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22 March 2004

Local investors returning to market

Improving sentiment has been reinforced by strong growth data released for the last quarter of 2003

Over the past few weeks, the positive outlook statements accompanying the release of full year results in Asia have sustained the positive momentum of the region's stock markets.

Improving sentiment has been reinforced by strong economic growth data released for the last quarter of 2003 and upwardly revised forecasts for the current year.

Asian markets have traditionally offered diversification from investment in developed markets. However, over the past three years, movements in Asian markets have shown a high correlation to the US indices but we expect a reversion to historic patterns. The importance and growth of domestic consumption and intra-regional trade is now evident with a decreasing reliance on the US as the main consumer of Asian goods

While the return opportunities are promising, the region continues to offer its share of risks. Forthcoming elections are already providing headlines, particularly those in Hong Kong and Taiwan with reference to their relationship with mainland China.

These may provide some short term volatility and remind investors that the Chinese state remains the major shareholder in many of the region's listed companies. The combination of improved sentiment and rising markets has kick-started equity fund raising.

China will be the biggest source of new issues in the region covering a range of industries from semiconductor to insurance. Recent new issue China Life, a mainland Chinese life insurance company, was heavily oversubscribed and such demand will spur on other new issues while China remains in favour with investors.

The region now offers an attractive historic dividend yield of 2.6% with most stocks paying out cash dividends including high profile technology stocks such as TSMC.

This does not mean that the region has fewer opportunities for profitable reinvestment; rather it reflects strong cash generation and improving corporate balance sheets.

Currency has had a major influence on stock market returns for UK investors over the last year. Many of Asia's currencies are either pegged to the US Dollar, such as the Hong Kong Dollar, or are managed by export-orientated policies like Korea and Japan.

Therefore the US dollar's weakness against sterling has had a knock-on affect in Asia and has reduced returns for UK investors investing in the region.

These moves are not forecast to be repeated this year and given the strength in economic growth and exports in particular, it is likely that we will see some strengthening of these currencies.

No significant changes are expected to the Chinese currency peg this year.

The Chinese government will want to address imbalances in the domestic economy and strengthen the bad-debt laden banking system before allowing greater flows of capital.

Overall the prospects for the other Asian markets remain positive with companies matching encouraging fourth quarter results with upbeat outlook statements. Although we are not expecting returns for 2004 as high as those achieved last year, we believe the region continues to offer attractive long term growth.

Howard Kippax
Investment Manager, Asia (ex Japan) equities
The Scottish Investment Trust PLC