Asia was a great place to invest this year.

While some individual Latin American markets have outpaced their Asian counterparts, the fact is that the 10.9% return of the overall MSCI Asia Index outdistanced the 10.3% return of the “Americas” region.

Investors can expect more of the same in the New Year. The fact is that the Asian region – including Australia and New Zealand – was a profit powerhouse in 2010. And Asia’s prospects for 2011 are even brighter:

  • It’s where a great majority of the world’s growth is taking place.
  • And it’s where investors can reap their biggest profits – if they pick the right investments in the best Asian markets.

[ad#Google Adsense]In this report, we’re going to detail that all for you.

The Case For Asia

According to a panel of forecasters assembled by The Economist, the world’s two highest growth rates in 2011 will be in China at 8.9% and India at 8.6%.

Needless to say, such frenetic rates of growth can pull a lot of the neighbors along, too. After all, if Mexico’s prospects are clouded by being next to the slow-growing United States – and if North Africa’s growth potential is stunted by being close to the troubled economies of Southern Europe – then countries close to China and India should be expected to have pretty brisk rates of growth.

And that’s just what’s happening. Economies in the Asian region are each enjoying nice tailwinds from the growth tempests being whipped up by China and India.

Vietnam and Indonesia, with projected growth rates of 6.8% and 6.0%, respectively, are both performing better than any other countries outside Asia.

Hong Kong, Singapore, Malaysia, the Philippines and Thailand are also above 4%, making them well worth a look. And Australia, South Korea New Zealand and Taiwan all have projected growth between 3% and 4%.

Last of all the major Asian economies in terms of projected growth – as has been the case since 1990 – is Japan, which is forecasted to grow at a 1.3% pace in 2011 (though investors need to remember that with its negative population growth, that economic growth rate is better than it appears).

India and China: A Tale of Divergent Prospects

The most interesting exercise is to compare projected growth rates with current Price/Earnings (P/E) ratios: After all, if you get the one (high growth rates), you should be able to tolerate the other (P/E ratios).

Here, however, we find that the Asia region’s two highest projected growth rates have wildly different P/E ratios: India is trading at 24 times earnings, while China is trading at less than 14.

For me, the P/E ratio rules India out as a home for a large chunk of my money, although I will admit that I could be tempted by individual companies with the “right” profile. I also think the Economist team is being a bit optimistic about that country’s growth potential.

One of the biggest issues is India’s finances. If you combine the national and regional governments, India has a budget deficit that’s equal to almost 10% of gross domestic product (GDP) and inflation that is persistently in the double digits.

Since India’s interest rates are about 5% below its inflation rate currently, you’d expect it grow pretty fast. But you also wouldn’t expect inflation to come down anytime soon. Add to that a negative current account balance – not to mention a savings rate far below that of China – and you have to conclude that the potential for a credit crunch in 2011 looks very real.

Attractive as India’s long-term growth prospects really are, at current prices I would probably avoid this market.

There are two reasons for the relatively modest valuation that China currently enjoys. And both those reasons tell us that investors “doubt” China’s true potential.

First, people fear rising interest rates and an economic slowdown. That’s a reasonable fear. But even after a slowdown, growth rates still will be outstanding by “non-China” standards, and the inflation rate will still be well below that of India.

And second, investors fear the fallout that they worry will be caused by widespread accounting fraud among China’s smallest companies.

Thus, we discover that China’s reasonable P/E ratio is a rough average between very high P/Es on some large companies and Western favorites, while the blizzard of smaller Chinese companies that have issued stock in the United States is under a cloud, trading mostly on P/E ratios in the 5.0 to 8.0 range.

Accounting fraud is a difficult issue. Institutional investors who put money in a company that is found to have fraudulent accounts get in trouble; their trustees or bosses ask: “Why didn’t you spot the fraud?” The reality is that that if the Beijing branch of a major auditing firm can’t spot them all, there’s no chance at all that some poor fund manager who has flown in from Cleveland for a week to visit as many as a dozen companies.

Because it deters institutional investors, the occasional accounting fraud knocks down prices more than it should, in my view. P/Es of 5.0 to 8.0 for companies that appear to be competing successfully in a giant economy growing at 8% have been discounted way too far – unless you truly believe that a full third or more of China’s smaller public companies are fraudulent.

Of course, in a dynamic economy, some of these companies’ business strategies will fail of their own accord – the companies are small and are therefore high-risk by definition in such a fast-paced marketplace.

However, if you put a modest percentage of your money in a spread of smaller Chinese companies, you should do well. If you’re really unlucky, out of 10 investments, two will turn out to have “cooked the books,” and maybe another three or four will get their strategy wrong or succumb to superior competition.

But the returns on the remaining four or five companies you hold should more than pay for those couple of mistakes. And one or two of them may turn out to be that elusive “10-bagger” that really boosts your net worth.

Other Top Prospects

Of the next two rapid-growth markets, Indonesia is trading at 20 times earnings, while the Vietnam market is so small that The Financial Times doesn’t calculate a P/E ratio for it. There is not much you can buy from Indonesia as a U.S. retail investor, while Vietnam is almost impossible to invest in directly. So these two should make up only a small portion of your portfolio.

The 4% growers are more interesting. Hong Kong is trading at about 15 times earnings, and many Hong Kong companies offer major exposure to China. The market is up 18% this year, but there ought to be more to go. Singapore is a little more expensive at 16 times earnings, but I regard Singapore as one of the world’s best-run economies, so you would almost always want to have something there – the market is up a reasonable 16% this year.

Malaysia is another well-run country, with interesting exposure to natural resources (though the best natural resource companies are not listed on the New York Stock Exchange). At 16 times earnings, the Malaysian stock market is up 30% this year, but so are many commodity prices, which should feed through to earnings growth for Malaysian companies.

The Philippines, on the other hand, features a P/E of 22 – and has poor governance (both governmental and corporate), to boot. Given that double-whammy combination, this market looks pricey to me. It’s up 45% this year, as it again has natural resource exposure. But I’d pass.

Finally, we come to Thailand. It’s trading at a 15 times earnings, but is up 50% this year – and, quite frankly, I don’t trust Thailand not to descend into civil war at any moment, (although the outbreaks of violence have so far not affected growth too much).

Of the 3-4% growth guys, Australia offers natural resource exposure at 15 times earnings and is up only 6% this year – I’d want something here. New Zealand, on the other hand, is small. At 24 times earnings, throw it back.

South Korea, and Taiwan – both trading at 15 times earnings – are two of my favorite economies. And I believe they will grow faster than the Economist panel thinks – I’d put their growth potential at closer to 5%.

You should remember, however, that – like Japan – they are big commodity importers, so have a big negative exposure to high commodity prices.

Finally, there’s Japan, now the world’s third-largest economy, with a market trading at 15 times earnings, despite tepid growth. The Japanese market is 9% in 2010 – I can’t help thinking it will do better than that in 2011, but would risk only modest resources there for the moment.

There you have it: Asia – gigantic, full of wealth traps – but also full of very interesting investment destinations.

Even as a U.S. investor, you should probably have at least a third of your money there.

Actions to Take: Although global investors move into the New Year facing one of the most uncertain economic backdrops in modern history, here’s one fact you can take to the bank: The Asian region will continue to be home to some of the world’s fastest-growing economies. You should have as much as one-third of your money in this part of the world.

Even so, several of those markets are destined to outpace the others. Let’s look at the true leaders of the pack – while also offering some insights on how to profit from the frenetic growth offered by the Asian-market leaders. We’ll start with Singapore.

Singapore: As I’ve noted several times here in Money Morning, I regard Singapore as one of the world’s best-run economies. At 16 times earnings, the Singapore market is a bit on the expensive side. But it’s up a reasonable 16% this year, and the excellent stewardship the government continues to provide for the Singapore economy makes this one market I don’t want to pass up. Indeed, you’ll always want to have something here.

The problem with Singapore investment is that the Sarbanes-Oxley mess has deterred Singapore companies from listing on the New York Stock Exchange, so there are now no companies with listings beyond the Pink Sheets. If you have a broker who allows you to invest directly on the Singapore [Stock] Exchange, that is not a problem. For those who don’t, I recommend the iShares Trust MSCI Singapore Index Fund (NYSE: EWS), which has net assets of $2.73 billion and a net expense ratio of only 0.53%.

South Korea: As mentioned, this is one of my favorite markets. The simplest strategy here is to buy the Korean exchange-traded index fund, the iShares MSCI South Korea ETF (AMEX: EWY), which invests in the Morgan Stanley Capital International Korea index. It has $4.76 billion in net assets and a net expense ratio of 0.61%.

Korea is very much a high-tech economy, and I’d be remiss in not mentioning at least one solid tech-related profit play – in this case LG Display Co. Ltd. (NYSE ADR: LPL), a leading manufacturer of thin-film liquid crystal displays (LCDs). Although LG Display’s shares have rebounded a bit from their year-to-date lows this past summer, they are still only trading at about 14 times earnings. Given Korea’s high-tech prowess – and given how important LCDs have become to the global consumer electronics sector – this is a stock that’s worth a closer look.

Taiwan: This, too, is a favorite market. The iShares MSCI Taiwan Index ETF (NYSE: EWT) is clearly an efficient way to invest in Taiwan; it has risen recently, but is currently trading at a reasonable 13 times earnings. It has net assets of $3.59 billion and a net expense ratio of 0.71%.

One of the factors in Taiwan’s favor is the reality that there are actually several ways to make direct investments in this strong Asian economy. For instance, one solid profit play is the Taiwan Semiconductor Manufacturing Co. Ltd. (NYSE ADR: TSM), that country’s largest chipmaker.

[ad#Google Adsense]There’s also United Microelectronics Corp. (NYSE ADR: UMC), which recently was forced to scuttle a proposed deal that called for it invest $285 million to acquire Chinese semiconductor manufacturer HeJian Technology (Suzhou) Co. Ltd. That deal – which would have given UMC a substantial foothold in China’s rapidly growing electronics market – was shelved back in November due to regulatory issues in Taiwan. However, UMC says that it will continue seeking possible “integration” alternatives with HeJian. And UMC recently announced that it was expecting a fivefold increase in profits for fiscal 2010: It said profits would advance from about $130 million (3.9 billion in Taiwan dollars) last year to $665 million (20 billion Taiwan dollars) for fiscal 2010.

Hong Kong: What I like about this country is that so many Hong Kong companies offer a major market exposure to China. The market is up 18% this year but there ought to be more to go. The simplest way to play Hong Kong is through the iShares MSCI Hong Kong Fund (NYSE: EWH). This ETF has $2.66 billion in net assets and a net expense ratio of only 0.53%.

Australia: Though you might not think to view it this way, Australia is becoming an increasingly effective way to benefit from China’s growth. That’s because the nation “down under” is rich in the commodities that China needs for its continued growth – and China is willing to deal. Indeed, Australia is becoming more and more important to the world in general.

The Australian economy is growing at 3% to 4% a year, and its stock market is trading at a reasonable 15 times earnings. It was up only 6% this year, but you can bet that a continued advance in commodity prices will have investors looking back on this market as a relative bargain.

This all combines to make the Australian market a “Buy.”  One way to play it is through the iShares Trust Australia ETF (NYSE: EWA), which is currently trading at 12 times earnings with a 3.44% yield.

Another alternative is to buy Australian mining companies directly, although few of them have ventured beyond the Pink Sheets in the United States. One smaller gold mining company (with a market capitalization of about $325 million) that looks somewhat interesting is Dominion Mining Ltd. (Australia: DOM/PINK ADR: DMNOY) which is involved in the Challenger gold mine in South Australia together with two exploration projects, in Western Australia and South Australia. In late October, the company said that gold production for the quarter ended September represented a “substantial improvement” on each of the previous quarters in the 2010 financial year.

Finally, at the blue-chip end, there is BHP Billiton Ltd. (NYSE ADR: BHP), a huge beneficiary from the run-up in commodities prices. The shares are trading at about 19 times earnings and feature a 2% dividend yield.

India: The potential is huge. But if you really want to get a bargain, wait until India runs into a crisis – as it undoubtedly will. That’s when you should buy the market, because the long-term growth prognosis is unquestionable.

China: This is a story unto itself – and Money Morning will actually examine the country in a separate report later in the “Outlook 2011” series. But as some food for thought, here’s one profit play to consider: the iShares FTSE/Xinhua China 25 Index (FXI), which invests in the 25 largest Chinese companies. It has $9.36 billion in net assets, a dividend yield of about 2% and a net expense ratio of 0.72%.

— Martin Hutchinson

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Source:  Money Morning