It’s tough for investors to find decent economic growth in the world.
The American economy hasn’t grown by more than 3% since 2005, the longest stretch of weak growth going back to 1930.
The latest labor survey shows that the economy only produced 38,000 jobs in May, the fewest since September 2010.
And Europe’s record and prospects are even worse.
Once the bright star, Asia and other emerging markets as an investment destination have lost considerable momentum over the last few years. The massive markets of Japan and China are slowing while smaller, more nimble, and more dynamic markets are surging beyond the radar of even the most sophisticated investors.
While the Shanghai Index is down a whopping 45% during the last year, Hong Kong has given up 27%, Singapore is down 18%, and even Japan has lost 11%.
Today, let’s first take a look at Asia’s two big economies to discover why these trends may be enduring, as well as why your investing approach to Asia has to adapt to a changing competitive landscape. Then tomorrow, I’ll tell you where in the world you can find 6% to 8% annual growth.
Japan’s Graying, No-Growth Economy
For Japan, we really need to go back almost three decades, to when its real estate and stock market bubble burst.
In the early 1980s, I went to Tokyo as an exchange student out of curiosity and an eagerness to learn the keys to Japan’s tremendous economic achievements.
What I learned is that Japan’s success was due to a combination of cultural factors that fostered great cooperation and national effort together with economic fundamentals: a cheap currency, steady increases in productivity and investment, a protected home market, and always putting exports over consumption.
But complacency leads to the mighty being humbled. As Japan approached the bubble bursting in 1989, the new generation wanted – and was getting – consumption.
Speculation and financial engineering were crowding out capital investment, international pressure was pushing up the value of the yen, and overconfidence and complacency led to bank lending practices being greatly relaxed.
But it’s surprising that, since the early 1990s, Japan hasn’t been able to get economic growth back on track.
There are a number of reasons for this:
- The hunger that drove postwar Japan just isn’t there anymore.
- Demographic headwinds are getting stiffer. The average age in Japan is 46 years (almost 20 years more than in Indonesia), and among Japan’s farmers, the average age is an astounding 70 years.
- China’s rapid rise was eating away at what was left of Japan’s competitive advantages.
Japan has suffered through several lost decades, zombie banks, anemic growth, and lower expectations punctuated by fruitless attempts to jumpstart the economy through infrastructure spending programs and pumping liquidity into the economy.
The last time Japan had a significant surge was in late 2012, when Prime Minister Shinzo Abe was promising to conquer deflation, bring the yen down to spur exports, and enact structural reforms.
These promises, together with a cheap market, drove the Nikkei up 25% in six months in dollar terms and 46% in yen terms.
In early 2013, on bright prospects for then-candidate Prime Minister Abe, I recommended the “Merrill Lynch of Japan,” Nomura Holdings Inc. (NMR), and the stock jumped 135% in just four months.
This rocket fuel lasted only so long. Unfortunately, Japan’s entrenched business and political interests continue to stymie Abenomics’ third arrow of meaningful structural reforms meant to unshackle the moribund Japanese economy.
On the reform table were freeing up the health sector, opening immigration, allowing more foreign investment, giving shareholders more power, and reforming agriculture.
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The result of this failure is that Japanese government debt now sits at a staggering 238% of gross domestic product (GDP), and 75% of these government bonds have negative yields.
In short, Japan, while still a wealthy and stable country, is running out of growth bullets.
China’s Great Reckoning
While a China skeptic, I always go out of my way to highlight China’s enormous – historically unequalled – economic gains over the past three decades.
In 1980, China exported about as much in a year as it did in a day in 2015. The entire size of China’s economy in 1980 was roughly the size of Taiwan or the Netherlands. In 2014, China’s economy grew about as much as the entire size of the Netherlands’ GDP.
Much of this growth has taken place along China’s east coast, and the transformation to its leading cities such as Shanghai has been remarkable.
But China’s economic model, built on exports and investment in manufacturing and infrastructure that delivered double-digit growth for so long is no longer working.
This is no ordinary slowdown, as Former Fed Chairman Alan Greenspan commented quite recently. One example is that Hong Kong home sales earlier this year tumbled 70% year over year, representing a 25-year low.
Next to debt, President Xi Jinping’s greatest concern is growing labor strikes, protests, and layoffs.
In 2015, strikes and protests doubled over the previous year to reach 2,700.
So far in 2016, they’re on track to surpass 6,000. Hebei province will close 60% of its steel mills and lay off over a million workers as it weans itself off polluting industries in the next two years.
But President Xi’s and China’s greatest challenge is its looming financial headwinds, which could lead to a crushing blow to its economy. In the past year alone, China has spent nearly $200 billion to prop up the stock market – $65 billion of bank loans have gone bad, and more than $600 billion of capital has left the country.
The Economist warns:
The scope for potential trouble in China is immense. Its banking sector is the biggest in the world, with assets of $30 trillion, equivalent to 40% of global GDP. China’s four biggest banks are also the world’s four biggest. Its stock markets, even after the crash, together are worth $6 trillion, second only to America’s. And its bond market, at $7.5 trillion, is the world’s third-biggest and growing fast.
Of particular worry is China’s shadowy banking system. According to UBS, it’s grown over 600% over the last three years and has been using off-balance sheet trust products to hide losses. China’s shadow bank financing now adds up to about 40 trillion yuan, nearly two-thirds of GDP.
Some analysts estimate that China’s troubled credit could exceed $5 trillion, a staggering number that’s equivalent to half the size of the country’s annual economic output.
China’s financial sector will have loans and other financial assets of $30 trillion at the end of this year, up from $9 trillion seven years ago, said Charlene Chu, an analyst in Hong Kong for Autonomous Research.
In her analysis, Ms. Chu estimates that at the end of 2016, as much as 22% of the Chinese financial system’s loans and assets will be “nonperforming.” In dollar terms, that works out to $6.6 trillion of troubled loans and assets.
It seems to me that the establishment financial media has missed this important point: China has gone from being the world’s leading growth engine to its leading global risk factor.
Tomorrow, I’ll explain what this means for you as an investor. I’ll also reveal where to look to find 6% to 8% annual growth.