What's next for emerging markets?
Robert Lloyd George is manager of the Bamboo fund at Geneva-based Quaero Capital.
The world is looking very different after the shock of the Brexit vote in June, which not only caused a sharp drop in Sterling and in European markets, but also made it less likely that the US Federal Reserve will raise rates in the second half of the year.
This is positive for the Asian and emerging markets, but the question is whether these very low or even negative yields on sovereign bonds in developed markets are a positive signal for emerging market equities. There has been a recovery in some depressed markets like Brazil, mainly because of better political news, but we do not see a sustained recovery in commodity prices, whether oil, metals, or soft commodities.
Where is growth likely to come from? With few exceptions, we appear to be at the end of a 30-year cycle of globalization and growth in global trade. In different areas we have now reaped the demographic and the urbanization dividend, and the enormous benefit of the end of the Cold War and the Communist Bloc.
What geographic areas are left to exploit? There are opportunities. On a recent visit to the Wilmar palm oil plantation company in Singapore, we were interested to hear there was not much more growth expected for exporters selling cooking oil to the China retail market, and other regions should be explored.
Within larger countries such as India, Pakistan, Bangladesh and Vietnam, there are still areas which have not been brought into the modern financial and consumer economy. There is clear potential for well-managed companies supplying young populations in these and other underinvested and under-researched markets.
Another trend in the past three years has been the significant shift away from commodity dependence (mainly oil and metals) in the emerging market index, towards technology, which is now nearly 23% of the total capitalisation. This includes Samsung Electronics, TSMC, Alibaba, Baidu, and Tencent, which together make up nearly 15% of the GEM Index – more than oil and mining stocks combined.
Emerging markets are still closely tied to the commodity cycle and our view is that any short-term bounce in oil and metals will not be sustained. We have seen a real slowdown in global trade and global exports, especially from South Korea, Taiwan, and even China. In the past two years, exports from Korea and Taiwan contracted at between 14% and 16%.
China is still the dominant influence as a trading partner and customer for all emerging countries, especially the commodity producers, but China’s new consumer economy is also driving demand for travel and tourism in Southeast Asia, as well as manufacturing and construction investment.
That is why we watch what happens in China’s domestic economy so closely. Our current impression is that it has stabilized, with a continuing slump in steel, ship building, construction, and heavy industry offset by government stimulus and consumer spending.
Whether the economy is really growing at 6% is hard to say, but we do not expect an imminent collapse. The debt situation appears manageable, at least for the next six to nine months. The renminbi is depreciating at a fairly steady, but slow, pace.
The real risk in China is political rather than economic, and like political risk everywhere, is highly unpredictable. We therefore remain cautious on most China investments, except special situations.
Increasingly, we feel the concept of a ‘global emerging markets’ asset class is more logically and usefully approached on the basis of regions and sectors. At present, we are focused on South Asia, particularly India, and sectors like technology, health care, and consumer brands.
As our investment style is stock picking, it is all about understanding local situations. Indonesia, for example, has had a history of commodity dependence but is now moving into a new era of middle class consumer growth. We recently added two food companies listed in Jakarta.
In the next two years, we expect India to outperform, based on real political and economic reform, especially the introduction of a Goods and Services Tax before the end of 2016.
We are reassured by the Indian Rupee’s stability and the continuity of strong central bank policy. Most importantly, we are finding well managed businesses with excellent earnings growth of above 20%, selling on reasonable multiples.
