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Emerging market fundamentals are stronger than ever
and talk of contagion, particularly now, seems overdone.
Seeing the opportunity
It’s been a challenging few months for emerging markets,
impacted by talk of trade wars and ongoing currency woes.
Unsurprisingly though, as active fundamental managers we
see the dislocation between (often overly) negative market
reactions regarding emerging markets and the actual longterm
drivers of growth in the asset class as a compelling
opportunity.
Indeed, we believe the asset class still represents good
value in terms of an international equity allocation. Return
on equity is fairly synchronised with developed markets, as
represented by the MSCI World index. Importantly though,
price-to-book and price-to-equity values remain low relative
to history and developed markets.
Gust or storm?
Turkey’s currency crisis in early August prompted an all-too familiar
set of headlines. A predictable news flow that was
eager to foretell that the crisis would deepen and inevitably
spread across the entire asset class. As is usually the case,
‘contagion’ quickly became the must-use word for every
emerging market commentator.
This customary, knee-jerk reaction prophesising that
emerging market turmoil will develop from an adverse
situation in one of the many differentiated emerging market
economies is, in our opinion, not only wrong, but a completely
outdated view of the asset class.
Distinctive markets
In previous bouts of emerging market turbulence, investors
have often been quick to ditch the asset class, making
little distinction between individual regions, governments,
economies or companies. It’s a response which continues
to have a lingering legacy, even though compared with any
other point in history, emerging market countries are more
stable economically, more independent of each other and
increasingly diversified.
Times have changed and economic vulnerability (leading to
contagion) in emerging markets has significantly lessened.
What’s more, investors are also gradually becoming more
aware of the different drivers between individual markets.
No two situations are alike
For instance, during the recent currency weakness in emerging
markets several varied factors have been at play. In Turkey,
the crux of the recent problem has been a substantial pickup
in inflation, as well as relatively high foreign-denominated
debt and a current account deficit, with the backdrop of some
unorthodox policy moves not helping matters either.
By contrast, in Argentina (which is not yet part of the MSCI
Emerging Markets index), circumstances are very different. The
government tried to implement an ambitious fiscal adjustment
that depended on constructive global markets and increasing
Foreign Direct Investment (FDI). Unfortunately, the FDI did not
materialise and markets became much more nervous, coinciding
with some policy mistakes. However, the situation has been
stabilised by an IMF credit line and interest rates at 40%. of some
unorthodox policy moves not helping matters either.
South Africa, meanwhile, has also experienced currency
weakness, forcing the monetary authorities to raise rates. The
greater issue there is politics – in particular, the coincidence of
a weak economy coinciding with the reforming agenda of new
president, Cyril Ramaphosa, as he looks to break the back of the
existing corrupt power structures in the ruling ANC.
Fundamentals stronger than ever
We should not downplay the seriousness of the situations
these countries face – recessions in Turkey and Argentina
are all but guaranteed. However, the currencies in question
have largely stabilised (albeit it at much lower levels) and it
is noticeable that wider contagion across emerging markets
has not materialised. In Mexico in fact, although not widely
reported, the peso has actually strengthened against the US
dollar.
Of course, the rising US dollar that we have witnessed
recently does have implications for countries where US
dollar-denominated debt is high, such as Turkey. Yet, for many
emerging markets that dependence on external funding has
dropped significantly. Domestic bond markets have developed
and provide a greater source of financing for emerging market
governments and companies. Sovereign balance sheets are
consequently in far better order than they were even five
years ago, with debt-to-GDP levels lower and debt increasingly
denominated in local currency.
In short, emerging market fundamentals are stronger than ever
and talk of contagion, particularly now, seems overdone.
Important information
This information is issued and approved by Martin Currie
Investment Management Limited (‘MCIM’). It does not
constitute investment advice.
Past performance is not a guide to future returns.
Market and currency movements may cause the capital value
of shares, and the income from them, to fall as well as rise and
you may get back less than you invested.
The opinions contained in this document are those of the
named manager(s). They may not necessarily represent the
views of other Martin Currie managers, strategies or funds.