After seven years of flat earnings growth, the Asian market is showing signs of life again. The Tiger economies are waking up and are on the prowl, led by a resurgent China.
Asian stocks, excluding Japan, outperformed the world in 2017 (see the chart below) and many analysts believe the region is likely to continue its growth story through 2018 and into 2019, but of course analyst forecasts are by no means a guarantee of performance.
We believe it might be a good time to invest in Asia, but the way we thought about the region in the past is not how we should think about it in the future — gone are the days when local companies supported the growth of global brands through manufacturing and production lines, only for a Western company to stamp its logo on the final product.
Most of my investment career has been looking at Asia in a particular way. Asia has historically been pretty cyclical; it’s been geared into whatever the rest of the world has been doing. So, if the world was growing quickly then Asia was growing quickly because it was making products and selling it to the rest of the world. That’s the old story – exports and outsourcing, which Asia has done very well out of. The problem, we think, is that this story is probably at an end.
Firstly, low cost labour is not low-cost anymore – especially in China, where wage growth has been quite rapid. Secondly, Asia’s market share of world-produced goods is so high they can’t gain any more market share. As of May last year, Chinese companies accounted for more than 25 per cent of the global manufacturing industry, while the country was the leading producer of 220 of the world’s 500 major industrial products.
In terms of growth, where does China go from here? Firstly, we think it may see a new kind of growth coming from within China – and Asia generally, with local brands eating into the market share of multinational companies in local markets. The next growth leg of Asia will then come from increasing the value of the goods it sells to the rest of the world.
China on the cusp of change
Historically, companies in the US have really grown over the years because they have been at the cutting edge of new technologies and new areas of growth. Asia has generally been associated with the low-cost stuff. That’s changing.
China is at the forefront of this change, and for the first time ever, we believe China will spend more on research and development (R&D) this year than the US and within five years we think it may spend more than the EU and US put together (see chart below). This is a huge shift and it’s in new areas, like electric vehicles, renewable energy, healthcare, artificial intelligence and virtual reality – things we will embrace in years to come and have the potential to become part of our day-to-day lives.
Please note that this is a forecast. Actual future government spending on research and development and the number of patents filed from these countries may differ considerably.
Our belief that China will lead Asia’s cutting-edge growth story stems from the increasing number of patents filed from the country, and across the Asian continent. Even on the manufacturing side, China is working to improve its efficiency and productivity. Of course, filing patents does not necessarily equal growth or economic success. But China is producing more robotics on an annual basis than South Korea and the US put together, and we believe the efficiency of their manufacturing over time will continue to improve.
So, what does all this mean for investors? Historically, Asian growth has been accessible for investors via Western firms selling goods into the region – think HSBC, Louis Vuitton and BMW, for example. That’s probably not the way we can look at it going forward. Local companies are targeting the market share of global brands as the quality of their goods and services improves.
Take ANTA Sports, a Chinese sportswear brand with ambitions to take on behemoths like Adidas and Nike – both at home and in international markets. The Chinese brand has been the official sponsor to the country’s Olympic teams since 2012, but started life in 1994 as a little-known manufacturer for other brands. Global market leader Nike has a larger market share in China than ANTA, but although Nike is still enjoying growth in the Chinese market, it is slower than ANTA’s, who’s market share has been consistently increasing in recent years.
Asian brands to compete globally
This is a familiar pattern developing across Asia in different sectors. The next step is to be competitive internationally. How many Chinese brands are we going to start seeing in our shops? Some of these brands already have a sizeable presence in Western markets. For example, Chinese video surveillance company Hikvision has grown to become the largest CCTV hardware provider in the world – although not many of us would recognise the name.
A more familiar brand, perhaps, is Alibaba. The e-commerce platform was founded in 1999 in Hangzhou, China, and has grown from humble beginnings to become a global enterprise worth around $480 billion at the end of 2017.
Alibaba’s success has a similar look and feel to US rival Amazon. The Seattle-based giant’s shares jumped 58 per cent in 2017 – turning founder and chief executive Jeff Bezos into the world’s richest man. The US online retailer broke its single-day sales record during the online sales holiday Cyber Monday, which saw Americans spend a total of about $6.6bn through online channels. This was dwarfed by the Chinese equivalent, which takes place on November 11th and is referred to as ‘Double Eleven’ or ‘Singles Day’.
In 2017, Alibaba generated $25.3 billion worth of sales on Singles Day (see chart above). At the peak of the event, Alipay, the online payment system created by Alibaba, was processing 256,000 transactions per second. Some 800 million parcels were delivered on the back of this. The first one was delivered within 12 minutes.
This gives you some idea of what is happening – China is embracing change, Asia too, but it is most acute in China. If people were worried about China’s spending on infrastructure – we believe that it is improved infrastructure that is facilitating this change.
Economic and political headwinds
Of course, the region’s growth is still vulnerable to economic and political risks. For most investors with interests in Asian markets, the war of words between US President Donald Trump and North Korea’s leader Kim Jong-Un will, quite rightly, have been a cause for concern. But the thawing of inter-Korean relations is a positive story for investors in Asia. North Korea’s most likely act of war would probably be to hit the South Korean capital of Seoul, but in light of the two countries’ cooperation during the 2018 Winter Olympics in Seoul – and the North Korean leader’s visit to the South’s capital this month – we are taking some encouragement that the situation is improving.
Another major risk to the growth ambitions of local Asian companies is the protectionist strategy outlined by Trump during his presidential campaign. One of Trump’s first major acts in the White House was to withdraw the US’ signature from the Trans-Pacific Partnership – a multi-lateral trade agreement between 11 countries. Since then, however, the former TV reality star has not delivered on a number of promises, and his speech at the World Economic Forum’s meeting in Davos in January carried a much more conciliatory tone.
Nevertheless, Trump’s recent proposal to impose a 25 per cent tariff on steel imports and a 10 per cent tariff on aluminium imports might cause some nervousness for investors. From China’s perspective, however, exports have become less and less important to the national economy, dropping as a percentage of the country’s GDP from 37 per cent to 19.6 per cent in the 10 years between 2006 and 2016.
In our view, we think this all points towards sustained growth in Asia, and that local companies will facilitate this growth, rather than Western brands selling goods into Asia. We believe there is significant earnings growth potential for local Asian brands and we hope this will be matched by dividends growth.
Mike Kerley is fund manager of Henderson Far East Income and director of Pan Asian equities at Janus Henderson Investors.
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