Emerging markets have been battered indiscriminately these past months. Now that the baby has been thrown out with the bathwater, it’s time to pick those stocks that have been unfairly hit and that can outperform in the medium to long term.
In emerging markets, all negative events that could have happened, happened. The looming prospect of the Fed hiking rates – eventually – has been putting pressure on emerging currencies. The Chinese government’s decision to move to a more market-determined exchange rate for the yuan, although much-needed, was very poorly timed, and on top of that Chinese domestic shares have been faced with great volatility. The earnings season for emerging markets has been disappointing. Outflows from emerging markets amount to a cool USD 63 billion year to date and are at the levels of annus horribilis 2008 (source: Bank of America Merrill Lynch, The Flow Show, 8 October 2015).
The result: since its most recent peak in April of this year, the MSCI Emerging Markets index has plummeted by almost 20%. The interesting part is that markets make little differentiation among the various countries – they never do when they’re in panic. Since June 30, 2015, 99.6% of the MSCI Emerging Markets index has underperformed Europe and the US.
‘Now is the time to start selectively looking for opportunities’
However, emerging markets are not one homogeneous investment category. They are spread across various continents, are in different stages of development, have other drivers and face highly diverse political conditions. There’s a huge difference between a country like Brazil, which is faced with a deteriorating macro-economic, fiscal and political situation, and India, where macro-economic figures are improving and Modi is implementing much-needed reforms. This creates investment opportunities.
When we look at the fundamental drivers of the pain, we see that these are mainly related to the slump in commodity prices. The decline in commodity prices had a negative impact on some but not all emerging markets. The commodity exporters were most vulnerable: it’s their currencies that were the most hit and their earnings that declined.
As Figure 1 shows, the lower oil price is, on balance, a positive factor for emerging markets, benefiting some 80% of the MSCI Emerging Markets index’s market capitalization.
When looking at currency pressure and earnings per share, we see a clear difference between manufacturing emerging markets and commodity emerging markets. This is shown in Figure 2.
The impact of the Fed’s policy also varies strongly across emerging markets. Emerging market equities do not necessarily drop when the Fed hikes rates. They drop when the outlook for growth is poor. From 2004 to 2008, for example, a period of tightening Fed policy, emerging markets thrived. The countries that will get hit by a Fed hike, are mostly those with a USD-denominated debt and a large current account deficit.
After such as a deep fall, at some point the market is set to rebound, and we have seen that happen in the last couple of weeks. When that happens, all stocks rise as indiscriminately as when they fell. However, it is key to look for sustainable medium- to long-term earnings growth. This can be found in several countries, but the strong structural reform stories that stand out are China, South Korea and India.
China is undergoing a structural transformation. An ambitious reform plan is on the way, providing, among other things, more freedom for private investments, reforms of state-owned enterprises and market pricing of resources and the environment. Currently there are two Chinas. One the one hand, there is the ‘old’, manufacturing China, which is dealing with overcapacity, and on the other there’s the China of the services industry, which is growing steadily as a part of GDP. Consumption is also holding up rather well. When looking for investment opportunities, it’s therefore important to look in the right places.
Currently, China is underrepresented in market indices. If A-shares and ADRs were fully included, China would account for more than 40% of the MSCI Emerging Markets index, versus the current weight of close to 23%. Add to this a valuation that is at all-time lows and there are plenty of opportunities for the discerning eye.
Large Korean companies are cash-rich and are showing the first signs of improving shareholder friendliness, for example by increasing their payout ratios or buying back shares. The payout ratio is currently still at the bottom of developed and emerging markets, but in December 2014, the government passed a law to either invest or pay out retained earnings. We expect the ‘Korea discount’ to tighten.
In India, the Modi-led government has implemented a commendable list of reforms, and more is yet to come. The red tape that has traditionally been an important obstacle to capital investment has been significantly reduced. Private sectors have been opened up further to foreign investments. The Insurance Bill, for example, has increased the foreign direct investment (FDI) limit from 26% to 49%. The railways FDI limit has even been increased to 100%. The infrastructure budget has been increased substantially and with programs like ‘Make in India’ and ‘Digital India’ we would expect job creation to accellerate.
On the back of these reforms and also helped by a benign inflationary environment and lower interest rates, the capital spending cycle in India has been recovering since mid-2014. Of course some important reforms still remain to be completed, of which the Goods & Services Tax is the most important. That said, we expect more progress at this end in the coming year.
There are many compelling investment opportunities in emerging markets, as long as you look in the right places. The times when everything remotely related to emerging markets went up, are over. Now is the time to do your homework, and thoroughly research which pockets of which market are interesting, and which ones you should steer clear of. For the discerning investor, emerging markets can therefore offer vary attractive returns for years to come.
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.