Investor outlook 2004: Donnelly bullish

Michael Donnelly, the emerging markets portfolio manager for American Century Investments discusses his views on how Asia will do this year.

What do you see as the main theme driving Asia's equity markets in 2004?

Donnelly: China will continue to be the number- one theme. China is experiencing rapid economic growth, almost approaching double digits, and to the extent it can maintain this, it's going to influence everything else that is going on in the region.

Do you think we are going to see China's growth rate hampered by structural problems in its economy?

I've been watching the emerging markets for 10 years now, and I have seen every market go through its ups and downs. Part of me does not believe China is any different. In some way, shape or form, it will have its currency or banking crisis. No one really avoids it.

Having said that, I do think China is different from other emerging markets. The others are not as centrally planned, or in situations where a structural disaster might lead to the overthrow of the government. The Chinese government has a high vested interest in keeping the machine running and not letting it break down.

Is the risk of some sort of structural crisis in China a concern for 2004, or a longer-term problem?

I don't think this is going to be a problem in the near term, at least until way out into the Olympics.

The provincial governments and townships are doing a lot of things that may not necessarily be part of the centrally planned economy. This could sow the seeds for a disaster, but I think the authorities will clamp down on any event or trend they think is an outlier, such that the economy will not overheat too badly.

Remember, China just got inflation figures for the first time. They have had deflation for the longest time. This implies they are now bumping up against the edge of how fast GDP can grow, structurally speaking.

There is a lot of talk about China as the growth engine for the region, but what about India?

I see India growing rapidly, but not as rapidly as China. India has already grown more towards its potential. If India were to grow at nearly double digit growth rates you would see inflation kick in.

We do have a bit of an overweight in India, and that has been very helpful so far. With low interest rates there, we are starting to see consumers back in the vehicle sector. You are also starting to see more housing loans, which feed through to construction and cement production.

All reports indicate that the IT sector there is entering a phase of high growth now. They are starting to hire more, pricing is stable (whereas for several quarters it had been in decline) and there continues to be more outsourcing from the United States and Europe.

What are your thoughts on Korea?

I think Korea might do well in 2004. If the United States can work things out in Iraq and stabilize its oil exports, then the price of oil would probably decline. Korea's balance of payments completely reverses itself when there is a declining oil price. That would encourage a stronger won, more economic growth and probably lower interest rates, since inflation would come down. If the price of oil stays between $15-$20 in 2004, then I believe you would see a very strong Korean domestic economy.

Which industry sectors are going to be the best bets?

I think the steel industry will do well for another year. China is creating a demand-pull for steel and iron ore as they are importing as much of this as they can get.

I think if the United States grows at about 3%-5% and if Japan continues to outsource more to Taiwan (as they have announced), then the Taiwanese electronics sector will probably have a good year too.

Do you think that the outcome of the US election next year is going to have an impact on relations with China?

You may see rhetoric in the run up to the election, but whether Mr. Bush returns or a Democrat gets elected, they will have to deal with China very delicately. The structural relationship with China is already in place.

The reality is that overall the United States economically benefits from outsourcing jobs to China. This has certainly kept inflation low.

Do you foresee yourself increasing allocations to Asia in 2004?

It's not unlikely. We have a structural strategy that keeps our Asian weighting at about 40%-60% of our Emerging Markets Fund. There is a high probability we will be at the high end of that range.

FinanceAsia is running a competition to predict the level of our Asian blue chip index The FinanceAsia 100 and a case of champagne will be awarded to the entrant that comes closest to predicting the level on December 17. If anyone predicts the number exactly, they will win an iPod music player. The current level of the index is 1220 and entries should be made as round numbers to [email protected]