I’ve been in sweltering Singapore for the past few days, but the most important news from Asia is happening 5,000 kilometres away.
I know that many of you will be expecting me to write about Japan’s earthquake, tsunami and nuclear accident. But I don’t have a great deal to say. It’s obviously an enormous tragedy. But if you want to look at it purely in financial terms – which is what MoneyWeek Asia is here for – the market reaction looks misguided.
I’m going to talk very briefly about why I think this. Then for most of this week’s issue, I want to add to a couple of other pieces I’ve written recently. Then, once this is filed, I’m on the way to Shanghai to update you from there for the next issue …
Don’t overreact to Japan
There will be handful of clear losers in Japan, including almost certainly Tepco, the Fukushima plant operator. The company has a long history of safety violations and cover-ups. I suspect that when the truth about the nuclear crisis comes out, the explanation for why it has continually escalated beyond the expectations of many nuclear specialists will not be pleasant reading.
This is very likely to damage plans for nuclear energy elsewhere. That’s a shame in many ways. I think nuclear is one of very few immediate solutions to our energy problems. But accidents like this make it very hard to argue the case.
But beyond this, the search for stockmarket winners and losers, in Japan and elsewhere, seems to be short-sighted. Just before getting on my plane, I had lunch with Andy Beal who runs the Henderson TR Pacific investment trust. He’s firmly of the view that it’s far better to wait until the dust has settled at times like this. He offered a few examples of strange decisions among the stocks he looks at.
Take the immediate buying of Korean manufacturers of DRAM (the memory in computers); Hynix Semiconductor rose 8.5% on the Monday after the quake. Hynix may get a two-three month boost in sales. But when the Japanese manufacturers are back online, they won’t have lost any market share in what is ultimately a commodity business these days.
Meanwhile, tour operator Hana Tour Service fell by 13%. About a fifth of its business comes from Koreans flying to Japan on holiday. This makes little sense: if they can’t go to Japan are they going to skip taking a holiday altogether? And will they stop going to Japan forever or just for a few months? The idea that Hana Tour’s long-term fundamental value is 13% lower after this accident is hard to believe.
One exception might be construction and engineering firms set to benefit from the rebuilding effort. But I think by now, any benefit is already well-reflected in their prices. And the idea that the rebuilding will be any kind of boost to Japan’s economy is the kind of blinkered thinking that could only occur to an economist. GDP growth may technically rise, but that that reflects weaknesses of GDP as a measure of the economy.
So in my view, we should not see this disaster as something that profoundly alters the fundamentals of the markets. Buy good stocks that seem to have been beaten down in the panic, by all means. But remember that most financial effects will probably fade faster than the headlines are telling you.
High growth markets and inflation – the lesson of the 1970s
Now, I’d like to follow up quickly on the piece I wrote last week. It was about the very different outlook for emerging markets and developed ones, and what that could mean for stocks.
Of course, we can make up any theories we want – we need some evidence they might work. And the obvious place to look is the 1970s. Back then, the US had just finished the long boom of the 1960s and was feeling the after-effects. The economy was weak and unemployment was up. All but the wealthy were feeling the pinch somewhat. Energy prices were up due to problems in the Middle East. And policymakers were so keen to stimulate the economy that they left monetary policy far too loose.
So what happened to stockmarkets? Well, we all know that the US and the UK had a miserable time. But the picture was rather different in a handful of other markets for which I can quickly find consistent data. These are; Germany, Hong Kong, Japan and Taiwan.
These weren’t all “emerging markets” in a true sense; Germany and Japan were more ‘re-emerging’ after the destruction of the war. But they were all growing and developing very quickly – and they all showed much the same trend.
Take Japan, shown below. Like every other market, it had a painful 1973-1975, when oil prices soared and inflation ran at 25%. But it finished the decade handily in the black, rising by 150%, or an average of 9.7% per year.
It was a similar story with Germany, up 105%, or 7.4% per year; Hong Kong, up 453%, or 16.7% per year; and Taiwan, up 380%, or 17% per year. It is worth mentioning that Hong Kong underwent an enormous bubble in 1972-73 of the kind it’s always been prone to. Had you bought then, you wouldn’t have finished the decade so well, as the chart below makes clear. But at other points, this was a good market to buy.
In contrast, the S&P500 gained just 31%, or 2.8% per year, over the decade (see chart below). And the FT 30 (the FTSE 100 didn’t exist back then) managed just a cumulative gain of just 6.2%, or 0.6% per year.
Obviously, the high returns in growth markets don’t translate into equally high returns after inflation. During the decade, Japan saw average inflation of 9.2%.
So share prices only just beat inflation. But that was still better than in the UK and US. They saw average inflation of 7.3% and 13.5% respectively, meaning substantial losses in real terms.
For foreigners investing in Japan, the picture was even more encouraging. The yen strengthened from 358 JPY/USD in 1971 (I can’t immediately find earlier data) to 237 JPY/USD, handing them solid currency gains. The one caveat here is that this period marked the end of the Bretton Woods arrangement. Currencies were pegged to the dollar and the dollar was pegged to gold. So the circumstances are not quite the same as today. However, even now, many emerging market currencies operate some kind of dollar peg. That’s an arrangement they may need to break to reduce imported inflation.
We can’t conclude anything definite from this. History doesn’t always repeat itself. There are differences as well as similarities between the 1970s and today. But it’s clear that assuming emerging markets were not the place to be during an inflationary shock was wrong.
Vietnam still looks cheap
After I wrote about Vietnam a few weeks ago. I had the opportunity to catch up with several local managers – Dragon Capital, PXP Asset Management and Vinacapital – who were attending an emerging markets conference in London. And the updates I got from them were cautiously encouraging.
The general view was that recent policy suggests that the government is serious about fixing its mistakes. This goes beyond moves such as higher interest rates to contain inflation – hiked again to 12% last week. New banking rules suggest that the old approach of throwing ever more credit at ever-less effective state-owned enterprises is genuinely being abandoned. Meanwhile, tough curbs on lending to “non-productive” borrowers imply that the government is rightly determined to prevent debt-financed speculation in real estate and the stock market.
The outstanding question is whether the government will stick to these plans when things start getting tough. Inflation is probably not going to come down much this year, while growth will slow. The next few months will not feel good. And after the last couple of years, policymakers have a bit of a credibility problem when it comes to doing what’s necessary to get this very promising economy back on track.
So there is no guarantee that the corner has been turned, only the possibility. But this is starting to look like a point where investors who are willing to take the risk could make a small investment in Vietnam, with a view to increasing it later if the trend is in the right direction.
Foreign investors aren’t yet flooding back into Vietnam, but interest is returning. At a Dragon Capital presentation I attended, there were probably about 50 attendees. Last year there was around a dozen, I was told. If confidence returns, there’s potential for this market to move a long way as money comes back. And on a current p/e of around nine, I think early movers are paying a fair price for that potential.
A closer look at some Vietnam funds
After my last article, a couple of readers asked me to look quickly at the options for investing in Vietnam, both via exchange-traded funds (ETFs) and managed funds. The short answer is that after an initial burst of enthusiasm when they first emerged, I’m no longer very keen on the Vietnam ETFs as a long-term investment.
In brief, there are a few problems with ETF investing in this market: its relatively small size with low liquidity; and – probably worst – the limits on foreign ownership that mean that the available shares in the most attractive stocks are already locked up by the managed funds. For a fuller article on the problems, please see this analysis I recently wrote for Index Universe.
So personally, I would stick to managed funds. The best bet is Vinacapital’s Vietnam Opportunity Fund (LON:VOF), an Aim-listed closed-end fund. This invests in a mixture of listed shares, unlisted shares, real estate and debt (see chart below).
The four largest holdings are dairy and beverages firm Vinamilk (5.3% of assets), Export-Import Bank (5.2%), Vinaland (4.8%), steelmaker Hoa Phat Group (3.2%) and chemicals firm An Giang (2.5%). Vinaland is its own real estate fund, which is separately listed on Aim (LON:VNL), alongside Vietnam Infrastructure (LON:VNI), another specialist fund from the same manager.
Overall, VOF’s portfolio looks superior to the ETFs’ portfolios. Plus the fund is currently available on an attractive discount to net asset value of 22%. The main caveat with the managed funds is that you pay relatively high fees. For example, an annual management fee of 2% and a performance fee of 20% of returns above an 8% hurdle for VOF.
There are a number of other funds out there. But most – such as Dragon Capital’s Vietnam Enterprise Investments – are aimed more at institutions and have higher minimum investment sizes. One exception worth mentioning is the PXP Vietnam Fund (LON:VNF). This has been listed in London since April last year. I’ve mentioned this fund in passing a few times since then, but this meeting was the first chance I’d had to catch up with manager Kevin Snowball for a full briefing.
The PXP fund is much smaller than VOF, with around US$50m in assets compared to US$730m. It’s infrequently traded (as the chart of the share price below shows). And it seems to be most popular with institutions rather than retail investors. The discount to net asset value is currently 8%. Lastly, it charges an annual management fee of 2% with no performance fee.
It is different in a few interesting ways to VOF. It’s purely a listed equity fund, which some investors may prefer. It’s listed on the main board of the stock exchange and so is eligible for an ISA (unlike Aim-listed funds). And it runs a pretty concentrated portfolio. Some investors like to see this as evidence that a manager focuses on a few high-conviction ideas. The top five holdings are Vinamilk (14.3%), Sacombank (11.1%), Refrigeration Electrical Equipment (6.5%), Dong Phu Rubber (4.9%) and Bin Minh Plastics (4.8%).
Within the last week, I have made a small investment in the PXP Vietnam Fund. You should not take the statement of my investment as a recommendation to buy this fund or a view that I consider it a better investment than any other Vietnam-focused fund. I consider it more suitable for my purposes than the alternatives, but for many investors, better-known and more liquid options such as the Vietnam Opportunity Fund may well be more appropriate.