Aside from qualifying for the 2018 World Cup, what do Japan, Korea and Australia have in common? One answer is that their economic and market performance is heavily dependent on China, writes Joe Little.
China is the destination for about 25% of Korean and Australian exports. The figure for Japan is 20%. All three economies benefitted significantly from China’s long period of investment-led growth, with Japan and Korea supplying components and machinery and Australia commodities. However, China’s growth model is changing and this will affect how it interacts with these economies.
At over 40% of GDP, Chinese fixed investment remains unsustainably high. The rebalancing of the economy towards consumption and away from investment, therefore, has much further to run. Providing that China continues to manage this adjustment smoothly, this does not necessarily imply a headwind to commodity exporters, such as Australia, but more that the boom days are a thing of the past. A high level of private sector debt also means Australian domestic demand faces constraints. Consistent with this, the risk premium versus cash suggests being neutral on Australian equities. Moreover, on a trade-weighted basis and adjusted for price levels, the AUD is trading above its long run average level, implying some risk of depreciation.
The situation facing Japan and Korea is more complex. China’s move away from investment is a potential negative, although China’s desire to climb the value added chain could insulate both economies, particularly Japan, given their specialism in high quality capital goods. Moreover, both also produce a wide range of branded consumer goods and are benefitting from the dramatic increase in Chinese tourism flows. Indeed, in 2017, China accounted for 30% of Korean visitor arrivals and 25% for Japan. Given these trends, the robust global cycle and accommodative domestic policy, Japanese and Korean equity valuations continue to look relatively attractive.
Joe Little is chief global strategist at HSBC Global Asset Management
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