Emerging markets have staged a rebound during the last two quarters, after a period of uncertainty at the beginning of 2016. AsianInvestor conducted an online poll in midsummer which underscores a positive mindset towards the sector, with nearly 60% of the poll’s respondents registering either ‘positive’ or ‘very positive’ views towards the sector (see graphs below, click to enlarge).
Amundi shares the broadly optimistic viewpoint of the poll towards emerging markets. Their reasoning is primarily because there has already been a huge adjustment for emerging markets in recent years.
Global growth has been slowing and that in turn has led to a cut in imports in Latin America and EMEA. As a result, there are many markets that have been improving in terms of current account numbers.
“External deficits have been narrowing, and this, combined with a huge search for yield, means that interest in investing in emerging markets is far higher than in developed countries,” said Patrice Lemonnier, Head of EM Equities at Amundi. “As long as there are virtually zero interest rates in developed countries, in tandem with continued improvement in macro-economic management, as well as greater political stability in emerging countries, the investment outlook for most emerging market countries should continue to improve.”
As a result of the combination of strong current accounts plus the search for yield, he perceives a trend towards increased investment in emerging market bonds, which, in turn, has a tendency to lower equity risk.
The AsianInvestor poll reveals a preference towards Asian equities (see graphs above), which, for an Asian-themed publication, is not surprising. Amundi, however, prefers to examine emerging markets by country rather than region.
Examining EM countries
A forensic appraisal of the investibility of a specific emerging market calls for lateral thinking. The broader political situation is a key determinant. Lemonnier indicated that it is important to be able to interpret signals of potential improvement – often from scenarios that initially appear to be contrarian.
For example; the failure of the recent military coup in Turkey ostensibly improves country risk. However, if it results in the incumbent administration clamping down and becoming more authoritarian, it could be negative for Turkey’s outlook in the long run.
Watching for key risks
In the global outlook for growth, dramatic changes to central banks’ policies would be negative for emerging markets if, due to inflationary pressures, tightening were to accelerate beyond the one interest rate increase projected in the US this year.
However, Patrice Lemonnier, head of EM Equities at Amundi, believes that China is the most vulnerable weak point, and being an important country for emerging markets, this signifies that China is the leading risk.
“I would flag the biggest risk to emerging markets is an abrupt slowing of growth in China, either expectedly – because the authorities move to reduce the growth rate, or unexpectedly, in the sense of the economy slowing down by itself,” he concluded. “It would have a negative effect on commodities and lower demand from China would spiral down to other emerging markets.”
In Thailand, a referendum was held at the beginning of August. It approved a new constitution that appears to erode democratic choices in favour of appointees. That overarching principle may appear to be a retrograde step – and yet the greater political stability it brings may result in improved investment conditions in that politically conflicted country.
Amundi is positive on Russia, where the external account has turned positive after foreign exchange adjustments, even though the oil price has fallen and commodity prices remain a question mark.
“We think the period of adjustment is ending in Russia. Valuations are still attractive and the ongoing situation continues to play strongly in Russia’s favour,” said Lemonnier. “There remain risks and Russian corporate governance is not the best. Yet there are well-managed companies. At times, the state-owned oil companies are priced at such a discount that they make sense as investment opportunities.”
Amundi is also overweight South Korea. Although growth prospects are not spectacular, valuations are attractive and dividend policies/payout ratios have been steadily improving, Lemonnier noted. “The consumer sector has produced some good opportunities and we are overweight in Korean tech, which has been attractive.”
He has also been positive for some time on Southeast Asia, including Thailand, the Philippines and India, but the firm has been reducing some of its positions as valuations have been reaching high levels.
Over a third of respondents to the AsianInvestor poll favoured China as their preferred emerging market in Asia (see graphs above). Amundi does not share that viewpoint and is currently underweight China.
Whilst the firm sees some interesting opportunities in consumer names, it is cautious about prospects for the finance sector. It is this sector that drives its underweight rationale.
“We know it looks cheap, but with the debt-to-GDP ratio growing strongly, it could make life difficult, alongside deteriorating loan quality and lower yields that lead to a fall in interest rate margins,” said Lemonnier. “The increase of debt in China looks unsustainable in the long term – though the present situation may continue at some point, as China does not require external money. It would seem reasonable if at some time the Chinese government adopts a policy to reduce the speed of loan growth.”
Further afield, Amundi has been positive about Peru for a long time. The country ranks behind Chile, which has a developed mining and agriculture sector and has reached a plateau of development, whereas Peru is still in an ascending phase – having begun its growth cycle later.
Peru’s mining industry is priced cheaper than that of Chile. Whilst it has a lot of catching up to do, Peru’s financial situation and macro-economic management is good and it has a very limited fiscal deficit. The country’s current account is negative but it does benefit from strong foreign direct investment and an extremely low level of banking debt to GDP.
Lemonnier currently prefers emerging markets over developed markets. The US market looks to be expensive, with somewhat at stretched levels of valuation. Even as earnings projections have been revised down, the US market has continued to rise.
He noted that valuations are less demanding in Europe but that there remain potentially troubling political issues. There is a lot of uncertainty with upcoming elections and therefore he believes it is hard to feel highly optimistic about European growth.
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