Riven by the cross-currents of currency crises in Argentina and Turkey and trade friction between the U.S. and China, sentiment has shown signs of bottoming out and skepticism in these markets remains high. Of course, this also means that opportunities to invest in emerging markets are plentiful.
“That’s the story of our life in emerging markets,” says Dr. Mark Mobius, the founder of Mobius Capital Partners, who many consider to be the dean of emerging-market investing. “Money won’t start to come back until these markets are up 30 to 50 percent.”
This is a familiar situation for emerging-market investors. After crises occur, markets and currencies decline. Eventually, a turning point is reached. But the overall perception that the markets are down prevents investors from noticing when that point emerges.
“If you drop from 10 to 1 and then move back up to 2, that’s of course a 100 percent increase,” Mobius says. “But people don’t notice because of a perception the markets are down.”
Mobius notes that this cycle is the essential irony of emerging markets: that incredible volatility in individual countries creates the necessary conditions for specific opportunities, but monitoring that volatility can be quite stressful. To combat this, many investors focus not just on inexpensively priced companies but also on those where investors themselves can have an impact on management.
“Volatility is the new reality,” says Siobhan Morden, head of Latin America fixed income strategy for Nomura Securities International. She adds that the volatility of 2018 makes it difficult to talk about stability with conviction. “Emerging markets have essentially been stress-tested and are now focused on addressing those weaknesses. Risk-reward for emerging markets is much better and, broadly speaking, the bias is shifting toward a rally heading into 2019.”
China: Will trade friction escalate?
“China is at the top of everyone’s question list,” says Man Wing Chung, investment director at Value Partners Ltd., underscoring what many analysts believe is a key to managing expectations for 2019.
More to the point, threat of a U.S.-China trade war has resulted in the IMF reducing its global growth estimates from 3.9 to 3.7 percent for 2019. At the same time, the Chinese economy has slowed somewhat and inflation may rise along with consumption and wages. Managing portfolio exposure in this environment will likely require a bottom-up approach, focusing on companies that manage to sustain and even improve profitability by exploiting new business models and technology.
“Ultimately, a portfolio consists of companies,” says Gary Greenberg, head of emerging markets for Hermes. “There is no shortage of companies in emerging markets and Asia in particular with decent growth, good profitability and solid management.” From a valuation standpoint, these include Chinese insurers, consumer companies and technology companies, especially those involved in telecom and the rise of 5G networks.
Mobius agrees that the trade war threat, as well as ongoing deleveraging in China, are creating “winners and losers,” noting that “many Chinese companies are well positioned with respect to the currency and have already moved manufacturing out of China.”
One bright spot for investors is robust global acceptance of the yuan. While it depreciated by more than 8 percent in the second and third quarters, it was buoyed by demand outside of China. Overseas deposits rose to 1.086 trillion yuan this year, the currency was added to the IMF’s special drawing rights basket and the U.S. declined to label China a currency manipulator.
Together, all of these factors should make markets more comfortable with emerging-market risk.
Brazil: How will Bolsonaro govern?
Gauging political risks remains the top issue with Brazil, where right-wing Jair Bolsonaro won the presidential election in late October. He ran as an outsider candidate committed to pension reform and privatizing “everything from lender Banco do Brasil to oil company Petróleo Brasileiro SA,” according to his Finance Minister Paulo Guedes. Right now, Bolsonaro has a great deal of momentum. What remains to be seen is how he will actually govern.
“There are two criteria to look at,” Morden says. “Will he delegate to his very competent economic adviser and will he negotiate with congress? There are a lot of independent parties emerging he could build a coalition with. He has said he will not work with major parties or engage in patronage politics. That is easy to say when you’re running, but in office you have to be much more practical.”
The markets clearly want pension reform. Without stabilizing the fiscal deficit, it will be difficult to stabilize overall debt dynamics, which remain the country’s main credit weakness.
“Bolsonaro’s win is a shock similar to a Trump win,” Mobius adds. “Investors are looking at the possibility of more rule of law, more stability. That’s what he represents. As always, there will be winners and losers, so look at which companies will be impacted.”
Saudi Arabia: Will the transition continue?
Due to rising enthusiasm for electric vehicles and worldwide plans to ban gas-powered vehicles, there could be as many as 125 million electric vehicles on the road by 2030. Even so, that is a relatively small percentage of the world’s two billion cars. As a result, oil prices are returning and could even hit $100 again relatively soon.
This is good news for Saudi Arabia, which is struggling to wean itself from oil revenue as it manages a transition from a conservative, isolate and tradition-driven society to one that aligns better with the expectations of the modern world.
Changes in 2018 were noticeable, including the lifting of a ban on women drivers and greater tolerance for secular entertainment. But the country is also in the spotlight for the continuing war in Yemen and the killing of a journalist, both of which have complicated the nation’s relationship with the U.S. and the U.K.
With the world’s largest petroleum fields and $500 billion in foreign reserves, Saudi Arabia can rely on oil money for a long time. But the clock will run out at some point. It is unclear whether the country can retool its economy and create enough jobs in time, considering its 30 percent youth unemployment rate, a population half of which is 25 or younger and a workforce expected to double by 2030.
Nevertheless, the nation’s Vision 2030 plan is ambitious and aggressive, pouring funding into the education, health care and tourism sectors and even devoting $500 billion to build a futuristic megacity on the Red Sea coast to be called Neom.
Mexico: Battle of the acronyms
In the near term, the outlook for Mexico hinges on whether the United States-Mexico-Canada-Agreement (USMCA) will actually replace NAFTA. The stakes are high. Together, these three countries represent nearly 1.2 trillion in annual trade. Yet there are doubts about implementation as President Trump is expected to encounter resistance from the Democratic Party-controlled House of Representatives. In fact, toward the end of 2018, he threatened to terminate NAFTA altogether.
“Concerns surrounding the passage of USMCA are weighing on private investment,” says Damian Sassower, chief emerging markets credit strategist at Bloomberg Intelligence. “Behind the scenes, NAFTA has served as a safety blanket during negotiations. If Trump terminates the current agreement, it will dial up pressure on Congress to pass USMCA. Terminating NAFTA appears unlikely, but as the impasse regarding Trump’s proposed border wall grows, you can’t disregard any possibility.”
Sassower is also assessing the spending plans of new Mexican president, Andrés Manuel López Obrador (“AMLO”). AMLO campaigned on boosting wages, which requires funding that is unlikely to materialize, meaning wider deficits and slower GDP, perhaps dropping from 2.2 to 2.1 percent.
“The new administration must acknowledge the fiscal limits of economic policy in Mexico,” Sassower says. “Despite AMLO’s lofty expectations, we need to see that he can work within the constraints of the current system. Access to foreign capital is critical as Mexico and state-owned oil producer Pemex rely heavily on external credit. AMLO has openly expressed opposition to the liberalization of Mexico’s energy market, so we need more color to understand how the end of the Pemex oil monopoly will unfold.”
The case for optimism
Despite all of the volatility past and present, the outlook for emerging markets looks positive in terms of corporate fundamentals.
“The market is saying the future is going to be a lot worse than the present, that 2019 is going to be a terrible year,” Greenberg says. “We’re not seeing that. With the companies we talk to,
revenues are growing, balance sheets are good and profitability is decent. Mobius concurs with this assessment. “Be optimistic,” he says. “I always tell people the world belongs to optimists.”
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