Why Asian stocks can rally further

Why Asian stocks can rally further
All signs point to the possibility of continued growth for several years


By MARSHALL GITTLER

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WITH several Asian stock markets hitting record highs, investors are once again worried about whether the rally can continue and whether prices can rise further.




Today I would like to discuss this question in general, rather than looking at the prospects for individual markets, and explain why I think the answer to both questions is a resounding yes. Of course, that doesn't mean that markets will potentially be up every day or even every month from now on, but I believe that it is still early days for the rally.

The first point to remember is that the price of a stock isn't how you should judge whether it is 'expensive'. Stock prices are a function of the future earnings of the company, and if the prospects are for record earnings, it's only reasonable that prices should be at a record too. In that respect, the P/E ratios of Asian markets are currently higher than they have been recently, but not at record highs by any means.

Secondly, there's no reason why yesterday has to rule today. Asia nowadays is very different from the Asia of even a few years ago. It wasn't so long ago that Koreans were lining up to donate their gold teeth to the government to stave off an international financial crisis. Now the country has US$290 billion in reserves (nine months' worth of imports). More broadly, we are just in the beginning of the Third Industrial Revolution.

The First Industrial Revolution was, of course, when the focus of the economy moved from agriculture to manufacturing. In the Second Industrial Revolution, workers shifted from manufacturing to services. Now the outsourcing revolution that is bringing China and India into the world economy is just taking off and looks likely to be every bit as big as the first two revolutions with regard to its impact on the global economy.

Just one example: Massachusetts Institute of Technology (MIT) is in the process of putting videos of most of its courses onto the Web and making them available for free (ocw.mit.edu).

Someone in Taiwan is translating them into Chinese, also for free. Soon anyone with a broadband PC connection in a village in India or China will be able to get an MIT education.

What will that do to the concept of 'comparative advantage'? Asia is at the centre of this Third Industrial Revolution, with India taking the lead in services and China in manufacturing, while the other Asian countries are linking themselves into the supply chain for these two. It's only natural that markets in this part of the world should be booming.

Along with this revolution, we are seeing the largest migration in human history as some 20 million Chinese a year move from rural areas to the cities. As they move, their productivity rises and their wealth does too, increasing aggregate demand.

Same for India. Those who are left in the rural areas are benefiting from higher crop prices and improved communications, which redresses the balance of power between farmers and the middlemen.

The result is more productive and affluent societies that can grow at a faster pace. On top of which, the infrastructure to accommodate that growth makes for a major long-term investment cycle.

The demographics are with Asia. This is another reason why we think that Asian markets will theoretically outperform the major developed markets over the next several years. We note that most Asian countries, with the notable exception of Japan, have declining dependency ratios (i.e., workers have fewer dependants to support), which allows these economies to save more, invest more, and thereby grow faster.

In particular, if we look at the ratio of middle-aged people in these countries (those who are most concerned with saving for retirement) to young people (who are busy buying consumer goods), then Asian countries are very well placed, much better so than the US. This ratio has a good correlation over the long term with stock market performance, as this demographic cohort tends to invest a lot in stocks.

These are long-term themes that are likely to play out over the next five years. Naturally, they don't generally guarantee the market will go up tomorrow or over the next month.

But what they do show is that in our view, the rally in Asian markets is not a bubble. It is a reflection of the fact that the last five years have seen the fastest global growth of any five-year period in history, and the likelihood is that this growth will continue for the next several years - with Asia at its epicentre.

The writer is chief Asian strategist, private wealth management, Deutsche Bank