Bargains?
Opportunities in Asia
A lot of the excitement in investment markets at the moment is centred around two very different stories in Asia. China, wrestling a monster property bubble, plays host to some very ‘cheap’ assets. Meanwhile, in Japan three decades of relative torpor following a property bust of their own, could be ending. This week we explore both opportunities for investors. (Figure 1)
China
The deflating residential property is still the elephant in the room here. The sector that was both beneficiary and enabler of much of China’s success in the last few decades is now a giant and threatening burden. China’s policy makers have so far opted for more surgical interventions, lots of thumbs jammed in multiplying leaks as such.
The tight rope walk still ahead for policy makers is complicated further by the fact that the supply of workers is slowing sharply, thanks to an ageing population and rising dependency ratio. The measured productivity of those workers is also decelerating. Meanwhile the returns on capital are low and investment to gross domestic product (GDP) ratios already suggest the economy is replete.[1] Meanwhile, some point to high youth unemployment as a sign that the adjustment pains are just beginning.[2]
How to escape…
The only perceived route on to the next stage of development would appear to be another surge in productivity growth. The agricultural revolution of the early 1980s saw land returned to farmers from the state. Freed from centralised decisions on what to grow and how to grow it, agricultural productivity soared. This in turn freed up farm workers to migrate to ultimately better paid, more productive jobs in the various cities springing up. That there were such jobs was a function of liberalised trade zones and increased presence from foreign firms looking for (relatively) cheap workers among other pro-market reforms.
This story is not quite finished admittedly. There are more gains that could be squeezed by allowing more flexibility in the social safety net for example. Many of those urban migrants are still not recognised as such under the Hukou system.[3] Educational and other outcomes are often inferior as a result. Meanwhile, there is still a surplus of workers engaged in agriculture if you take comparable developed world percentages.
History lesson
Nonetheless, the message from economic history (I know, I know) is reasonably clear here. Many societies and countries have managed the trick of one (sometimes long) surge in economic growth. Urbanisation and industrialisation are generally important struts. However, the trick of repeating it is much more difficult. Part of this is how, as a country, you manage the inevitable losers from technological change, so that all may ultimately win. It is a necessarily delicate and difficult social contract to strike and maintain. Individual freedoms have been one way to soften these blows in prior country success stories.
So far China’s development has generated many more winners than losers. However, if past is prologue, the next bit of development can be a bit more balanced between short-term losers and winners, again making for a more challenging path ahead.
There is potentially more here as well. A recent detailed study of the history of technological change and growth in China points to several fascinating conclusions. There would appear to be some relationship between inventiveness and ideological and political diversity over time.[4]
This joins the ranks of other attempts to explain why wasn’t it China that led the world out of the morass of thousands of years of stagnation? Why was it North-western Europe in the 18th and 19th centuries that soared, so providing a template for others to follow? Meanwhile (ish), China was slumping, moving from one of the world’s most sophisticated and advanced economies to being one of its poorest by the 18th and 19th centuries. The so called ‘century of humiliation’ represents to many the nadir of that multi century decline.[5]
As we’ve pointed out before, for much of the medieval period, North-western Europe looked to be an unpromising, even barbaric, corner of the world. Particularly the case when set against the sophistication of China at the time. The big four inventions often thought to be at the centre of Europe’s ultimate ascent (Printing press, gunpowder, compass, and clock) were actually invented in China centuries earlier.
That these Chinese technological breakthroughs sprung from a period of greater religious and political freedom matches up to perceived essential ingredients in North-western Europe’s take off – burgeoning individual freedoms, public debate, and a degree of permitted iconoclasm.[6]
But…
Now this of course is a very western centric view. Perhaps we simply want individual freedoms to matter, so we look harder for causal evidence for its role in productivity growth in history? Or more simply, perhaps it mattered in the past, but won’t so much in the future. China after all can bring formidable powers of cohesion to its production and construction process. For those in doubt, see the rapid emergence of a high-quality, high-speed rail network or her rise to the top of many green technologies, such as solar power and electric vehicles.[7]
The response from the developed world
The plot thickens further when we look at how ‘western’ policy makers seem to be learning certain lessons from China’s incredible ascent of the last few decades. The return of industrial policy, admittedly puny in scale relative to anything China has undertaken, represents a potential vital shift in thought and deed.
The major legislative successes of President Biden’s first term owe much to a bipartisan desire to regain some perceived lost ground to China. There is a growing sense that it’s working too. Part of the aim of these legislative acts was to bring slugs of strategically important production back to the US. Factory construction spending more than doubled in one year after being more or less unmoved for decades. This splurge is happening in all areas but the northeast.
Japan
The career graveyard is filled with investors who confidently predicted Japan’s return to the fore over the last three decades. The popping of a giant property bubble in the late 80s has been followed by prolonged stagnation. Monetary and fiscal defibrillators of varying shapes and sizes have all been tried, albeit a little schizophrenically.[8] Perhaps the pandemic forcing both fiscal and monetary forces to act in tandem is significant.
For investors, the story has long been surrounded the question of Japanese companies’ lower trend in profitability relative to much of the developed world. Low valuations increasingly suggested that this lower trend would persist, but what if it didn’t? What if Japanese companies somehow managed to raise their profitability to levels seen in the US (even sector adjusted)? The result would be mouth-watering investment returns and hero status (as an investor!). (Figure 2)
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The role of history…
The history of the corporate sector in Japan is perhaps instructive in understanding some of the causes of this lower level of profitability and why boosting it has long been easier said than done. Japanese chief executives and owners have long focused on stability and market share over the traditional American model of maximum profitability being the first, and in some eyes only, responsibility of management.[9] (Figure 3)
At least some of this stark difference in corporate attitudes has its roots in the very different ownership structures of Japanese corporations relative to their US peers. In Japan, the family-controlled groups (Zaibatsu) such as Mitsubishi that dominated the late 19th century and early 20th century Japanese business landscape evolved to provide themselves with advantages such as stable supplier relationships.
So, Mitsubishi, originally founded as a shipping firm in 1870, also had controlling interests in coal mining (to provide the coal needed for ships), shipbuilding, steel mills, marine insurance and so on. The Zaibatsu fell victim to the enforced economic liberalisation during General MacArthur’s post-second World War occupation administration. The family owners were removed, and the groups split up in an attempt to move Japan closer to the US economic model of dispersed shareholder ownership and a more competitive, and therefore less settled, corporate backdrop.
However, in the years following occupation, these same corporate groups quietly reassembled under a different name – Keiretsu, which exhibited many of the same characteristics. Interestingly enough, there have been times in the post-war period when many academics and business leaders have gazed longingly at such Keiretsu structures and wondered whether the US corporate sector should not try and emulate Japan’s. Nonetheless, this stability that corporate Japan has tried so persistently to embed within its culture has some obvious ramifications.
First, it created one of the least flexible labour markets in the world, which is surely at least part of the cause for the persistent wage deflation, one of the symptoms of the country’s economic stagnation. The second point concerns the theory that bad companies need to fail so that the capital they monopolised might be allocated to more productive, better companies. This remains one of the hallmarks of the US corporate sector and key to understanding that very different trend in profitability.
And to today
There are fascinating signs emerging that real change is afoot.[10] As described above, the microeconomic barriers to a step change to US levels of profitability are possibly larger than realised. However, the prize for investors is mouth-watering even if some structural change to the degree of shareholder focus can be effected.
Investment conclusion
The world of investments is regularly reduced to the story of seven, admittedly magnificent, companies that bestride the US market. From Amazon to Alphabet to Nvidia, very little else seems to matter. However, in Asia there are two key stories playing out that should have the value hounds out there drooling.
Our multi-asset class funds and portfolios deliberately keep some carefully tailored exposure to both of these very different stories. The point being that we should stay humble about which, if either, comes off in the years ahead.
If we had a hunch, it would be that Japan looks the more immediate opportunity. For China, the policy measures still seem short of what is needed to restore the confidence of investors (domestic and international) more durably. The US experience of subprime is perhaps indicative.
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[3] A hukou (household registration) is an official document issued by the Chinese government to Chinese citizens. Hukou registration indicates the particular area a person is from, and entitles the registrant to certain benefits in that area; for example, hospitals, schools, or land-purchasing rights
[4] Huang, Yasheng (2023) – The rise and fall of the EAST – How Exams, Autocracy, Stability and Technology brought China success and why they might lead to its decline – Yale University Press
[5] Lovell, Julia (2012) – The Opium War – Picador
[6] Mokyr, Joel (2016) – A culture of growth – the origins of the modern economy – Princeton University press. (Chapters 16 and 17)
Advisor to a Web3 Fintech, an Impact VC, a Hedge Fund, a Zero Emissions Shipbuilder, an AgroFoodTech, a Token Valuation platform & an Endowment. Ranked #3 Most Influential Service Provider to the Investment Space, 2023.
10moDoesn’t the almost unimaginably protracted nature of Japan’s recovery, William Hobbs, beg questions about the value of the policy response to its issues (what could have been done differently?) and about how long China may take to recover from its problems?