Surprising News from Asia

Toward the end of this month, Elisabeth and I will be off to Shanghai with two goals in mind:

I will give a talk at the Shanghai Money Show on global banks. Plus, I want to take a hard look at on-the-ground economic conditions in China.

So to get a head start, I reached out to Weiss Research’s Tony Sagami, who lives in Asia and had just been to Beijing for a similar purpose.

I have known Tony for nearly thirty years and he has been with Weiss Research for nearly twenty.

His personal story begins in a small noodle shop in Tokyo after World War II, where a beautiful young waitress served American GIs stationed at a nearby base. That was considered acceptable behavior.

But then she courageously ventured to go out on a date with a young soldier. That was not so acceptable.

She spoke very little English; and the soldier, even less Japanese. Still, the romance blossomed, and they were married after a few months’ courtship. Like clockwork, Tony came nine months later.

Tony’s father was no Marlon Brando. And we don’t like clichés.

But if his story conjures memories of the movie “Sayonara,” the images you remember are probably not very different from the scenes I’ve described.

(For more on Tony’s personal background, see “Extreme Hardships and Big Profits.”)

Although he now lives in Asia and specializes in finding investment opportunities there, he also has three decades of hands-on experience with U.S. financial markets.

He and I met recently via Skype, and here’s an edited transcript:

A Tale of Two Chinas

Martin Weiss: You’re looking good, Tony! Lost some weight?

Tony Sagami: Not really. I’ve been diligent about my exercising but I still eat too much. I had a physical when I was back in Montana in June. My doctor said: “You’re the healthiest fat guy I’ve ever seen. But you still need to lose 30 pounds.”

Martin: You’re not the only one.

Tony: And not only in the West! When I was in Beijing this week, I felt people were noticeably heavier, probably because of more Western-style fast foods. One of my taxi drivers even politely chastised America for “making Chinese women fat.”

Martin: It’s a global problem.

Tony: Yes, but the more urgent global problem is the financial one.

Martin: Let’s talk less about diet and more about that.

Tony: I’m referring to heavy debt burdens in Europe, super-sized deficits in the U.S., and the fiscal cliff that the U.S. could fall off early next year.

Martin: Meaning …

Tony: Meaning that many U.S. stocks are going to sink like a rock. But there’s a select few that are prospering — leading revenues, leading earnings, beating expectations.

The common denominator among all of them is their commitment to Asia — especially China — as one of their primary sources of present and future growth.

Martin: How should investors respond to that?

Tony: First, you need to look at every stock in your portfolio and ask, “Does this company have an effective, dedicated China strategy?”

If it doesn’t, you may want to get the heck out of it because it could sink along with the rest of them.

Martin: Just a China strategy? Or Asia as whole?

Tony: Not just China, but not all of Asia! Japan has its own fiscal cliff. Countries of South Asia and Western Asia are not as strong. So my research focus right now is companies that have a strong foothold in China and southeast Asian nations. They’re the ones that are surprising analysts to the upside.

Martin: For example?

Tony: Take L’Oreal, for instance. Sales for the first half of 2012 grew 10.5%, and that growth was bolstered especially by the Asia Pacific region, where sales surged 21.9%.

Yum Brands’ sales were up 8% worldwide, driven in large measure by a 27% surge in China.

Kimberly Clark’s growth was also led by personal care, with sales (excluding acquisitions) up 7%, particularly in diapers outside the U.S. and Western Europe. The company saw a 40% volume increase in China!

Crocs reported a quarterly profit that beat Wall Street expectations — again helped by higher gross margins and growth in Asia. It won’t be long — probably by the end of next year — before Asia becomes the company’s single largest market.

Already, its sales in Asia account for 44% of the company’s revenues. And they jumped 20.5% in the second quarter.

Martin: Impressive. But what makes you say China is going to stay on its rapid-growth track? Some people now fear it’s a boom ready to bust.

Tony: It’s the good ol’ formula they taught us in Economics 101.

GNP = consumption + investments made by industry + government spending + excess of exports over imports.

Martin: Ok. Give us a quick run-down of how China stacks up in that formula.

Tony: First, domestic consumption is extremely strong.

Second, investments made by industry is continuing to grow, even if at a slower pace.

Third, the Chinese government, which still dominates many industries, is continuing to invest massive amounts in the economy.

So the only place where I see a real slowdown is with exports.

Martin: As bad as expected?

Tony: Actually, worse. But the consumer and government spending are picking up nearly all the slack. Plus, investment money is still pouring in from overseas. And Beijing is making it a lot easier for that to happen.

Martin: But if you’re right about Western economies hitting the skids, then that would also be a big hit to China, wouldn’t it?

Tony: It would be unrealistic to say China won’t be unaffected. But more and more, I think it’s a tale of two Chinas: Exports economy weaker; domestic economy continuing to grow hand over fist.

Plus, China’s exports are less depending on the West than in the past. The U.S. only takes 12% of China’s exports. And a far larger chunk of Chinese exports is now going to their Asian neighbors — their biggest markets. I’m talking about Malaysia, Indonesia, India, and other emerging markets, which also continue to be very strong.

And I repeat: Even though China’s exports are bound to be weaker, domestic consumption and government spending are picking up the slack.

Martin: Why? What’s behind the domestic consumption boom?

Tony: A big factor is rapidly rising incomes.

You see, one problem that analysts have correctly identified in China is how rapidly wages are going up — wage inflation. But the flip side of that “problem” is that massive numbers of workers now have more cash to spend.

Martin: What’s driving the wage hikes?

Tony: An intense and chronic shortage of labor — for qualified labor. There’s no shortage of migrants from rural areas to sew t-shirts or assemble basic electrical appliances. But for the skilled labor needed in China’s most vibrant industries — from high tech to auto manufacturing — there’s definitely an imbalance between supply and demand.

This is a key reason why the provinces of China’s two largest metropolitan areas — Shanghai and Beijing — have raised their minimum wage.

This is why other provinces all over the country are gearing up to do the same … why virtually the entire pay scale is undergoing a sharp upward shift … and why vast numbers of consumers are upgrading their diets, pouring into retail stores, and snapping up the latest technology.

Martin: OK, but here’s the $64,000 question: Is China just another big bubble ready to bust with a real estate collapse? Or is it a sustainable boom that will continue for years to come?

Tony: China is no paradise. There are pockets of social unrest. There are hot disputes over industrial pollution and local government abuses. But as far as the real estate bubble theory is concerned, I don’t believe it at all.

Yes, real estate suffered a correction. But it has rebounded pretty strongly.

Remember: Back in the States, the big reason that real estate in Dade County, Sacramento and hundreds of other counties collapsed —  was huge over leverage. China does not have that kind of leverage problem.

Martin: Was there no speculative fever?

Tony: There was some. But it’s hard to make the bubble argument when 70% of the homes purchased last year in China were paid for entirely with cash!

Meanwhile, the powerful, overwhelming factor driving China’s real estate is virtually unstoppable — the greatest human migration in the history of the world.

I’m talking about the population shift from mostly agricultural western regions to cities of the eastern seaboard. This is a long-term megatrend that’s boosting real estate prices, sopping up any oversupplies.

Martin: Oversupplies?

Tony: Yes, but that was two years ago. Now it’s far less of a problem because of the huge continuing migration from the rural interior.

Martin: Can recent migrants really afford new homes?

Tony: Immediately? No. They come in on the lower end of the housing chain, and after a few years, move higher — step by step.

Plus, as new people set up residence and ultimately move into new homes, that drives the demand for all kinds of purchases.

Typically, the first thing they seek to do is upgrade their diet.
Next, they want a better roof over their head.

Then, after they’ve taken care of the essentials, they seek to add a TV and air conditioning … consumer technology … and ultimately an automobile.

Martin: What’s a major focus in consumer technology?

Tony: Cell phones! Most citizens of China can’t afford both a PC and a cell phone. So they are bypassing the PC market and using the iPhone as their personal computer.

This may help explain why Samsung has been such a big success with its mini-tablet — a hybrid between a smartphone and an iPad-size tablet. I’m shocked to see how many people in China hold those things to their ears or use them like a PC terminal.

Meanwhile, the iPhone 5 coming out this fall will be installed with a new version of the Siri voice recognition program that “speaks” Mandarin. For China, that’s a pretty big technological jump, and I don’t see anyone else coming out with anything like that anytime soon.

Martin: I have Chinese installed on my iPhone, and even if you’re super-fast, you still have to enter the keyboard sequence in Roman letters, select the correct Chinese character and then repeat those steps for each successive character. Anything that can bypass that process will be huge in China.

Tony: The Chinese people I talk to all know that Siri is going to speak Mandarin. That’s a big reason why Apple had a disappointing quarter.

Martin: Because the Chinese are deferring their iPhone purchases until after iPhone 5 comes out?

Tony: Right. They all want the Mandarin speaking Siri!

Plus, there’s another factor driving iPhone demand in China, which often exceeds the most desirable functionality: Fashion!

In China, the iPhone is viewed as a fashion accessory — just like a purse or a watch. Many of the girls don’t even want to put their iPhone in their purse. They wear it proudly with a lanyard around their necks so everyone can see it.

You know, a girl in China will spend one week’s salary at Pizza Hut and a month’s salary on a pair of Nikes. But she’ll spend three months’ salary on an iPhone!

Martin: Pizza Hut?

Tony: Yes. Pizza Hut is the big date thing here. The Pizza Huts here have linen tablecloths and are very nice restaurants.

Or check out Louis Vuitton stores. I was just inside a Louis Vuitton store, and it was shocking how many people were there. I bet you that, just in the 10 minutes I was in there, they sold as much as $100,000 in merchandise.

And if you think Louis Vuitton is packing ’em in, wait till you see Apple Stores around here!

I’m in Hong Kong right now, and I just filmed a very short video at a massive 2-story Apple store here. When you view it and hear the audio, you can’t help but be impressed by the tremendous excitement and buzz.

Martin: Why so short?

Tony: You’re not supposed to be running through those stores with your camcorder on. Usually I get thrown out after about a minute. I figure I need to upgrade my technology to a young girl with an iPhone hanging from her neck on a lanyard, with the camera running indiscreetly.

Martin: Haha. But first, tell our readers how to avoid the investment landmines and how to make money from these megatrends.

Tony: Surprise: It’s not necessarily by investing in Asia or in Asian companies. I have what I think is an even better way.

Martin: Many thanks, Tony! Have a great day!

Good luck and God bless!

Martin