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Asia Drives for Stability

Wells Fargo Investment Institute - October 2017

Today, China, Japan, and South Korea are three dynamic economies, each seeking stable growth. All three are grappling with aging demographics and the potential threat posed by North Korean nuclear weapons. What might this mean for international investors? Recently, Paul Christopher and Sean Lynch, experienced international strategists with Wells Fargo Investment Institute (WFII), travelled to Beijing, Tokyo, and Seoul to see for themselves.

The new “Asia Drives for Stability” report, which is based on what the strategists discovered during their visit, addresses key questions including:

  • How will these countries’ aging populations affect economic growth, and what could that mean for markets?
  • How might improving corporate governance, competition in innovation, and changing market compositions produce new investment opportunities?
  • How might investors prepare for potential market volatility resulting from a nuclear-armed North Korea? 
Download the report (PDF)

Transcript: Asia Drives For Stability

We're here in Tokyo, the world's most populous metropolitan area and the capital of Japan, home to the most Michelin-starred restaurants, and soon to be host of the 2020 Summer Olympics. Tokyo is one of the stops on this East Asia research trip. We plan to stop in Beijing, China and in Seoul, South Korea. Again, very important economically, but they've also garnered the headlines back home from a geopolitical standpoint.
Yeah, that's right. There are a lot of tensions here in Asia right now, but those tensions come at a time when there's brilliant upswing in progress here in the economies and we want to take advantage of that, too. And investigate whether there could be some opportunities despite some of those geopolitical risks. And frankly, Sean, over the last three decades, people have, many in the US, dismissed the Japanese economy and dismissed investment in Japan because of the real estate crisis that occurred in 1989 and then the subsequent buildup of cash, caution and, really, poor economic performance. We see some of that going away now. We see policies starting to gain some traction. We see spending. We see unemployment, really, at a 25 year low, corporate profits starting to pick up a little bit.
So, let's bring this all back to what does this mean for investors. And one, Japan is a key part of the global economy and we see that economy steadily improving. We see corporate earnings continue to improve into next year. The consumer seems healthy here and tourism is on the rise. And valuations seem pretty compelling to other parts of the world. But to all these things that support the markets, there always remain those challenges.
Right. And demographics make an unbeatable challenge. There's no getting around demographics, but if Japan can figure out a way to put to work people who are already here in the labor market, that could minimize the impact of those negative demographics going forward. Also, Japan's got to deal with government debt, which is very high right now. And there's some interesting and possibly very effective tax measures that are being talked about now that could help a lot with that going forward. So, it's not our base case that we have these problems ongoing. And the third, of course, is the geopolitical. Very unpredictable. Need China's growth to boost trade with Japan. Need North Korea to stay peaceful.
Well, Sean, that skyline has become one of our favorites to visit over the course of the years. That's Seoul, South Korea. And the equity markets have had a pretty good run this year. You want to talk a little bit about that?
Yes, they have. You know, South Korea has done pretty well so far this year. Keep in mind that the South Korean equity markets are dominated by the large conglomerates. And one of the reasons for the South Korean equity markets that we watch is that their valuations trade at cheaper valuations than US markets. So, again, South Korea, the semiconductor provider to the world. Things seem to be on pretty good footing here. But we'd be remiss if we didn't think about the threats 30 miles to the north behind us that are starting to impact the markets here.
Yeah, Sean. Thirty miles to the north we have the demilitarized zone and then North Korea and certainly those headlines of new missile tests and an H bomb possibly being tested. Those headlines have been effective here as well as around the world. But for perspective, these people here have been living under the threat of invasion for the last 60 years.
Yeah, and you know, we've had some fascinating discussions around this issue. And we could talk a lot about it. But I think the main thing is that the equity markets so far have handled these threats not just the past year but the past decades, pretty well. But again, it seems different this time. And any heightened measures that are taken, I think, are going to result in increased volatility here for these markets.
That's against the backdrop of a pretty solid fundamental background. Economic growth here is going to be solid. We think this year and next. A little bit below the 15 year average, but well supported by trade with their biggest partner, biggest client, which is China.
In China, they're dominated by the large state-owned enterprises, which are the 5 or 6 big banks there. And yet, again, in China we're increasingly seeing technology companies become the focus of investors in the US and of their equity markets. So, I think China, one thing you can count on for US investors, is you're going to get better access to those markets over the next three to five years. You're going to see their markets open up a little bit more and the investible options will increasingly improve for US based investors.
It's been a very interesting trip with three very different countries. But really, a very strong theme running through all three markets, all three economies. That being the search for stability and sustainable growth combining those two.
Investors often voice concerns over what to buy and whether international markets are trustworthy. In our opinion, these concerns can be overcome. Our investment professionals have selected managers that we believe can take advantage of international opportunities. Active management can help take the guesswork out of overseas investing. What's more, our recent visits to India and now East Asia show that these economies are becoming more technologically competitive and are improving their corporate accountability to investors. It's worth noting as a risk that corporate reforms are in an early stage and could move slowly but we expect the global competition in the coming years will push these trends further to the benefit of investors. For more reasons why you should be considering international investments for your portfolio, please download our special report.