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Friday 18 October 2019

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Coming full circle

Written by Lynn Strongin Dodds
February/March 2014

Developed markets are once again finding favour after years of growth in emerging countries has stuttered. But Lynn Strongin Dodds finds selectiveness is advisable

After years in the wilderness, developed markets are having their day in the sun as European institutions desert the once fashionable emerging countries. This trend is set to continue for the rest of 2014 but there are still opportunities to be had in the less advanced nations. The difference today is that investors will have to tread much more carefully and do their homework to unearth the prospects.

There is no doubt though that China’s spluttering economy and the Federal Reserve’s tapering of its $85 billion a month bond buying programme has not only spooked European pension funds but their counterparts across the globe. The descent started last year with the MSCI Emerging Markets Index, a gauge of stocks in 21 developing markets, dropping 5 per cent compared with the double-digit-percentage rallies in stock markets in the US, Japan and Europe.

Performance has slightly improved in the developing world but investors are continuing to retreat in in droves. The latest figures from data global provider EPFR shows that less than two months into 2014, $4.5 billion was withdrawn from emerging market funds in the week through to 12 February, extending the total outflow this year to $29.7 billion. This already tops the total $29.2 billion pulled for the entire year in 2013. Their fall from grace is also reflected in the recent Bank of America Merrill Lynch survey, which revealed that exposure has reached an all-time low with a net 29 per cent of asset allocators underweight these countries. By contrast, a record net 40 per cent of the 175 managers, overseeing $456 billion globally, are targeting the eurozone as the region they most would like to overweight in the coming 12 months. US equities are also becoming more popular with a net 11 per cent favouring the country, up from a net 5 per cent in January.

“The pendulum that swung away from the US for 20 years is now starting to swing back, as the key advantage of China, a vast seemingly unlimited supply of cheap and underemployed workers, has become a disadvantage,” says Principal Global Investors chief global economist Bob Baur. “There are structural issues such as the one child policy, which is now showing up in the shrinking labour force and the peak in productivity growth. Also, the country is no longer as competitive because wages have increased and the currency has appreciated by 40 per cent over the past five years. As a result, it is unlikely to ever see double-digit growth again - 6 to 7 per cent is the best it can do.”

Although China may garner most of the attention given its size, the spotlight is also firmly on the so called “fragile five” – Turkey, Brazil, India, Indonesia and South Africa – which together comprise over 12 per cent of global gross domestic product (GDP) and have contributed almost one-fifth of world economic growth since 2009. Each has ratcheted up large current account deficits and their respective impending elections are making European as well as global investors nervous. For example, in South Africa, the African National Congress, the ruling party of 20 years, is expected to win but with a reduced majority. This is due to lack of reform that has left the country with a high 25 per cent unemployment rate, weak infrastructure, frequent labour unrest, low investment and a growth rate of just under 2 per cent.

Brazil has also been beleaguered by economic woes including excessive state intervention, faltering exports to China, alleged corruption and ballooning expenses tied to hosting the World Cup. Brazil President Dilma Rousseff is expected to win a second four-year term but he will have his work cut out in restoring its once-booming economy that is entering a fourth year of slowdown, with an expected rate of around 2 per cent in 2014. By contrast, India may look healthier with a GDP rate of 4.9 per cent but inflation is almost 9 per cent and the country has been racked by a raft of corruption and reform paralysis. The opposition BJP is seen as more pro-business than the ruling Congress, but leader Narendra Modi is a polarising figure for his alleged role in 2002 riots that killed over a 1,000 Muslims. Courts have absolved him of any wrongdoing.

“Emerging markets have been in the maelstrom,” Threadneedle Investments head of global equities William Davies says. “However, you cannot group them all together and you need to be selective.

For example, I would avoid those countries running large current account deficits or facing elections but there is no reason why South Korea or Taiwan should be caught in the same net. They are in a much stronger position economically than some of the other countries.”

European investors are also advised to be discerning on the developed front, especially in the US where stocks are looking expensive after its prolonged bull run. “Investors want yield and return and the equities markets are still the best bet,” says BlackRock head of global equities James Bristow. “We like the US because companies are very shareholder focused. They have been active in share buybacks as well issuing dividends and I think this will continue as long as interest rates are low and investors want yield.”

Combined, stock buybacks and dividends in the US totalled $207 billion in the third quarter last year, which was the highest in nearly six years, according to data provider S&P Dow Jones Indices. Among the biggest buyers of their own shares were Apple, Pfizer and Exxon Mobil Corp. The main advantage is that they return cash to investors while boosting companies’ earnings per share by reducing their share count.

Neuberger Berman head of global equity Benjamin Segal does not believe buybacks and dividends alone are a good enough reason to buy the US. “Buybacks help boost earnings per share, but largely offset stock option programmes that otherwise dilute EPS. From a European as well as North American perspective, we think currency will be a big issue. As a result we are looking at local domestic exposure from the US because of the relative strength of the dollar. In Europe, we believe that companies that are less sensitive to the European recovery – those that were not beaten up in the crisis but executed effectively - offer the most interesting opportunities. This ranges from technology group SAP to car manufacturer Volkswagen, engineering group Linde and consumer giant Unilever.”

State Street Global Advisors head of portfolio management Brian Routledge is portfolio manager of the global spotlight fund, and adds: “Things seem to be in much better shape in the US but I think it will be a struggle to find cheap quality companies. There were a lot of bargains in 2008 and 2009 in the US but that is no longer the case. As for Europe, I think they are still early in their profit recovery cycle. We are invested in industrial late cycle and select consumer shares where profits have yet to normalise and valuations remain depressed.”

Templeton global equity group fund manager Dylan Ball notes that they had found cheaper value oriented ideas in Europe such as in healthcare, industrial and telecom stocks. “They have strong balance sheets and dividends, limited debt and growing free cash flows. We are now taking advantage of the discounts in European financials and insurance companies.”

Fund managers are also being more discriminating when looking at Japan, which has enjoyed the fruits of Prime Minister Shinzo Abe’s generous monetary and economic reforms. “I think it will be more challenging this year,” says AXA Investment Managers senior portfolio manager Mark Hargraves. “This is the year we will see if Abenomics has really worked. The market re-rated last year driven by earnings growth compared to other countries but it is no longer particularly cheap and the country is facing a potential double whammy of new consumption tax and stagnant wage growth. This is why selectivity will be key.”

Written by Lynn Strongin Dodds, a freelance journalist



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