China the New Leader in Asian Stock Markets

By: David_Urban

Historically Asian markets tended to follow Japan as Japanese equities provided regional leadership over other developed markets such as Hong Kong, and South Korea. However, in the coming market cycle Japan may find itself replaced by the Chinese markets as the Chinese economy begins to recover from the global slowdown.

Currently, Japanese equities offer attractive valuations; selling for a significant discount to the S&P500, a competitive dividend yield, and slightly higher ROE. However, demographic, political, and cultural changes within China may cause investors to reassess the stock market leadership of Japan.

Income and spending growth has slowed to a snail’s pace in Japan while the economy continues to fight the effects of deflation. As this looks to continue for the foreseeable future, it appears as though Japan will have difficulties rising out of the malaise which has plagued the economy and stock market for almost two decades. Slow economic growth at home and abroad will put a damper on efforts to increase personal incomes and retail sales.

As Japanese investors continue to focus on savings rather than spending in an uncertain economic climate it becomes difficult for the consumer to provide a solid base for the economy. Without a strong consumer presence, the role of leadership within the economy falls upon the shoulders of government and businesses. Slow economic growth will cause businesses to retrench in order to ride out the storm leaving the government as the final leg to keep the economy going.

In contrast, the Chinese economy registered 9% growth in the 3rd quarter of 2008. Personal income and retail sales also registered strong year over year gains. It is not to say that China will contract the ‘Olympic disease’ of slower growth in the years following the Olympics but even if growth contracts to the 5% range it will be strong compared to the US and other developed regions.

With the global economic slowdown trickling down to the Chinese economy, the government has responded aggressively by lowering interest rates, cutting a 28% tax on exports, and adding almost $600 billion dollars in new spending through 2010 in an effort to keep the economy afloat.

The Chinese will be able to fund the stimulus plan from foreign exchange reserves (country savings) rather than the US plan of funding the program through the issuance of debt. This makes the Chinese plan less inflationary than the US plan.

On the bright side, inflation has slowed to 4.6 percent while urban disposable income rose by 14.7 percent in the first nine months and rural incomes rose by 19.6 percent. Next year should see a slowdown in both income and spending growth while inflation continues to fall.

An important point that people are missing with respect to the Chinese economy is the construction of GDP. During the first half, consumption contributed 50.2 percent of economic growth while investment contributed 44.9 and exports 4.9 percent. Last year, exports contributed just 21.5 percent of economic growth. As the Chinese economy grows and matures the consumer is taking a larger and larger role in the economy while exports are decreasing. This will help to soften the dropoff in exports during the coming year.

People in the US think of the Chinese economy as being primarily export based but they do not realize that the retail sales market trails only the United States in size.

As export growth slows and the Chinese consumer contributes a greater share to economic growth allowing China to become more self-sufficient and less export driven in contrast to Japan where slow consumer demand and wage growth is combined with a slowdown in export growth.

The recent agreement with Taiwan will increase economic ties and help bring down trade barriers within the region. While the press obsesses on political issues relating to China and Taiwan, economic measures have moved both sides closer together. Where political differences lie, economic agreements and growth will help soften hard feelings built up over time.

For a number of years, Taiwanese businesses have been hamstrung by capital controls and the stock markets have been unjustly penalized with low PE ratios in general. This should change in the coming years.

When the market turns positive it would be wise for investors to look to China as the leader instead of Japan. A number of Chinese ETF’s and other investment vehicles currently exist and would be well positioned to capitalize on the future leadership of China in the Asian markets. These funds should benefit from a confluence of factors to follow on the coattails as China leads the Asian markets in the next business cycle.

By David Urban

http://blog.myspace.com/global112

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