This Interview was originally published by Investorama Magazine of LGT Capital Partners Ltd
2018 was a very difficult year for the markets in general and emerging markets in particular. The markets continued to set new lows, testing the patience of investors. In terms of fundamentals, however, the emerging markets remain an attractive investment destination. The expert and pioneer for investments in emerging markets, Mark Mobius, makes the case in the following interview that this asset class still offers lucrative opportunities despite the challenging market environment.
Investorama: From a fundamental point of view, emerging markets (EM) seem to be less vulnerable compared to previous episodes of EM stress. Still, the asset class experienced significant drawdowns during 2018. How do you explain this sell-off?
Mark Mobius: The sell-off was primarily due to the strong US stock market and the strong US dollar which attracted investment dollars to the US. The threat and then the reality of a trade war, accompanied by a strengthening dollar, have contributed to a bear market. Currencies have weakened in the vast majority of developing nations, while Turkey and Argentina have suffered financial crises. The MSCI Index has fallen around 16% last year.
But there are also some positive signs. These markets remain the fastest growing economies in the world. The International Monetary Fund estimated that EM will grow 4.7% in 2019, more than double the predicted growth for developed countries. Furthermore, FX reserves have increased almost five times, from USD 1.7 tn to over USD 8 tn, between 2002 to 2017. EM government debt (as a % of GDP) is now lower than in 2002. This mitigates concerns about the rising cost of hard currency interest payments. Crucially, intra-EM trade has also increased significantly in the last few years, now representing 41% of total EM trade. This makes local champions far less dependent on developed markets.
Most crucially, EM now offer a dramatically more attractive set of companies that no longer follow the developed markets – they lead.
Which factors are clouding the outlook for EM?
From an investor psychology point of view many would become bearish if the US-China trade war continues, oil prices go back up and US interest rates move above a 5% level. But the US-China trade war is beneficial to a number of EM since they will pick up the manufacturing and export business that China has to abandon. As regards to interest rates, much of that has already been discounted and – unless rates in the US go above 5% – much of the interest rate expectation is already in the prices and exchange levels. So those factors cloud the outlook but are, at least for 2019, not critical.
What could trigger the next EM bull run?
A halt in US interest rate rises and a subsequent weakening of the US dollar could trigger an EM bull run. Also positive growth numbers in those markets, although they already are good, would be another trigger. A rise in populist policies would be another trigger. For example, in India there are proposals by the government to cancel farm loans and at the same time recapitalize the banks. This would result in a surge of spendable cash in the hands of consumers resulting in a consumption boom. Although such free spending government policies could result in future financial instability and inflationary tendencies, in the short-term they would be bullish for markets.
Given the current pessimism of market participants, are their fears justified or is it time to take a contrarian approach and buy EM?
Many market participants have been holding off investing amid the recent volatility, particularly in view of falling EM currencies. We should acknowledge that this offers more attractive prices for overseas investors.
Every market crisis always creates winners and losers. It is our job as investors to ensure that we can dig out the winners. The sharp drop in currencies and the fall in the market give investors a double opportunity for potential upside.
Where do you see attractive investment potential in EM (e.g. countries, sectors, corporates)?
Countries like Argentina and Turkey, that have suffered the most from the recent crisis, could offer the greatest opportunities. In terms of its economic size and export potential, Turkey could be particularly interesting. However, this is contingent on whether the volatile political situation calms down. At this stage, it is all about winning back the confidence of investors. With the Lira down, any exporter will be in a good position to trade with developed countries. At the same time, the currency crisis makes investments in Turkey relatively cheap.
Generally, the global currency depreciation is a big opportunity for EM. It will allow them to grab a bigger share of the export market. Furthermore, countries like Brazil, Mexico and India, for example, could benefit from a continued trade war between the US and China. Brazil could sell more soybeans to China, Mexico could take a portion of Chinese auto parts exports, while India could grab some of the manufacturing capacity moving out of China.
As investors, these changes to the status quo and the knock-on effects are where we see greatest opportunities.
EM have been the winners of the (hyper-)globalization of the past decades. Is the fact that we have reached the peak of this development and globalization’s momentum is declining a chance or a threat for EM?
EM are estimated to grow more than double the rate of developed countries this year. A lot of this growth is coming from intra- EM trade and internal demand.
Populations and living standards in emerging and frontier markets have ballooned, creating enormous middle classes with growing consumption levels. Furthermore, there has been a notable shift from traditionally export-driven industries such as textiles, towards sectors such as technology. These new industries tap much more strongly into the home market. When I go to trade shows, it is increasingly the EM companies that have started to dominate in areas such as robotics and high value component manufacturing. Intra-EM and especially intra-Asian trade is a common characteristic for a number of sectors such as technology, fashion, shipping and media.
In China, technology ‘unicorns’ are being born with increasing frequency, without ever leaving the domestic market. In Indonesia, entire sectors (such as banking) remain undeveloped, offering numerous multi-billion-dollar markets to tap into for Southeast Asian companies that can combine cultural and domain expertise.
These sorts of domestic and regional growth opportunities, regardless of what happens in developed markets, offer resilience at a time when many are concerned about a fallout from the ongoing trade war and a decline in the globalization movement.
Therefore, I believe that developing economies are well positioned to generate significant and sustainable returns. As a result, this year we might be seeing more money flowing back into EM stocks.
Dr. Mark Mobius co-founded Mobius Capital Partners LLP in May 2018, an emerging and frontier markets asset manager offering innovative and sustainable investment solutions. Prior to that Dr. Mobius was with Franklin Templeton Investments for more than 30 years, most recently as executive chairman of Templeton Emerging Markets Group. Dr. Mobius is an internationally recognized pioneer of emerging markets investing and a member of the Economic Advisory Board of the International Finance Corporation (IFC). His career and influence has earned him numerous industry awards, including most recently the Life Time Achievement Award in Asset Management (2017, Global Investor Magazine) and 50 Most Influential People (2011, Bloomberg Markets Magazine).