrialised Asia are highly fragmented, mergers and acquisitions will remain a key theme in the sector and will keep valuations buoyant. The report notes that several Asian retailers have recently established joint ventures with foreign retailers in anticipation of increasing competition. Foreign companies have also been acquiring local retailers in order to reduce their time to market.
Meanwhile, AsiaÆs real estate markets still offer many opportunities supported by strong fundamentals and the regional economic and earnings growth. For instance, the research team projected ChinaÆs real estate market will continue to see active development and rising demand as multinational companies continue to relocate manufacturing and other operations to the region.