On the plus side, Headley says economic growth is broad-based. Foreign capital is flowing into the region and corporate earnings look positive. But in China, stock prices and the economy are overextended, he says. "The great theme in Asia remains the regional integration of the Asian economies, which has been building for many years," he continues. "This makes the region highly competitive versus North America and Europe."
One-third of the Matthews Asia Pacific fund's assets are in Japan, which has been the sick man of Asia for the last decade. Headley says Japanese stocks are undervalued. The Japanese government and corporations have been making adjustments. Japan is benefiting from the economic growth in China.
The fund invests 15% of its assets in Hong Kong, 11% in China and 30% in Korea. The rest is well-diversified throughout the region. The largest sectors are financials, information technology, telecommunications and consumer companies. Among the fund's largest holdings: Honda Motor, Kookmin Bank, Giordano International, AXA Asia Pacific, SK Telecom and Swire Pacific.
Greig of William Blair International also looks for solid returns from his Japanese stocks, which he bought at reasonable prices. Japan makes up almost 25% of his fund's holdings. "The growth outlook in Japan will continue to benefit from higher corporate cash flows and strong Asian markets, while the make-or-break factor could be consumer and business confidence," he says. His largest Japanese holdings are Sumitomo Trust, Nitto Denko Corp., Keyence Corp. and Seiko Epson Corp.
When it comes to China, Romeo Dator, manager of the U.S. Global China Region Opportunity fund, is concerned about a mushrooming bubble in that market. Last year, his fund gained 81%. "Hot money has been moving into this sector," he says. "The overheated economy and stock markets are at bubble levels. Manufacturing has been strong. But you will get to a point where supply outstrips demand and the economy will slow."
Dator says financial advisors must be long-term investors. China is taking steps to open its economy. It is now part of the World Trade Organization. There is a lot of investment capital flowing into the country. But there are structural bottlenecks. The government is building the country's infrastructure dramatically. Torrid lending practices could hurt the banking system. Plus, corporate financial reporting is not as good as it is with United States and European companies.
"The government is trying to slow the pace of lending and increase the level of reserves in banks," he says. "There are definitely some bad loans on the mainland's bank books. The government is injecting $45 billion into two state-owned banks and is taking steps to improve the situation."
There also are nascent labor issues in China. Workers are organizing. They want high wages and better benefits. Most of Dator's investments are in Hong Kong. He usually avoids mainland China due to the lack of liquidity. Sectors he favors are basic materials and commodity companies. Aluminum Corp. of China and Jiangix, a copper, energy and petrochemical company, are growing earnings in excess of 20% annually. Dator has also increased his exposure to property stocks. The Henderson Land Development Co. is building properties in mainland China. Earnings are growing at 17% annually. He owns Capital Alliance, which is building schools in mainland China.
Expectations for Latin American and European stocks are noticeably less optimistic than Asian stocks. On the European side, fund managers must buy undervalued companies based on future earnings. Euro area stocks gained just 22% in euros, while growing 46% in U.S. dollars last year.
Thomas Tibbles, manager of the Forward Hansberger International Fund, believes European economic growth will lag the rest of the world. His forecast calls for less than 3% growth for the near future. Nevertheless, he says there are a lot of attractive, undervalued companies with strong franchises and fast earnings growth compared with their peers. The fund's average holding trades at only 2.5 times book value. But future earnings are growing at 14% annually. Half the fund's assets are invested in the United Kingdom and Europe.