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"I can calculate the motions of the heavenly bodies, but not the madness of people," Isaac Newton is reputed to have said after losing a large sum of money in the South Sea Bubble. Yet even although there's plenty of evidence that trying to forecast the ups and downs of the markets is a waste of time, it doesn't stop us trying.
As is usual at this time of the year, my inbox is overflowing with forecasts of what markets will do in the next twelve months. Most are written by intelligent, informed and experienced analysts. The vast majority will be utterly wrong.
So I'm certainly not tempted to join them. I've said that I expect a large sell-off at some point. I've said that markets will be volatile. That's as much of an opinion on 2010 as I have. Instead, I'd rather focus on the longer term and why Asia remains the best place to invest...
The difference is debt
If a single word sums up the case for Asia, it's debt. Western economies have huge consumer debt burdens. Over the next few years, people will focus on paying this off. That means their consumer-heavy economies will be sluggish for many years. They are quite likely to dip in and out of recession as government spending expands and contracts.
But Asian economies are generally in pretty good shape. Countries such as China, India and Indonesia have consumer debt-to-GDP ratios of around 10%. For the US and UK, it's 100%. So Asia doesn't face the same drag on growth. And its consumers will become a major force in the years ahead.
Of course, the idea that Asian consumers can replace US shoppers immediately is delusional. Just now, this market is less than 40% the size of the US consumer market. But as the chart below shows, it's been growing steadily and will continue to outgrow the West.
Figure 1. Asia ex-Japan consumer demand relative to US consumer demand (via CLSA)
The relative resilience of Asia's consumers allowed the region to rebound rapidly in the second half of this year. When global trade collapsed at the end of 2008, export-dependent economies shrunk –in most cases, by more than Western ones. But once exports turned around and government stimulus programmes kicked in, growth roared back because the underlying domestic economies remained healthy.
In cases such as Singapore (see chart below), the turnaround was spectacular. At the start of last year, I said that I expected Asia to come back strongly compared to the rest of the world. But it happened much sooner and much faster than I'd anticipated.
Figure 2. Singapore GDP, quarter-on-quarter seasonally adjusted annualised growth rate
Asia's high level of exports meant that economies were hit hard initially. But it has had one very positive result. Years of export-driven growth racked up substantial foreign currency reserves and made most countries net creditors to the West.
So the implosion in financial markets hasn't hurt emerging Asia as badly as many other countries. Eastern Europe will spend years repairing its finances. But Asia learned the lessons of its own crisis in 1997-1998, and avoided getting caught out again.
Asia starts to pull its weight
Of course, Asia still has structural issues to work out. Exports won't be able to supercharge growth in future. While global trade has come back a fair way from the trough (see below), further progress will be much slower as Western markets remain sluggish. It could easily be 2011-2012 before it regains its pre-crisis peak.
Figure 3. Global trade volumes (via Capital Economics)
That means that Asian economies have to focus more on building domestic demand from now on. Reforms will be needed. The crisis may help with this. It will ultimately force many Asian economies to make changes that they wouldn't otherwise have made, if they could still profit from Western overconsumption.
One such move will be boosting regional trade and co-operation. We've already seen progress on this in the last year. There have been a number of international trade and investment deals, plus some proposals for Asian countries to support neighbours in future crises.
These are only the first steps in a long process. But they are a sign that Asia is taking on greater responsibility for the global financial system. And that's something that will have to happen if this is to be the Asian century, as many hope. The emergence of the G20 (which includes Australia, China, India, Indonesia, Japan and South Korea) as the main global economic council in the place of the G8 (Japan only) promises to be a very significant shift in the long run.
Domestic politics are also improving
You need to pay attention to local politics when investing in emerging markets. And many countries still have major political issues. But Asian political trends this year were mostly encouraging. In fact, they were probably better than in many developed markets, where governance continues to slide backwards.
India's election results were about the best imaginable, with a resounding win for the capable Congress-led coalition. Similarly, Susilo Bambang Yudhoyono was re-elected as Indonesia's president. In both cases, reforms will hopefully continue, slowly but steadily.
Relations between Taiwan and China have improved. More agreements to liberalise trade and investment between the two should follow. Malaysia has made some moves towards shaking up its economy. In Japan, the eviction of the dominant Liberal Democratic Party should be a first step towards tackling the country's problems.
There were some interesting developments in frontier markets as well. I don't look at these areas on a regular basis, because they're generally hard for most investors to get into (not to mention being very high risk). But it's worth watching them to see what might pop onto our radar screen in years to come.
Mongolia for example, signed a major mining deal that could eventually set this resource-rich, sparsely-populated country on the path to development. Sri Lanka defeated the Tamil Tiger terrorist group to bring an end to a long-running and brutal war. With the right policies and lasting peace, it could become the next Asian miracle economy.
Cambodia plans to open its first stock exchange early in 2010, which could eventually make it an option for very adventurous foreign investors. The country is poor and corrupt and its democracy is extremely flawed. But exports are growing – mostly textiles, taking advantage of low labour costs – and China and South Korea are investing heavily.
Burma's elections next year will be blatantly rigged to leave the military junta in power. But there are a few hints that this could be the first step in a long process of reforms. Obviously this would have huge benefits for the long-suffering population. But it could also be a compelling investment story. The country is extremely poor, but has a wealth of natural resources, good demographics and reasonable levels of basic education.
On the downside, there was no progress in Thai politics. The country remains mired in the struggle between supporters and opponents of exiled former prime minister Thaksin Shinawatra. The anti-Thaksin coalition that took over last December in a near-coup remains nominally in power but cannot govern effectively. Until this is resolved, it's hard for me to be optimistic about the country. Hopefully 2010 will see some changes.
There is no bubble in Asia – yet
With the outlook for Asia so positive compared to the West's relatively bleak prospects, it's no surprise that money has flooded into its markets. As the chart below shows, US investors are steadily returning money to foreign equity funds while withdrawing it from domestic equity funds.
Figure 4. Net flows into US funds
This has raised fears of a bubble, fuelled by cheap money policies from Western central banks. But while I think such a bubble is very possible in the next few years, it isn't here yet. No Asian markets yet look expensive relative their growth prospects and risks.
So is it plain sailing for Asia from here? Not quite. While Asian economies will become more independent of the West in time, for now exports remain important to most. So if conditions in the West remain choppy over the next few years, it will certainly have some impact on Asia.
Second, while there is no bubble in Asia, there is a dangerous level of 'groupthink' developing. In particular, the idea that China will inevitably deliver spectacular returns is probably the most widely held in the investment community. Blind belief like this is very reminiscent of past bubbles such as the real estate boom, the dotcom disaster, the Asian crisis and Japan.
I'll write about China's risks in more detail in the new year. But briefly, I would be very surprised if it does not shock investors at some point. Probably not next year or the year after. But sooner or later the economy will be a lot more turbulent than people are expecting. No economy has ever abolished boom and bust. Developing countries always go through ups and downs. I'm not betting that China will be any different.
For the prudent, patient investor, that won't be a problem. At these prices, China – and the whole of Asia – should deliver healthy long-term returns. But we should still expect plenty of volatility and invest accordingly.
• This article is from MoneyWeek Asia, a FREE weekly email of investment ideas and news every Monday from MoneyWeek magazine, covering the world's fastest-developing and most exciting region. Sign up to MoneyWeek Asia here
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