South-east Asia: The ‘it’ economies

In the larger global context, it may seem that to an extent this middle ground is something that is sometimes overlooked, says Philip Poole, global head of Macro Investment Strategy, HSBC Global Asset Management. The numbers, though, tell a different story, he says.

“The valuations don’t suggest that they are markets that have been overlooked in the last year or so, because the markets are largely fully valued,” says Poole.

Although geographically, and to some extent culturally, in the same grouping, the MIT states are very different in many ways. Indonesia was long held back by political instability which was a big overhang for the market. The country has now been going through what’s arguably a rewriting phase.

“I think what we’ve seen really is a little consistency now in terms of economic policy, because we’ve had political consistency,” says Poole. “That’s a big change in that respect.”

Thailand, of course, is different. There’s been a lot of volatility in Thailand in the recent past, and its political issues are far from fully resolved. The interesting thing, however, is that despite political uncertainty, the markets have been quite resilient. “It hasn’t really impacted the market as much as perhaps one would have expected given the events that we’ve seen over the last two years, not even just the recent one,” says Poole.

Malaysia, the third bit of MIT, is a relatively small economy. Here’s an economy which often doesn’t get attention but has been growing steadily on the back of exports and commodity, particularly agricultural commodities like palm oil.

How do these economies thrive despite being repeatedly buffeted by crippling internal conditions and global crises? The short answer is the reasonable debt to GDP ratios, says Poole. “What that type of development highlights is that the debt metrics and indeed the public sector finances, in many emerging markets, look a lot better than they do in large parts of the developed world.”

The gross debt to GDP ratios in Malaysia, Indonesia and Thailand are about 40%, 60% and 50%, respectively. These are not heavily indebted countries in the way somewhere like Greece, Italy or Japan, which are dealing with debt to GDP ratios that are close to 200%.

There is another reason why growth rates in these economies is doing well, particularly in Malaysia. Mark Mobius, executive chair of Templeton Emerging Markets Group, says it is the improved ties with the neighbouring Singapore, a country battling the growing cost of labour.

“(Malaysia’s) relations with Singapore are getting better, which is another good sign, because there’s a lot of synergy between Singapore and Malaysia,” says Mobius. “Given the fact that labour rates (in Singapore) have gone up to very high levels, they can’t really do the kind of high labour content manufacturing that Malaysia can do.”

Cheap labour and low production costs contribute significantly, but there are other forces at work, too. “In the case of Thailand it would be the banks profiting, and oil and gas, says Mobius. “In the case of Malaysia it would be plantations, banks, and some manufacturing.”

Banks and automobile manufacturing are driving the Indonesian market with some of the consumer oriented retail companies lending further support, he says.

Then there is the generic economic factor that is the common theme across all the emerging markets: domestic consumption. “One of the themes that run right through the emerging markets, and I would include all of these economies in that, is the domestic consumption theme.”

There seems to be underway a rebalancing process where the relative importance of the developed world will decline and the relative importance of the emerging world will be increasing. “We’ll see a shift in global consumption towards countries in the emerging world where the demographics are positive,” says Poole.

These countries have a decent sized, in the case of Indonesia a large, young population whose rapidly growing income levels are fuelling and supporting consumption like never before. “There’s a need and a perceived requirement on the policy makers to support that consumption process, in an environment where the external demand from the developed world will be constrained by a need for deleveraging over time,” says Poole.

Foreign investors may find sectors such as staples and consumer discretionaries particularly interesting components of the consumption story. Commodity exports is another aspect important in the Malaysian context, given its role in the overall economy.

It plays an even bigger role in the economic scheme of things in Indonesia and Thailand. “There’s quite an interesting commodity export story here from places like Indonesia, (a country that) has ties into the rest of Asia, through China and into Japan, and it’s an exporter of a number of commodities,” says Poole. “The domestic consumption story is something that we think is very compelling in the median term in the emerging market context.”

Poole uses very opportunity to highlight the thematic perspective that domestic consumption and commodities provide. He holds up China as an example for the organization process supporting consumption and likens it to Indonesia. “The only economy of any size that I can think of which has urbanized more rapidly than China since the early 90s is Indonesia.”

The MIT prospectuses abound in attractive features, but make no mistake, they are not without cautionary notes and it’s in investors’ best interest to examine the small print.

Governance, inflation, liquidity, susceptibility to external events blows and, by one account, the fear of double dip recession in the U.S., there are all the usual flies in the ointment applicable to all investment objectives.

“As you know there’s been pretty much a bull market, and some of the stocks could get too expensive, and therefore risk would go up,” says Mobius who’s not overly concerned about political and currency risks in those markets. “They’ve all been pretty smart in allowing adjustments in the currency rates.”

Inflation is a generic emerging market risk, and, therefore, applies to these economies. “What tends to happen in emerging markets (including these countries) is that the CPI baskets reflect, in large measure, food and fuel,” says Poole. “Higher food and energy prices reflect quickly into inflation in emerging markets, much more so than it does in the developed world.”

Poole asserts these markets, relative to their trading history, look pretty fully priced. In other words, they are not cheap. “Asia, of the regional blocks in the emerging world from an equity point of view, looks expensive.”

These are not the most liquid markets in the world either. Emerging markets tend to be less liquid than the developed markets. Investors need to bear in mind that these markets don’t have the kind of liquidity they can get in China or India.

What also must be considered is that the geographic dispersion and diversification of these countries doesn’t guarantee diversification in terms of performance. “A lot of people think that if they spread their debts across different emerging markets then they’ll get some kind of diversification benefits,” says Poole. “But the way that markets trade, and have traded in the last couple of years, suggest that when there’s a global event, then markets tend to move in sync.”

In short, the diversification benefits that investors may think they’re buying into tend to disappear when markets get really stressed.

From the domestic perspective, there also political risks to worry about. Indonesia has been a lot more stable, and investors are pricing that in now, but that can change.

Thailand clearly remains vulnerable to political instability as there’s still a lot of underlying political tension. British singer Murray Head might as well be talking about current investor risks when he referred to Bangkok as the place where the tough guys tumble.

But that was 1984, and this is 2010. If investors look at the emerging markets as an integral part of global diversification in their portfolio then they can put a comfortable gap between despair and ecstasy.

(09/20/10)