Is 2014 the year for the contrarian investor? F&C’s Chowdhry responds
Jeff Chowdhry, head of Emerging Market Equities at F&C Investments, provides his outlook for emerging markets and suggests that now could be the ideal time to purchase emerging market equities.
Over the past few years, those of a contrarian persuasion who follow the stock market adage that you should buy shares when everyone else is selling, and vice versa, have been generally well rewarded. By that logic, now is the time to be purchasing emerging market equities.
Investors in emerging market assets have suffered a challenging year or so of performance. Emerging bond and equity markets have lost ground against their developed country peers, with Brazilian and Indian stocks sustaining double-digit sterling denominated losses in the last twelve months. This has been in marked contrast to Japan, the US and Europe ex-UK, which posted returns of between 20 and 30 per cent.
Brics under pressure
Part of the reason behind the sell-off is that investors are recognising that emerging markets have much more work to do in terms of structural reform. For these economies to regain their previously impressive growth trajectory, infrastructure and financial systems need to be upgraded and more progress needs to be made on stamping out corruption.
Nowhere are the growing pains of transition more apparent than in China. Growth in the world’s second largest economy has slowed in the last eighteen months as the country’s leadership has committed itself to diverting emphasis from exports and infrastructure projects to servicing increasing demand from the domestic consumer. Emerging markets are no longer exclusively the workshops of the West and now need to cater for their own increasingly aspirational populations.
Brazil’s current economic problems also stem largely from structural issues. The economy has been struggling against a headwind of high interest rates and inflation. Rising prices have been largely a consequence of the fact that the demand for consumer goods is increasing but the service sector dominated economy is not set up to deliver them.
Russia’s economy is also decelerating. We have already seen in the summer President Putin announce wide-ranging infrastructure spending in an attempt to reinvigorate growth but it is clear that more efforts need to be made to diversify an economy that remains dominated by oil and gas.
In India, the desire to bring in the necessary infrastructure spending to kick-start growth has been stymied by a determination by the government to get the budget deficit under control. Unfortunately, the authorities’ hands have been tied by the fact that the weakening rupee has accelerated the rate of wholesale inflation to above the central bank target and has increased the upward pressure on interest rates.
The clear need for fundamental economic restructuring nevertheless underlines the fact that there is still so much raw investment potential left in the emerging markets story. Those who suggest that the economies of Brazil, Russia, India and China have already emerged are simply not appreciating the profound social and economic changes that are being created by rising personal wealth. With demographics on their side, the emerging economies retain much higher long-term growth potential than the developed nations.
Shares are cheap but stock selection is critical
The perception of a cyclical downturn in emerging markets has pushed equity valuations down to very cheap levels. It has also brought about a sharp depreciation in a number of emerging market currencies. This represents an excellent buying opportunity if you believe, as we do, that the long-term emerging market story remains intact.
But it is imperative that investors are selective. The sectors that fuelled the first emerging markets boom probably won’t be driving the next. Caution needs to be exercised, for example, with commodity companies. China’s determination to restructure has seen its demand for raw materials slide, and this has contributed to the downturn seen in the big producer nations such as Brazil, South Africa and Russia.
As emerging economy growth rates return to more ‘normal’ levels, we are optimistic that stock markets can deliver double digit gains next year, even if company earnings growth decelerates as expected. Emerging countries are brimming with high-quality companies, many of which have been hit by indiscriminate selling as investors have withdrawn funds from the asset class.
Investors can take some encouragement that data from emerging markets now looks to be moving in the right direction. The HSBC Emerging Markets Index, which is a gauge of business sentiment derived from the influential PMI surveys, reported that business activity across global emerging markets in October had expanded at its fastest rate since March. This has found some corroboration in the fact that the latest quarterly growth figures for India were better than expected.
Emerging market assets have always moved in and out fashion and 2014 could be the year when they are back in vogue. Some of the high-quality companies we are backing include Ultrapar (Brazil) TSMC (Taiwan), HDFC Bank (India), Samsung Electronics (Korea) and BIM (Turkey).