Investing Insights from a Westerner in the Far East

Investing Insights from a
Westerner in the Far East

Asia has long fascinated me – for its rich history (much older than our own), its exotic cultures, and its promising investment opportunities. Recently, I had the opportunity to visit several Asian countries. I came away with some new investing insights I’d like to share with you.

I believe there are good reasons to favor investing in Asia over North America, Europe, South America, and Africa. Of course, that assessment relies on some very broad generalizations about the respective regions. I do acknowledge the existence of potentially lucrative investment opportunities waiting to be found in all parts of the world. But on a macro-level, it seems inevitable that in the decades ahead the East will rise as the West declines in terms of global economic might.

Leading the way will be China. The Chinese economy has surpassed Japan as number two in the world. It will soon surpass the United States. By some calculations it already has.

China: Red Still Reigns in Politics,
But Appetite for Green Drives Economy

Communist China today is “communist” in name only. Yes, the infamous poster of Mao Zedong still looms over Tiananmen Square. But if you think the Chinese aren’t interested in making money off of you, then you have another thing coming!

I certainly experienced this as I toured the famous historical sights of Beijing. I could hardly go out without being offered a taxi or rickshaw ride or being approached by someone – usually a young woman – asking me where I was from. Much to my disappointment, these young women weren’t really interested in getting to know me. They were interested in my money.

You see, they were all salespeople for various enterprises like tour companies, art galleries, and tea shops. Many of these enterprises are set up specifically to hard-sell and scam tourists. I quickly came to be suspicious of anyone who presented a more outwardly friendly face toward me than normal.

China’s Appetite for
Gold Is Growing, Too

You can’t trust the official economic data in China. Not the GDP or central bank gold buying numbers. However, we do know with pretty good certainty (based on import figures from Hong Kong) that last year China became the world’s largest gold consumer. China’s burgeoning middle class is buying tons of gold jewelry, both for showing social status and for wealth protection.

What we don’t know for sure is how much gold the Chinese government is buying. The Chinese would like to lead the gullible among us to believe they are content holding U.S. Treasuries even as they and their allies (including Russia) are quietly accumulating the world’s largest gold reserves. China and Russia are also entering into bilateral trade agreements that allow trading partners to bypass the dollar.

I have little doubt that it’s the long-term ambition of China’s rulers to make China the world’s dominant economical and geopolitical power. The Chinese have a much longer history than we do (most of the Great Wall was constructed during the Ming dynasty, even before Christopher Columbus set sail for the New World). In part because of that (and the fact that their leaders don’t have to pander to voters), they tend to have a very long-term time horizon.

China’s Mixed Economy vs. Ours

Beijing pursues what it calls a “socialist market economy.” The concept isn’t all that different from the system now in place in the United States.

Far from exemplars of free-market capitalism, the U.S. operates a massive and growing welfare and entitlement state that represents some $100 trillion in unfunded liabilities. The U.S. is now pursuing “market socialism” in healthcare (Obamacare). The U.S. imposes heavy taxes on corporations (the highest nominal corporate tax rate in the world, in fact). And like China, the U.S. has government-sponsored enterprises (Fannie Mae and Freddie Mac, General Motors, and the too-big-to-fail banks).

Many of China’s state-sponsored corporations actually produce real things and generate real profits. You can even invest in some of them. China Petroleum & Chemical (SNP), for example, trades on the New York Stock Exchange as an American Depository Receipt. It pays a 3.9% dividend – better than most U.S. oil majors. You can get exposure to Sinopec and other large-cap Chinese stocks through iShares China (FXI).

You can get broader exposure to emerging Asia through SPDR S&P Emerging Asia Pacific (GMF). It is weighted 36.0% in China; 27.6% in Taiwan; 16.8% in India.

Chinese Transportation Infrastructure
Is Improving by Leaps and Bounds

Some say that China’s physical economy has become overbuilt in relation to actual demand. In the near-term, that may be true. But the infrastructure upgrades in
Chinese mega-cities like Shanghai over the past 25 years have transformed them from Third World to First World status. In another 25 years, current infrastructure
spending in China will undoubtedly pay off, even as the over-indebted U.S. struggles to maintain its aging bridges, roads, pipelines, and subway systems.

My hotel in Beijing provided free copies of China Daily, an English-language newspaper. The May 15th edition of the paper contained an intriguing story about how Chinese maglev (magnetic levitation) trains may soon be able to travel much faster than jets: “Chinese scientists have built the world’s first prototype testing platform for an ultra-high-speed vacuum maglev train, which theoretically could hit speeds up to 2,900 km per hour, or almost three times the speed of a passenger jet…”

Some may lament that China Daily is fed propaganda by the government that writers regurgitate as journalism. If so, then it isn’t much different from the New York Times in that regard. In any event, China is already home to the world’s fastest passenger train. The maglev in Shanghai connects to the Bund to the airport at speeds of up to 267 miles per hour. In Shanghai, transportation infrastructure is now first rate – far newer and more efficient than what you’d find in New York City or Chicago.

Can China Ever Reproduce
the American Spirit?

China still lacks much of the intangible infrastructure that made America’s economy number one – the creative energy, the unbridled entrepreneurship, the absolute rights to free speech and private property. But as America loses much of what made it great, China is heading in the other direction, albeit slowly.The State Council recently announced it would move to make financial markets more open and accessible to start ups and foreign investors.

Still, China has a long way to go in terms of freedom of speech and the press. Although Internet access is widely available in China, some of the world’s top web sites are inaccessible. I couldn’t get on Facebook, Twitter, YouTube, DailyMotion, and a host of other popular media and social networking sites while visiting Beijing. These sites are all are blocked by the government. Yet CNN and CNBC were pumped into my hotel’s television, no problem. That should tell you something! Specifically, it should tell you that China (and other authoritarian governments) regards the free expression and dissemination of independent points of view on the Internet as a bigger threat than what’s aired on establishment media outlets.

Efforts to restrict political speech have succeeded in Britain and Canada (where expressing “racist” or “Islamophobic” opinions can get you arrested) and are gaining traction here in the Land of the Free. Senator Edward Markey (D-MA) recently introduced a bill that would, according to the Boston Herald, “direct a government agency to identify hate speech” on the Internet and elsewhere.

“Hate” is the politically correct version of “counterrevolutionary” under Chairman Mao.

Are Japan’s Lost Decades
Becoming a Lost Future?

In contrast to China, which continues to expand its material wealth at a rapid pace as it moves further away from doctrinaire Maoism, Japan’s best days may be behind it. My Asian expedition took me to several cities in Japan via rail. The trains there are fast and efficient. The cities are clean and safe. The people are unfailingly courteous. But underneath the surface, Japan’s future is fading away.

Japan has a fertility rate of only 1.3 children per woman – drastically below the 2.1 necessary for a population to sustain itself – Japan faces the pros – pect of rapid population decline. Its demographic decline was noticeable in the proportion of seniors walking past me on the streets. The proportion of Japanese aged 65 or over is expected to reach 2 in 5 by 2060. The country’s total population could drop by as much as a third between now and then.

Against this bleak forecast, who in their right mind would consider investing in Japanese stocks? Perhaps someone who recognized the better valua – tions to be found in Japan as compared to virtually any other industrialized nation. Consider that the Japanese Nikkei index has already fallen as far from its highs and remained depressed for as long as a doomsday scenario for Japan’s demography and economy would predict.

In 1989, the Nikkei 225 peaked at nearly 39,000. Today, it wallows at levels 65% below those highs. Almost half of the companies listed in Japan trade below book value. They are being put up for less than their intrinsic value – a true fire sale.

Prime Minister Shinzo Abe has committed his government to pursuing stimulus. Meanwhile, the Bank of Japan has pledged to double the monetary base over the next two years. “Abenomics” will fail to fix what actually ails Japan’s economy. However, much like the U.S. Federal Reserve has pumped up our stock market without helping the real economy, Japan may be able to pull of f a similar feat.

If Japanese officials succeed in lifting asset prices, the risk for foreign investors is that the gains realized will be a consequence of a depreciating yen. Fortunately, there is a vehicle through which you can own Japanese stocks while limiting your currency risk: WisdomTree Japan Hedged Equity (DXJ).

I’ve become suspicious of funds that proffer to be “hedged.” Too often their hedging strategies don’t perform as expected, and they charge investors heftier expenses to boot. But DXJ’s expenses (0.48%) are actually slightly lower than those of the unhedged iShares MSCI Japan (EWJ). The two instruments have nearly identical holdings, but DXJ has slightly outperformed since its inception in 2006.

If I were going to bet big on Japanese equities using a broad country index, I’d probably own both the hedged DXJ and the unhedged EWJ. I’d be inclined to overweight toward DXJ – perhaps along the lines of a 60/40 split.

Other Asia-Focused Equity Funds to Consider

Besides index ETFs, another way to get exposure to Asian equities is through well-managed, no-load mutual funds. You can focus on solid dividend payers through some of the offerings of the Matthews family of funds (800-789-ASIA; Matthews doesn’t attempt to be a mutual fund mall like Vanguard or other leading players in the industry. Instead, it expressly focuses on Asia (including, in some of its funds, Australia). Some of the Matthews funds you might want to consider include:

  • Asia Dividend (MAPIX)
  • Asia Pacific (MPACX)
  • Asian Growth and Income (MACSX)
  • China (MCHFX)
  • China Dividend (MCDFX)
  • Japan (MJFOX)
  • Pacific Tiger (MAPTX)

Most “Asia” funds from Matthews and other mutual fund and ETF issuers are ex-Japan – they omit Japanese stocks entirely. It’s understandable since Japan isn’t an emerging Asian economy and its stock market operates on totally different fundamentals from others in the region. Also, Japan would overpower some of the smaller Asian countries in weighting in a fund that indexed by country market capitalization.

Even though shunning Japan is popular, the contrarian in me says it may no longer be wise.