Domestic demand and intra-regional trade to drive Asia Pacific markets

Growth in intra-regional trade and the rise of middle income consumers will drive returns in Asia Pacific markets during the Chinese Year of the Pig, according to Jupiter’s Asian team.

Economies in the Pacific Rim, including China, Singapore and Japan, have traditionally relied on exports to the West for their growth. However, this relationship is diminishing, with much of the recent growth in these economies being driven by domestic demand. Intra-regional trade is also playing a key role in severing the historical reliance on the West and now accounts for around 55% of total trade in the region, compared with 43% in 1990.

Philip Ehrmann, manager of the Jupiter Asian and Jupiter China funds, said: “The Asia Pacific region has changed markedly during the past 30 years, with economic growth driven by not just one engine but several, including Japan, the ‘Asian Tigers’ of dynamic markets such as Malaysia and Singapore and, more recently, the emergence of the new economic powerhouses of India and China.

“Asia’s GDP is now approaching 30% of world GDP – double the figure for 1960 – and we expect this growth to gather pace. While some economies in the region, such as Taiwan, remain dependent on exports, economies in the region will increasingly rely on regional trade and the rise of middle income consumers.

“I am playing these themes in both the Jupiter China and Jupiter Asian funds as I believe that while a slowdown in the US economy will affect those economies still overly dependent on exports, the impact will not be as great as it would have been in the past.”

The £40m Jupiter Asian Fund is currently favouring China, Singapore and Malaysia, with a focus on consumption plays and property stocks in Hong Kong and Singapore. The consumer also remains an area of focus in the £60m Jupiter China Fund, which is 1st in its sector in the three months since its launch, although Philip has also increased exposure to transport infrastructure stocks, an area that stands to benefit from significant investment over the next few years.

Philip says: “China had an amazing run in 2006, with the MSCI Zhong Hua index rising more than 45%. These gains were fuelled by a variety of factors but above all, it was the ongoing process of reform that drove markets higher. In particular, the huge state-controlled overhang in the ‘A’ share market started to unwind via a number of IPOs, at a time of plentiful liquidity. The economic backdrop remained supportive as well. The trade surplus grew to a new record (in spite of a 6.2% devaluation in the renminbi since the dollar peg was dropped in July 2005) while GDP grew by over 10% again over the year.

“The government remained vigilant in its efforts to calm down excessive investment and new lending through a variety of measures including increasing bank reserve ratios and interest rates to tighter control of planning applications.

“Despite China’s strong gains, there is potential for another strong performance in 2007, although, it would not come as a surprise if we saw a short term correction at some point in the coming months. We are finding plenty of value among mid and small caps and believe further progress will be driven primarily by earnings growth, which is likely to be in the region of 20%-30% this year for many of the companies we hold.

“Chinese businesses should also benefit from continuing reforms, such as the forthcoming tax unification plan announced by the government. We would expect a greater focus to emerge on maximising earnings in the years to come as a result.”

The performance of the Japanese stock market in 2006 stood in sharp contrast to China. Despite a continued improvement in economic fundamentals and company earnings in Japan, the Topix index rose just 1.9% over the year*, with redemptions from leveraged investors such as hedge funds, depressing the stock market. Yen weakness added to the gloom for sterling investors, pushing the index into negative territory

Simon Somerville, manager of the £116m Jupiter Japan Income Fund, said: “The Jupiter Japan Income Fund outperformed its peers and the benchmark in 2006 but it is still disappointing that the market performed so poorly last year.

“Valuations are certainly attractive now and the economy looks in reasonable shape and companies I visited in Japan last week are positive on the outlook, so I would expect corporate earnings to beat consensus estimates. Perhaps the most important news, that highlights the recovery of Japan, is that Sumitomo Mitsui Bank is said to be increasing graduate pay by 18% - the first increase in 14 years! Consumption data has been disappointing recently but signs of better wage settlements should benefit consumer sentiment. Another positive is M& A activity, which although concentrated in the smaller companies sector, is spreading up to mid caps.

“Overall, I would expect a much better year from Japanese equities in 2007 and while the weak yen may continue to dampen returns, it does help profit growth and the overall competitiveness of the economy. Like other parts of Asia, the economy is benefiting from intra-regional trade and my portfolio is positioned to benefit from this. In terms of allocation, we are currently favouring areas such as real estate and the retail sector, while remaining particularly underweight in areas such as autos and financials.”