Addressing misperceptions in China and Japan (excerpt)

Jeff Everett

Jeff Everett

Investors with misperceptions about China and Japan could be missing out on significant opportunity. Jeffrey Everett, CFA, portfolio manager with the EverKey Global Equity team at Wells Capital Management, joins us in this excerpt of On the Trading DeskSM from Friday, April 4, 2014.

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Jeff, let’s start by clearing up a few misperceptions about China. First is regarding the lack of health of China’s banking system. What’s your take?
The banking system in China is one of the most hotly debated and, I believe, most misunderstood investment areas in the world right now. First of all, the banks are very tightly tied to the state—that’s a very important point when you’re dealing with any emerging markets, especially a country as important as China. Second, the Chinese banks have a very long history with bad debts. Bad debts are nothing new to the Chinese banking system. And last, there’s no question that China has embarked on some serious regulatory reforms, and these take time to develop.

The next perception that I’d like you to address for us is about China’s investments. It seems there are a lot of reports about ghost cities being built and maybe bridges to nowhere. A lot of spending to prop up growth in the short term without much thought about the long-term consequences. What’s your take on that issue?
China actually has one of the most vibrant internet economies—internet sectors—in the world. So, for all the talk about China having spent over the years and made poor investments in highways and infrastructure and so forth, it’s ironic that some of that growth is probably coming back—and paying dividends—in the form of a very vibrant internet sector. As for the banks, for all of the criticism the Chinese banks are now facing, they are generating today (a) profits and (b) substantial returns on equity. You just don’t get banks at these prices anywhere in the world unless investors are clearly disenchanted with the sector. And that, to us, is what creates the opportunity for the upside going forward.

What other misperceptions, or maybe misconceptions, could create opportunities for investors?
China is full of misconceptions. One of the misconceptions is that the industrial empire is the engine that drives China. Increasingly, the fact is that, in aggregate, the consumer part of the Chinese economy in 2012 for the first time exceeded the aggregate profits of the industrial complex of China—its medical, tourism, consumer, food, and luxury [sectors]. Very importantly, the Chinese growth in incomes will benefit the world in a myriad of ways, and the way you can play that is through Chinese equities, through global equities. Again, our view is that Chinese equities in many cases are the most undervalued way and direct way to play some of this income growth.

Let’s clear up a few misperceptions about Japan. Ever since November 2012, perhaps based upon expectations of reforms coming out of the election of Prime Minister Shinzo Abe, the yen has weakened significantly. We’ve also seen the Nikkei 225 rally pretty substantially. What do you think, Jeff, in terms of perceptions surrounding the political stability, or ability, of Shinzo Abe to actually follow through on these reforms?
I just came back from Japan, and I have to tell you, as much as I’m not a fan of polls in terms of politics, they do count, they are watched. The public knows what’s coming, and the public is buying in. Japan really risks becoming fiscally, economically, and politically irrelevant in that region. And, there’s no question that a lot of the companies are benefiting already from some of the early shifts in policy.

Would you summarize that investors maybe should be cautiously optimistic or maybe optimistically cautious about investing in Japan?
Good question. I think you always need to be cautious when you’re investing in equities around the world. There is no question we’ve seen spikes in volatility that have really bothered people and caused people to miss, I think, some wonderful opportunities. The opportunities right now—some of the best in the world—are in Japan. There is reason to be optimistic that Abe and his team’s reforms will work. The Japanese people seem to want to follow a strong leader who will help them regain a sense of economic strength.

What are some of the companies that are benefiting—and may continue to benefit—from these reforms?
Well, a great one is financial services; financial services is a big emphasis of ours around the world for a number of reasons. Among them is the proliferation of products, the ability to deliver to more people as they become wealthier—not just in emerging [markets] but also in the developed world. The developed world has income protection preservation requirements. In the developing world, they really want growth. There’s no question that financial services is going to be a growth industry.

Jeff, we’d appreciate any final thoughts you’d have for investors.
In our experience, too many investors believe that imitation is the recipe for success, and we have found time and time again, in emerging markets or developed markets, that the best way to make money is to invest when it looks darkest. Many investors will remember what Europe was like in the summer of 2012, what European banks looked like in the summer of 2012—in the summer of 2013 as well. It was a wonderful time to buy into not just Europe but into the banking system. So, while we are talking about Japan and China, when it looks darkest, it is a wonderful time to make investments. You have to do your homework, have to know what the downside is. But, in our view, the upside of China and Japan and many investments in those markets now far outweighs the downside.

Thank you very much for joining us, Jeff.
Thank you for the time, Brian.

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