In Asia, booming demand powers stock rise

It looks like nothing but good news coming out of Asia. In March alone:

• Standard & Poor's raised its outlook for Japanese government debt from negative to stable. S&P credited the country's corporate debt restructuring and a decline in the number of bad loans held by banks.

• Also in Japan, the government reported that household spending rose for the fourth month in a row in February, as consumers spent more on things like restaurant meals and cars.

• In South Korea, the economy expanded by 2.7 percent in the fourth quarter, the best pace in almost two years. Much of this growth was fueled by exports, particularly semiconductors and cars.

• In China, the central bank raised the interest rate it charges banks for loans. Unlike their counterparts in Japan and South Korea, Chinese officials actually want to slow the rapidly growing economy and keep inflation in check.

Finally, it seems, all of Asia is gaining strength. So are funds that invest there. In the first quarter, Pacific region funds advanced 10.5 percent, while Japan funds gained 13.7 percent, according to Morningstar. For the past 12 months, Pacific region funds have risen more than 62 percent and Japan funds are up nearly 70 percent.

Several factors contributed to this strong performance, but the main driver seems to be China. "You're seeing accelerated economic growth out of China and you're seeing a lot of demand for products into that market," says Michael Donnelly, a senior portfolio manager at American Century Investments in Kansas City, Mo.

This demand has boosted exports into China from Japan, South Korea, Indonesia, and India, Mr. Donnelly explains. Even Taiwan, which has a very good commercial - if not political - relationship with China, has benefited from China's growth, he notes.

"The second thing, which is not so much talked about, is that India is growing very rapidly as well," Donnelly says. Public attention is focused on the technology jobs Indians are gaining at the expense of American workers, but other factors are also at work, he says.

One of the biggest is an ambitious new highway system now being built to connect four major cities in India. While the new highway is creating jobs in the engineering, construction, and cement industries, it is also making the country's transportation system more efficient and boosting sales of new, larger trucks. Many of the older, slower trucks are not allowed on the new road, Donnelly says.

In South Korea, the domestic economy continues to lag other Asian countries, but exporters, such as automobiles and steel companies, are doing fairly well, Donnelly notes.

Although China's rapid growth is helping almost all of its Asian neighbors, Japan has been one of the biggest beneficiaries, says Edward G. "Ned" Riley, chief investment strategist at State Street Global Advisors in Boston. "Japan's exports to China are as large as they were to the United States 10 years ago," he says.

Consumer spending in Japan has increased a little over the past few months, but it still has a long way to go before it provides real stimulus to the economy. Trillions of yen are still socked away in low-yielding postal savings accounts held by consumers worried about their jobs and pensions. "The export business is encouraging if it ignites some kind of fire under the consumer there," Mr. Riley says. "People have lived in this environment for 10 years and that's been depressing. They don't want to go out and spend. But if the economy picks up and employment picks up, maybe they'll become more confident."

While Asian funds have done very well recently, experts warn against throwing too much money into this sector. Like any mutual fund that concentrates on one region or one industry, prices of these funds can go down as fast as they go up.

"If you're going for Japan funds, or China funds, or Asian region funds, that's performance chasing," says Donald Cassidy, senior research analyst at Lipper, Inc. Still, he agrees that Japanese investors have the potential to start a big rally that could benefit Japan and the region.

"There's a huge amount of money sitting on the sidelines in those postal savings accounts," Mr. Cassidy says. "If the locals ever decide that it's fun to play the stock market again, that market will just explode."

Finally, investors considering Asian funds but who are concerned about the potential added risk should check the portfolios of diversified international funds they already own or are considering, suggests William Rocco, a senior analyst at Morningstar. "If your whole fund portfolio has four or five funds, one of them should be a diversified international fund," he says. "That fund probably already has Asian and Pacific exposure."