Daniel Graña, Emerging Market (EM) Equity Portfolio Manager, believes that it is critical to have many lenses through which to identify the most compelling opportunities and that country analysis matters in emerging markets.
- The intersection between country analysis, governance considerations and fundamental company analysis can offer an attractive hunting ground within emerging markets
- Daniel believes that Vietnam, Kuwait, Indonesia and Taiwan have very good starting points in terms of macroeconomic fundamentals, as well as good policy direction at a government level, and are currently good hunting grounds for stocks
- EM countries such as South Africa, Turkey, Argentina and Nigeria, have poor fundamentals and deteriorating government policy, according to his team’s analysis
We believe it is critical to have many lenses through which to identify the most compelling opportunities within emerging markets (EM). Countries within the asset class are at different stages of economic and political development, and as a result have a broad range of corporate and political governance standards. Therefore, we believe that the intersection between country analysis, governance considerations and fundamental company analysis is the best hunting ground within emerging markets.
Country analysis matters in emerging markets
In Brazil, for example, approximately 75% of stocks (by number not by market capitalisation) have outperformed the MSCI Emerging Markets Index over the last three years, as shown in the chart below. In contrast, there are countries like Turkey, South Africa and (South) Korea where only approximately 25% of stocks or less have outperformed the benchmark index over the same period. Clearly, some countries offer better stock-picking pools than others.
Percentage of stocks out- or underperforming the MSCI Emerging Markets Index (annualised over 3 years)
Source: Bloomberg, annualised total return data for the 3 years to 31 December 2019 in USD terms. Note: Analysis includes the 20 largest MSCI emerging markets country Indices. Past performance is not a guide to future performance.
We believe that countries such as Vietnam, Kuwait, Indonesia and Taiwan have very good starting points in terms of macroeconomic fundamentals, as well as solid policy direction at a government level. Vietnam, in particular, remains an attractive destination for direct foreign investment and continues to be a successful export platform, helping to diversify supply chains as it benefits from competitive labour costs. As a result, these countries currently provide a solid foundation for us to then closely examine company fundamentals and corporate governance credentials.
Similarly, Korea, Thailand, Mexico and Chile appear to be attractive places to invest with good fundamentals. However, their respective investment stories, in our opinion, are frail because government policy outcomes are deteriorating.
Favourable policy direction
Meanwhile, we believe that government policy direction in Brazil, China, Saudi Arabia, Egypt and India is improving so if we can get comfortable with the issues that the country has then these markets potentially provide additional stock-picking pools.
Brazil, arguably a new hope for EM, has a compromised starting point having recently suffered its worst recession on record. According to Bloomberg, gross public debt as a percentage of GDP currently runs at around 80%, which is Brazil’s Achilles’ heel. Opportunities are likely to emerge if the government can continue to enact growth-enhancing reforms to reduce debt. These include pension reform, anti-corruption initiatives, education system improvements, infrastructure enhancements, and corporate competitiveness. We believe that the country’s large output gap – the difference between actual GDP output and potential GDP, which in Brazil’s case implies potential for greater growth – and a record low interest rate could translate into an improved economy for Brazil in 2020.
Limited tools to manage China’s slowing growth
The coronavirus, which continues to weigh on China’s economy and reputation as a trade partner, is likely to negatively impact the country’s GDP output in 2020. Prior to this tragic crisis, Chinese policymakers needed to stabilise or reaccelerate GDP growth albeit with a limited toolkit.
Interest rates have been cut and the banking reserve requirement (cash) ratio is now lower than during the Global Financial Crisis. Despite the financial system being flooded with liquidity money supply growth has remained static. Infrastructure spending is leverage intensive and would push China’s debt levels higher. Concerns over medium-term financial stability now outweigh the perceived benefits of stimulating the property market.
Meanwhile, income tax cuts and other consumption-friendly measures are unlikely to have any desirable impact. We also believe that currency depreciation will not substantially help, given China’s already high global export market share and rising global protectionism. Opportunities clearly exist but stock picking remains key given the clouded macroeconomic outlook.
Lubricating the wheels of diversification
Despite Saudi Arabia’s Vision 2030 plan to diversify its economy away from oil, the vast majority of government revenues and exports are oil based. The country’s exposure to the price of oil, therefore, continues to be problematic. Egypt, meanwhile, has still not completed its economic and political adjustment process; and given weaker exports, government spending and overall capital investment levels, we believe that India is currently facing some cyclical challenges. Elsewhere, countries such as South Africa, Turkey, Argentina and Nigeria, in our view, have bad fundamentals and a deteriorating government policy and so we do not wish to invest there.