Asia Awakes

It seems as if everyone is talking about investment opportunities in Asia these days. China, people say, is the new "workshop of the world." You can almost hear the machines grinding out increasingly sophisticated products, all neatly stamped "Made in China." India, you may have heard, has become a world leader in the service industry. That helpful customer service rep you just called up might easily have been talking to you from an office in one of India's fastgrowing high-tech centres.

Vietnam, Pakistan, Singapore, Thailand, the Philippines – all of these economies, plus China's and India's, are growing more quickly than those of most Western nations. The catch is that some of them are starting from a very small base, and that each one is an emerging (not developed) economy. Both of these factors mean that investments in their stock markets may be more volatile in the short term. So what do you need to know about Asia to make informed decisions for your own portfolio?

Well, first you should have a sense of the scale of development halfway around the world. Asian economies are powered by the combined energies of billions of people – 2.3 billion in China and India alone, and an overall Asian population the United Nations expects to rise to 5.2 billion by 2050. All of that creativity, ingenuity and ambition concentrated in one geographical area is propelling gross domestic product (GDP) growth. In response, Asia is attracting a greater share of the world's foreign direct investment. For example, Canada'sforeign direct investment in Asia was just $1.6 billion Cdn in 1980, but more than $32 billion Cdn by 2004¹. Investments by individuals and companies in developed countries are helping to fuel further economic growth in this part of the world.

At the same time, many Asian countries are starting to recognize the value of well-regulated stock markets and improved corporate governance. Governments are reforming their systems and company managements are focusing more on shareholder value, which strengthens profitability and boosts dividends. There will be ups and downs in the performance of the emerging economies of Asia – and not all Asian countries are sharing equally in the region's growth. However, this may be the ideal time to talk to your financial advisor about the potential rewards of diversifying your portfolio by allocating a portion of it to Asia. Let's look more closely at two of the most exciting – and distinctly different – Asian investment opportunities: China and Japan.

Gross Domestic Product (GDP) for 2005 (Estimated)  

Selected Asian Countries

China	9.2 %
Pakistan	8.4 %
Vietnam	7.6%
India	7.1%
Japan	2.1%

Selected Western Countries

United States	3.5%
Canada	2.8%
United Kingdom	1.8%
France	1.5%
Germany	0.8%

 
Source: Central Intelligence Agency, The World Factbook 2005

China is the hungry dragon
Imagine the United States at the beginning of the 20th century and you can get a good sense of what China is today. Farmers are packing up by the millions and leaving the land to move to big urban centres. They are attracted by the hope of better jobs with better pay in the factories, and the lucky ones are joining a new middle class. It remains to be seen whether China will follow in the footsteps of the U.S. to become a global superpower. But there's no question this vast Asian country has great potential.

Already, the Chinese middle class is 256 million people strong, not much smaller than the entire population of the United States. And the nouveau riche are flexing their consumer muscles. All kinds of luxury goods are flying off the shelves: cell phone subscribers' numbers swelled to an estimated 365 million in 2005 from 85 million in 2000; and car sales rose to an estimated 6.7 million in 2005 from 2.1 million in 2002.²

Meanwhile, resources such as oil, copper, nickel and aluminum are in great demand to power the unstoppable factories, produce high-quality manufactured goods and build the infrastructure necessary to house and transport the new city dwellers. Agriculture is fading into the background, contributing just 14.4 per cent to the country's GDP, while industry, construction and services take centre stage.³

Intellectual capital is becoming a valued national resource as well – not too surprising for a country with a proud history of inventing innovative technologies, from the compass to the wheelbarrow. China has been steadily increasing its investment in research and development, according to a United Nations report released in January 2006.⁴ Within five years, the country's universities will be graduating more PhDs than the United States.

China is also beginning to open up to the world. It joined the World Trade Organization in 2001 and is allowing capitalist markets to thrive and develop in Hong Kong and on the mainland. And Chinese companies are looking abroad for expansion opportunities. As just one example, Chinese-owned Lenovo Group acquired IBM's Personal Computing Division in May 2005, leapfrogging over the competition to become the third largest PC company in the world.

At the same time, China is attracting financing from foreign companies. More than 400 of the world's top 500 multinational corporations have invested in China, sensing its great potential. Dozens of them, including household names like UPS and Hewlett-Packard, have set up regional bases there.

Exceptional GDP growth, combined with expanding global trade, could make China the world's largest economy by 2045, according to Goldman Sachs. Even sooner than that, by 2010, the Organisation for Economic Co-operation and Development forecasts that China will be the world's biggest exporter.⁵

Of course, the future isn't completely rosy for China. Obstacles to the country's continued growth include thegovernment's tight control over the population, serious concerns about uncontrolled air and water pollution, and growing protests by people who feel they have been left behind in the rush to modernize and industrialize the nation. Nevertheless, this is a part of the world that most investors cannot afford to ignore.

The sun rises again on Japan
Japan has a very different story. It has been an economic giant for decades and its annual GDP approaching $4.4 trillion Cdn is topped only by the United States, the European Union and China. The Tokyo Stock Exchange is the world's second largest, with market capitalization of about $5.2 billion Cdn and a 2005 index return of 44 per cent. And the country's cutting-edge automotive and electronics industries are the envy of the world. Companies like Toyota, Mitsubishi, Honda and Sony came out of Japan and made their mark on the world.

However, the past 15 years have been hard on the land of the rising sun with next to no growth, high unemployment, low domestic consumption and deflation. It's been a long struggle but, thanks to a mix of reform and restructuring, the worst appears to be over. Today, all signs indicate that the Japanese economy is rebounding.

For one thing, companies have improved their profitability. Operating profit margins are now at about five per cent and climbing, while earnings growth has averaged 10 per cent in the last couple of years. Better profits are allowing companies to reinvest in their businesses, pay out dividends to investors (up 23 per cent in fiscal 2004 over the previous year), hire more people and increase salaries.

Unemployment is declining across the country and the number of permanent, salaried employees is going up. That's having a powerful effect on domestic consumption because now that they have more disposable income, employees are spending more and consumer confidence is on the upswing.

The property market is also starting to lift, with housing starts experiencing three straight years of growth – an important indicator since the collapse in real estate prices was one of the triggers of Japan's economic downturn.

At the same time, the government is supporting this positive momentum with a program of reform. Prime Minister Junichiro Koizumi has made it clear that he is committed to improving the banking system, introducing flexibility to the old system of "employment for life," and privatizing the postal savings system where millions of Japanese hold their savings. These reforms will continue to pay dividends for many years to come.

As a result of these positive developments, in September 2005, the International Monetary Fund increased its real GDP growth projection for Japan to two per cent for 2005 and 2006, and described conditions there as "a strong rebound."6 Now, both domestic and foreign investors are returning to the Japanese market to participate in its potential for long-term growth.

They are attracted to the likelihood of a domestic consumption boom, as Japan's 127 million citizens take advantage of lower unemployment and higher salaries to indulge their passion for everything from high-status cars and sophisticated electronics to designer clothing. There is also the possibility of tremendous economic expansion as the Japanese become more comfortable with credit and relax their strict attitudes towards saving. And remember that Japan is on China's doorstep, well-positioned to benefit from that country's expected strong growth for many years to come.

The risks Japan will have to overcome in the long term include significant government debt and an aging population. However, investors should consider the promise of a mature, developed economy that just happens to be in Asia – the epicentre of tomorrow's economic growth.

Investing in Asia depends very much on personal investment objectives. Talk to your financial advisor first, and remember that the most effective way to invest in that part of the world is through a diversified mutual fund managed by experts with on-the-ground expertise.

¹ Statistics Canada, May 2005.
² OECD / China Industrial Linkages: Trends and Implications. Directorate for Science, Technology and Industry. Ministry of Information Industry, China. China Automotive Technology and Research Center, April 5, 2002.
³ Central Intelligence Agency, The World Factbook 2005.
⁴ UNESCO, 2005 Science Report.
⁵ OECD, based on the report "Did You Know – OECD Economic Survey of China," September 16, 2005.
⁶ International Monetary Fund, World Economic Outlook: Building Institutions, September 2005, chapter 1, p. 30.