India is emerging, China has well and truly done so, and other Asian economies, outside of Japan, are still on solid growth paths.
The AMP's Head of Strategy, Dr Shane Oliver says that while the sharemarket boom is maturing, some parts are not as susceptible as others.
Asia, specifically Chin and India continue to offer value. In fact Dr Oliver says both are in 'the driver's seat' and will be for some years to come.
Here's his latest report:
For some time we have been of the view that the global equity bull market that commenced in March 2003 has entered a more exuberant phase. But if we have entered a more exuberant phase it's natural to ask what will be the focus of this investor exuberance.
Stage three of the cyclical bull market
Cyclical bull markets go through three stages:
1. A recovery phase from excessive pessimism – which characterised the initial share rally in 2003;
2. An earnings driven phase where strong earnings growth drives share prices higher – this has essentially been the case since late 2003 into this year; and
3. An exuberance driven phase where share prices rise faster than earnings – as investors become increasingly optimistic pushing share valuations to extremes.
The third stage can last for years as was the case in the late 1990s in the US where IT stocks became the focus.
Our assessment is that we have now entered stage three, but we are a long way from reaching the extremes that normally characterise bull market tops. Stage three is characterised by slowing profit growth, rising price to earnings (PE) multiples, rising volatility as more investors become exposed and shares start to lose some of their earnings support and increasing investor exuberance for a key investment theme (or themes) which results in a narrowing of participation in the market's advance.
The first three are now arguably evident: • Profit growth is slowing in most regions; • PEs are rising helped by US monetary easing – lower interest rates make shares more attractive relative to cash and hence usually result in higher PEs; • Volatility is on the rise.
This is clearly evident in the increasing severity of share market corrections. For example, corrections in the Australian share market are becoming more severe – just 3.5% in 2004, two 8% corrections in 2005, a 12% fall last year and a 14.8% decline in July/August this year.
And after a huge rebound since mid-August it looks like share markets are now undergoing another correction, although this one should be more modest than the falls into August as the Fed continues to cut interest rates.
But the big question is what will be the focus of investor exuberance this time around?
The next investment mania:
Every decade seems to end with some form of global investment mania that attracts investor attention in a big way. In the late 1960s/early 1970s there was a mania in mining stocks and then the "nifty fifty" in the US. In the late 1970s there was a mania in gold. In the second half of the 1980s it was Japan. In the late 1990s it was technology stocks.
Our view is that the next investment mania is likely to be focused on emerging markets and related themes. The emergence of the BRICs, and China and India in particular, is the biggest economic displacement this decade.
This has been a very positive force in the global economy, boosting growth while helping to keep inflation and interest rates down. But as is often the case, investors can end up pushing asset prices too far.
So in thinking about what is the next investment mania to take hold, emerging markets, China, Asia and related plays such as commodities are ideal candidates.
This is arguably already underway. While all share markets have benefited from recent US monetary easing, Asian shares have risen far quicker from the August correction.
And in part reflecting its Asian exposure the Australian share market has too, with resources leading the way.
Asia now into a secular bull market versus world:
Relative to global shares, Asian shares now appear to be back into a secular bull market.
After booming during the "Asian miracle" years, Asian shares spent a decade spinning their wheels.
The next chart shows the performance of Asian equities in absolute terms (top line) and relative to global equities (bottom line). When the relative return line is rising, Asian shares are outperforming global shares and vice versa for falls.
But while Asian shares have started to accelerate relative to global shares the ratio in the chart above is well below 1990's peaks suggesting it may have a long way to go.
Asian shares now at a premium to global shares Asian share valuations are not as compelling as they were a few years ago and are in fact trading at a PE premium compared to global shares.
However, there are good reasons for believing that this is sustainable.
Firstly, Asian economies are now in far better shape than was the case during the "Asian miracle" years.
In contrast to the situation ten years ago: current accounts are in surplus; foreign exchange reserves are huge; foreign debt has collapsed; inflation rates are low; Asian currencies are undervalued; and corporate gearing is low.
On top of this, there has also been a big improvement in government transparency, the availability and quality of information, the prudential supervision of banks and in corporate governance.
If anything, given Asia's current account surpluses & huge foreign exchange reserves macro risk has now shifted away from Asia to the US which has been highlighted by the US sub-prime crisis. This is the exact opposite of the situation a decade ago.
In the second half of the 1990s, Asia was in trouble and the US was the place to be. Today it i
