Timely commentary from Wells Fargo Investment Institute on international topics in the news.
Peter Donisanu, Investment Strategy Analyst
Why Invest in Asia-Pacific
- Some investors perceive the Asia-Pacific region to be a homogeneous group of economies and markets. However, we believe that the Asia-Pacific region is far from homogeneous and that investable themes are accessible through opportunities spanning across countries.
- We believe that long-term investors with patient capital can benefit from broad and narrow investment themes, which we anticipate will play out over the next decade.
What it may mean for investors
- From a near-term perspective, we like Asia-Pacific stocks and are constructive on U.S.-dollar-denominated debt in emerging markets. Yet, we prefer the U.S. bond market over the developed Asia bond market.
To some market participants, investing in the Asia-Pacific region might mean gaining exposure to China, Japan, or Korea. While these three countries account for a large portion of Asia-Pacific economies and markets, they represent just a fraction of the investment opportunities in the region as a whole. Indeed, the Asia-Pacific region consists of a number of other key, vibrant economies and markets that are often overlooked by investors, including Taiwan, Singapore, Indonesia, Malaysia, the Philippines, and Thailand.
We believe that a number of broad and narrow themes, such as favorable economic growth conditions and changing demographics in the region, may present those investors with patient capital some unique long-term investment opportunities. In the near-term, we believe that earnings and economic fundamentals in the developed-market Pacific and Emerging Asia regions remain attractive, and we therefore maintain a favorable rating on their equities. For bonds, we are constructive on U.S.-dollar-denominated debt in emerging markets, yet prefer the U.S. bond market over the developed Asia bond market.
It’s Not All the Same
The Asia-Pacific region encompasses 33 countries and territories, represents one-fifth of global landmass, and houses half of the world’s population. For perspective on the geographic expansiveness of the region, it takes roughly the same amount of time to fly between Hong Kong and Sydney, Australia as it does to fly between New York City and Sao Paulo, Brazil or between Frankfurt, Germany and Johannesburg, South Africa. In terms of economic output, China and Japan are Asia-Pacific’s two largest economies, yet the other economies in the region combined are twice the size of Japan’s, and nearly equivalent to China’s. In total, the region accounts for one-third of global economic output. From a capital markets perspective, the size of the combined Asia-Pacific stock and bond markets is slightly smaller than the U.S. stock and bond markets, but among the largest in the world (Table 2).
At a more granular level, the Asia-Pacific region can be segmented further into the subregions of East Asia, South Asia, Southeast Asia, and Oceania—each with its own unique characteristics. For example, national income is significantly higher in Oceania, which includes the countries of Australia and New Zealand, compared to South or Southeast Asia, which includes India and Thailand. From a demographics perspective, 90 percent of South and Southeast Asia is younger than 60 years old, and nearly half of the population is under the age of 25. However, the rate of income growth in these two subregions is notably higher than the rest of Asia-Pacific (China excluded). To contrast this point, in high-income East Asia economies, almost one quarter of the population is 60 years or older, youth percentage is the lowest among major peer countries, and income growth has slowed in recent years.
To further this point of varying characteristics across Asia-Pacific, we find that the drivers of economic growth are not homogeneous across the region. As illustrated in the left clip of Chart 2, the primary industry (agriculture/mining) contributes more to economic output in South Asia than it does in East Asia, where the tertiary industry (services sector) is more prominent compared to other subregions. The contributions of sub-industries such as mining, manufacturing, and finance also vary widely across subregions (Chart 2, right clip). Finally, even within regions, the variations abound. For example, mining contributes 10 percent of total economic output to Malaysia’s economy, which is twice the 4 percent average for Southeast Asia (Chart 3).
Look for Opportunity in Broad and Narrow Themes
We have established in broad terms that the Asia-Pacific region is geographically vast and economically significant, while in a narrower sense exhibits differences across subregions in demographics and income. What does this mean for investors? We believe that the Asia-Pacific region is far from homogeneous and that investable themes are accessible through opportunities spanning across countries. We further believe that investors with patient capital can tap into long-term opportunities by focusing on the broad and narrow long-term trends that may play out over the next decade across the Asia-Pacific region.
In terms of broad long-term trends, we believe that Asia-Pacific has been a growth market for foreign multinational companies over the past two decades. Indeed, investors that had put money to work in U.S. and European companies targeting early investments in China, Korea, and Taiwan have, in some cases, been handsomely rewarded. We continue to believe that the Asia-Pacific region is a key growth market, yet expect large Chinese, Japanese, Korean, and even Taiwanese multinational companies to play a more influential investment role in countries like India, Indonesia, and Thailand. A key reason being that technological and infrastructure advancements have increased entrepreneurial know-how and eased the movement of people and ideas across the region.
In terms of narrow long-term trends, differences in income and demographics across the Asia-Pacific region can present investors with an opportunity to tap into investment opportunities. For example, Japan, Australia, and New Zealand have among Asia-Pacific’s largest 60-and-over population. In five years, more than 7 percent of Hong Kong, South Korea, and Taiwan’s population will also cross this threshold. High income levels, coupled with an aging demographic, are likely to produce opportunities in the region’s health care sector. In contrast, South and Southeast Asia’s youthful population and rapidly rising incomes are likely to benefit real estate and consumer-oriented companies as disposable incomes rise and household formations grow in the coming years.
From a near-term investment perspective, we believe that investors can benefit from improving economic and earnings fundamentals in the Asia-Pacific region. As such, we like the region’s stock markets and favor U.S.-dollar-based fixed income investments in Emerging Asia. Using MSCI’s equity market classifications, the Pacific (developed markets) and the Emerging Asia regions are our top two international investment destinations (Table 1, bottom clip). Robust improvements in Japanese labor market conditions, consumer spending, and business investment continue to underpin our favorable rating for Pacific stocks. Stabilization in China’s economy and a rebound in international trade broadly support our favorable rating for Emerging Asia stocks. Each of these factors has supported an earnings recovery in the region, and we believe that this trend will continue into the near future.
We expect emerging-market (EM) currencies to appreciate versus the U.S. dollar over the next 12 months, as economic growth and trade fundamentals support EM currency strength. Nevertheless, we continue to recommend that investors seek out U.S.-dollar-denominated EM bonds over local-currency EM bonds, given the potential for heightened levels of volatility in EM currencies. We are underweight international developed-market bonds relative to their benchmarks, as we expect widening interest-rate differentials induced by the Federal Reserve to favor the U.S. bond market.
Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Currency risk is the risk that foreign currencies will decline in value relative to that of the U.S. dollar. Exchange rate risk between the U.S. dollar and foreign currencies may cause the value of the portfolio's investments to decline.
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