Emerging Markets Outlook: Will Emerging Markets Continue Their Run in 2013?
A number of times we have been asked whether emerging markets will continue their run in 2013. Our response typically begins with the following clarification: "Emerging markets" may be a handy way to refer to the countries that constitute a generally recognized asset class, but this group is far from monolithic. Widely differing levels of development, economic drivers, opportunities to invest, and returns exist under the emerging markets umbrella. For this reason it's not entirely correct to imply that "emerging markets" had a run in 2012. Some markets, such as Thailand, Turkey and the Philippines performed extremely well, while others such as Brazil, Russia, and China lagged.
Given the above, a more appropriate way to frame the question would be, "Will emerging markets continue to offer attractive investment opportunities in 2013?" To that question we would certainly answer, "Yes."
We are most positive on the prospects for Southeast Asia and Mexico. Other areas we will closely monitor include South Africa and India, while we have concerns regarding Brazil and China. At this point we should note that we are, first and foremost, stock analysts rather than macroeconomists. Excellent investments can be uncovered in poorly performing countries, while being headquartered in a strongly performing country does not guarantee success.
Having said that, Southeast Asia is the region with the best opportunity to support economic activity through increased domestic consumption. Following years of recovery from the 1997 Asian currency crisis, the region now boasts government finances, as well as corporate and personal balance sheets, of a quality to which Europe's southern tier (or the United States for that matter) can only longingly aspire. With the possible exception of Singapore, all of the countries in the Association of South East Asian Nations (ASEAN) are anticipated to undertake much-needed major infrastructure upgrades – be it communications, transportation, power generation, or water infrastructure. They may also benefit from the efforts of several Pacific Rim countries (including the U.S.) to establish a Trans-Pacific Partnership leading to significantly enhanced trading and investment opportunities.
|
Gross Government Debt As a Percentage of GDP |
|
|
Indonesia |
25% |
|
Philippines |
41% |
|
Thailand |
42% |
|
Malaysia |
53% |
|
United States |
103% |
|
Italy |
120% |
|
Japan |
230% |
Source: International Monetary Fund
Not only do Southeast Asian nations have the need to develop their infrastructure, they also have the means to do so. Contrast the government debt levels of the four ASEAN countries listed above with their more developed counterparts.
ASEAN demographics are also attractive relative to the developed world and even relative to other developing countries such as China, which is feeling the effects of its three-decade-old one-child policy.
The Philippines, in particular, has a young population and a strongly performing economy. Its third quarter year-on-year GDP growth rate of 7.1%¹ was above expectations and represents the third consecutive quarter of 6%+ GDP expansion. The country has enjoyed rising credit ratings and may become investment grade in 2013. The Philippines receives huge remittances ($20 billion annually²) from its army of overseas workers. In President Noynoy Aquino the country has a leader committed to rooting out corruption, increasing transparency, and bringing good governance to the archipelago - something sorely missing during previous administrations. These developments have been welcomed by steady appreciation of the Philippine peso versus the U.S. dollar and strong stock market returns.
The development of Vietnam, Cambodia, and, most recently, the positive moves made by Myanmar, also bode well for the region's economic future. Although equity investment opportunities are currently limited, the productive potential of long suppressed peoples is being unleashed. These countries will also benefit from rising costs in China as labor intensive manufacturing shifts to less expensive locales.
Outside of ASEAN, we like the prospects in Mexico, Turkey, South Africa, and India. Mexico, with its large, underemployed population and its proximity to the U.S. is strategically positioned to benefit from the rising costs of producing in and shipping from China. In more and more of our meetings with company managements we hear of strength in their Mexican operations. While the drug trade and violence are undoubtedly serious negatives, and security requirements are a drag on productivity, the desire for smaller-run, made to order manufacturing, lean inventories, and quick, efficient shipping to the U.S. are right in Mexico's wheelhouse. In 2012 the Mexican stock market enjoyed double-digit returns, while the Mexican peso also strengthened against the U.S. dollar.
Turkey remains a key emerging market for 2013, with its strategic geographic locale, 75 million-strong population, open markets, and continuing political evolution. Certain of Turkey's manufacturing activities are suffering due to the reliance on Europe as an export market but, like ASEAN, there are substantial domestic investment opportunities as well as a fairly broad and deep equity market available to foreign investors.
South Africa and India are our two dark horse markets for 2013. As the most developed economy in Africa, the former offers world-class companies, good management, the broadest equity market, and access to what is arguably the least developed continent on Earth (Antarctica excepted). While there's little to show to date, the Johannesburg Stock Exchange's goal to develop an African Board to attract listings from across the continent could be interesting.
India presents a conundrum in that the Indian diaspora has been one of the most economically successful groups in history. Unfortunately, overbearing regulation, identity-based politics, and byzantine bureaucracy hamstring domestic economic progress. As has been said, the British brought bureaucracy to India and the Indians perfected it. Political reform or improved governance in India would be a positive sign for investors.
Governance is a recurring theme in emerging markets, bringing us to our list of unattractive countries. In Brazil, President Rousseff has implemented a number of confidence-damaging statist policies. She has strong-armed the Central Bank of Brazil on interest rates, maintained domestic fuel subsidies, and presented power generation companies with a no-win scenario by imposing price reductions as a condition of license renewal. The effects have been felt in both the currency market and the equity market, as the Brazilian real, unlike the Thai baht, Philippine peso, or Mexican peso, depreciated against the U.S. dollar in 2012.
Nor are we enthusiastic about China's prospects. After a long period of underperformance beginning in 2009, the Shanghai A Share Index rebounded toward the end of 2012. Nonetheless, rising costs, a still over-supplied property sector, and the hangover from the world's biggest post-crisis stimulus program as a percentage of GDP do not paint an attractive scenario.
As investors, we are ever mindful that emerging markets don't run as a pack any more than developed markets. There will always be front-runners and laggards, while our task remains to identify the best opportunities regardless of locale.
Footnotes
1 Philippine GDP growth at two-year high of 7.1%, Business World Online, November 28, 2012.
2 Remo, Michelle. Overseas Filipino remittances up by 5% to P10 B in 1st half, Business Inquirer, August 15, 2012.
http://business.inquirer.net/76985/overseas-filipino-remittances-up-by-5-to-p10-b-in-1st-half
Copyright 2013 Saturna Capital Corporation and/or its affiliates. All rights reserved. Vol. 7 · No. 2
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