Why Asia Is Again A Hot Investment Theme

August 12, 2014

Few may be saying it these days, but it could be time to venture back into Asia.

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Scott Kubie, chief investment strategist of Omaha, Neb.-based CLS Investments.

After a number of rough years, Asian markets are beginning to show some signs of life, and for good reason.

Asian markets are becoming fundamentally more attractive, offering excellent value, and are ripe for increased interest in their securities. While a number of excellent ETFs cover Asia, the iShares MSCI All Country Asia ex Japan ETF (AAXJ | B-79), is my preferred ETF to take advantage of the opportunity.

Before getting into the finer points of this ETF, let’s take a closer look at Asia and the changes for the better in places like China, South Korea and elsewhere.

Fundamentals

As I said, Asian markets have stumbled in recent years. One of the reasons has been anemic earnings growth. Earnings have stayed relatively stagnant in recent years, declining 0.2 percent per year over the last five years. This poor corporate performance has contributed to poor stock market performance.

A number of factors, however, point to improved performance. First, the global economic recovery keeps rolling along. A strong second-quarter gross domestic product (GDP) report in the U.S. suggests increased consumer demand for many Asian exporters.

Of perhaps even greater importance to the economies in this region is the return of Chinese economic growth. While the U.S. is an important market, China is often a larger trading partner, and a key source of export demand.

The early estimate of China’s Purchasing Managers Index (PMI), which measures manufacturing activity, hit 52.0 in July. July’s reading was the second-consecutive reading showing expansion, reflected by a reading greater than 50. It was also the highest reading in the past 1 ½ years.

Interest rates and lending also may be moving in favor of stock investors. China, for example, has sought to make borrowing easier for individuals. Korea, the second-largest country concentration in the AAXJ portfolio, appears to be on the verge of cutting rates soon.

Also, the companies in AAXJ are fundamentally sound. Their debt ratios are below those in the U.S, Europe and Japan.

Net margins are above 21 percent, compared with 14 percent in the U.S., and even lower in Europe and Japan. Return on assets (ROA) and return on equity (ROE) also look competitive with the rest of the world.

The companies in this region seem likely beneficiaries of improved fundamentals. Based on improving economic fundamentals, an improving interest rate environment and healthy balance sheets, Asia is looking better.

Valuations

Valuations in Asia don’t reflect the good news. Price earnings multiples (P/E ratios) are just above 12, based on Morningstar data—lower than the U.S., Europe and Japan. The price-to-book ratio is slightly more than half that of the U.S., and the price-to-sales ratio is also at a significant discount.

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