Opportunities in Emerging Markets
Tim Morris: Everyone, thank you for taking the time to join us today. My name is Tim Morris and I'm an Investment Specialist for the Emerging Markets and Asia Pacific Equities Team here at JP Morgan Asset Management.
Today, I'm joined by my colleague, (Sonal Tanna). (Sonal) was a Portfolio Manager and two decade veteran within the NEP Equities team, based in London. She's a member of a group responsible for our core emerging market strategies, including the GEM Opportunities and GEM Analyst Strategies. (Unintelligible).
(Sonal Tanna): Thank you, Tim, for having me here today.
Tim Morris: Of course. Over the next 45 minutes or so we will touch on a range of macro and more industry specific topics across a broad array of emerging markets. So with that, let's jump right in (Sonal).
You spend the majority of your time speaking with our research analysts and directly with emerging market equity companies to talk a little bit about what you're seeing and hearing in the market right now.
(Sonal Tanna): Sure Tim. So big picture, the way we are seeing market evolve within our region, that emerging markets is actually quite similar to what's happening in developed markets right now. It's interestingly, a typical to other recession. So obviously, with other recessions, historically, we've seen cyclical through the recovery. But this time given issues because of COVID, associated restrictions, et cetera.
We've seen sectors such as e-commerce, really adapt and be the quickest to recover, there should be an upgrade in this sort of sector. Healthcare is another one. And the more recently we have seen reasonable rebounds in materials, obviously, industrial sectors also starting to rebound.
That regionally within emerging markets, we are seeing a pretty strong bias towards North Asia. And we can talk a little bit more around what the drivers of that all. Other regions, Latin America, emerging Europe, et cetera, are still lagging. Obviously, they've had sharper economic contraction and are struggling due to the lower oil prices as well.
But we are starting to see perhaps some stabilization in the data. And once again, similar to what we're seeing elsewhere, in terms of sectors, is the lack of 3d are the pure, typical value cyclical sectors, financials, energy, et cetera. The ones that are really struggling.
That's just a very big picture view to share with you today.
Tim Morris: Certainly very helpful. I think, particularly for the research analyst, it's certainly an interesting time to be covering the industries and stocks that they look after.
How are they feeling about the outlook and what they're hearing from their companies under coverage?
(Sonal Tanna): Yes, it's not easy being an analyst in this environment, I'm sure now at the start of the move back in March and April, given the intense volatility that we had, but also, there was far greater uncertainty as it was rather difficult for any of us to really judge how long the lockdown would last. How severe they would be.
And also, we weren't sure about how governments across emerging markets, be willing and able, really to react. So early visibility was obviously quite narrow. At this point now, I feel based on my conversations with analysts, we have more of a view on what the base case assumptions are. And therefore the range of our competitors gotten extremely large, is now most of the sensible and narrowing.
But also intersector, we are finding it easier to differentiate the winners and differentiate the businesses that will continue to thrive. In a crisis, certainly help management teams differentiate themselves. Certain we are seeing that come through in terms of our analysts’ views and conviction levels.
If I may, I think what's interesting also is how the period has really accelerated some of the changes that were happening already. And within emerging markets.
Again, like I mentioned, e-commerce type of in equities to recover. This is no surprise. This is an industry clean and the disrupted and there was clearly a trend change happening.
This has been accelerated. And the conversations we're having with our analysts and the companies we look at, are really sort of reaffirming the fact that this is something which is not going to go away, even when we get on top of things like COVID, for example.
Another example I may share is something that we've seen particularly on the technology side companies like TSMC, they will lead us into this and they come out even stronger. I think, both in terms of their own emerging market peer group, but also against their developed market peers, their US competitors, et cetera.
They clearly are able to stand out as well. So that's, again for the second areas of the market starting to see a lot more of confidence returning to great companies and particularly to us investors and analysts.
Tim Morris: And certainly very interesting. From interaction you could even you personally have with some of these companies over the past few months. Many firsts sticking within the tech and e-commerce space, any other businesses that are jumping out as being particularly surprising or having very strong results?
(Sonal Tanna): I think one of the very rather encouraging surprises as you increase supply has been how even the bigger more established companies and Alibaba is the one that comes to mind has been adjusting and responding particularly well. In fact, they just had sort of a series of investor days visited on the virtual format. And I think what was extremely encouraging for me personally and certainly we've seen a lot written about this, is that cloud business will becoming profitable within the next 12 months. Which is hugely encouraging.
And this is, again, you know, these businesses have been incredible growers over the last few years. We ourselves, we're forecasting, you know, we've been very pleased to see the ecosystem develop. And it's been extremely encouraging, even in the challenging time, how are they continuing to do that. That's incredible.
I think China as a whole, just stepping away from e-commerce for a minute or from technology and the disruption piece for a minute. China as a whole has been betting what we're seeing on the ground, talking to both our colleagues who are on the ground there, but also, to companies that we look at. We are seeing a very nice recovery coming through. And that's a pretty good reminder to the rest of us of what recovery from COVID might look like or what normality in this new normal world might look like.
And this is actually happening. Obviously, some sectors are doing better than others. But encouraging, even sectors just travel and domestic tourism is starting to see a pickup. One of the hotel companies that we speak with, they -- I think that hotel demand to be backed and Austria's level already by the end of 2020, which I think is hugely encouraging. So you are seeing quite a nice pickup in a lot of places within China.
Cap Tech has been lagging, I think services consumption has been lagging a little bit. But we would expect to see that also pick up over the next few months as the economy continues to come out of the COVID hit as well.
If I go on to maybe share with you a couple of other parts and bringing together what we're hearing from some other sectors. Financial has clearly been hit extremely hard in all parts of the world. We are starting to see again as we emerge from lockdown. So some activity levels rebound for the emerging markets.
I think India is a good example. The virus is far from defeated. But speaking with HDFC, which is a home loan business that we've been long term followers of in India. Speaking with them, they do expect volume levels to go back to a normal run rate as we get towards year end. And what's interesting to me there is there is obviously a much bigger disconnect between what we see as gradual improvement versus through the valuation that these sectors are trading on.
Similarly, some of the conversations we're having with banking franchises in Mexico. Clearly they acknowledge that the rate environment is certainly more challenging than it has been historically. But well about zero, the negative rates that we see in some parts of the world. And actually are looking forward to seeing here partly because of very strong and decisive action from Central Bank, et cetera. We are looking forward to seeing provision reversals in recoveries coming through over the next 12 to 18 months.
Tim Morris: So with the negative impact, clearly, earnings took a substantial hit. You mentioned with the exception, perhaps of some names and e-commerce that were beneficiaries of some of what's transpired just across the majority of stocks and sectors within the asset class. As we're starting to see, as you mentioned, better earnings visibility, are we seeing the signs of recovery and earnings and how our forecasts starting to look going into next year?
(Sonal Tanna): Yes, so I had to stick to sort of consensus numbers that have been forecast for the asset class for 2020. At the moment, the numbers are sort of minus 13% in dollar terms. Obviously, a lot of that has already happened in the first half. And actually from where we are now, we are starting to see some sort of stability, sustainability maybe not being necessarily revised up in the very, very short term, but we are seeing some stabilization.
Looking out obviously to 2021. We are seeing actually quite a reasonable, in fact, quite a big move within a 31% earnings good being forecast by the street. So arguably a lot of the street is already building the signs of recovery that they're seeing. And particularly I think the interesting thing is when I look at the sexual breakdown of where that earnings recovery would come from, it's much more evenly spread out than the narrow positive earnings in the tech and e-commerce space and healthcare space that we've seen this year.
So, assuming we get this to happen and we can obviously talk about some of the risks to this, but assuming this happens, I think I'm quite encouraged with how we are set up looking into the next 12 to 18 months.
Tim Morris: I think we'll come on to risks in a second. I'm curious, maybe this is one of the risks that investors particularly in developed markets have grown concerned that perhaps things are priced for perfection. Do we share concerns about emerging markets and I know, valuations are crossing broad range within the asset class at the moment.
So I'm seeing aggregate valuations for emerging markets that clearly rebounded from the very attractive entry point that we got back towards the end of March, early April. At this point where, to the no man's land. We are not those cheap levels, but we're not expensive relative to the history of the asset class. We're really bang on average valuation for emerging markets.
Now, clearly, a lot hinges on, I think makes sense to go into the risks of what might derail this, a lot hinges on the risk of any second COVID wave and any further economic fallout from renewed lock downs, et cetera.
So that is the risk out there that we think all of us in all parts of the world have to contend with.
But I think China is a good example of what if you are able to contain the virus and avoid it for Yorktown typically, is a model for the best case scenario until you've got widespread vaccines and proven therapies to deal with the virus.
Tim Morris: Thinking about other risks in assets class, I think, within emerging markets, sometimes geopolitical or even just political risk is fairly inherent. Though, to some extent this year COVID and the associated recession has drawn some of the attention away from some of these hotspots.
I think the US China relations, which have been much spoken about for the past few years now, continue to grab headlines. While some other markets, particularly in Turkey, which is flirting with the crisis yet again. I think is less on the radar of international investors.
Can you maybe then just spend a couple of minutes thinking about and talking through those situations and how we see them playing out?
(Sonal Tanna): Yes, US China relationship, I think has been tense or has continued to sporadically come back up, even though we had some sort of tempering down over the last couple of years. But it's clearly something that is emerging market indices, we continue to be aware of.
The companies we speak to us certainly thinking about their long term growth trajectory. With that backdrop that is a new normal, it is clearly centered around tech, even though other sectors do get pulled in.
And so some of the conversations that we have been having with companies is around how companies are able to think about the differentiated customer bases and a way from having an over reliance towards a single customer, particularly, American customers only.
And importantly, also on the other side, have their device on their supply chain. And so luckily, encouraging conversations with companies within one of the companies, Sem So, that is a big apparel manufacturer and a supplier to companies like Nike, et cetera.
Have been very just recently, but over the last few years in terms of diversifying their supplier base. And particularly their production basis as well as to where their factories are located.
So you've seen a lot more of that continue. As well as to some degree at least in the portfolio's that I manage. And speaking with analysts, we spend a lot of time portrait thinking about companies that are possibly overly exposed to a single smartphone maker. Which is pegged to the US.
So those are some of the tensions that are underlined. But obviously this is something that's big and impactful in many ways across the portfolio's. The Turkey question that you raised. Now, that's obviously somewhat more contained.
And I would actually say that what's been happening in terms of slower growth, et cetera is just exposing what has been a continuation of poor macro-economic policy. And market concerns around the lack of independence of central bank really come through.
We have been talking about this for a number of years. It was only as recently as 2018, that we had the last sort of test the crisis as well. So you do have this issue, but the problem is that every time that it's not resolved and instead of craft and papered over, you end up with a potentially bigger issue further down the line.
So I think Turkey is in a while, obviously, there's geopolitical tensions as well, that are making the situation worse. It's the economic fundamentals that really would be of concern to us.
And so for us in terms of our positioning, we are relatively cautious on something like Turkey, while despite US China tensions, China has a much broader range of investment opportunities for us that we can still find long term, interesting growth opportunities without having to be overly concerned about trade tension.
Tim Morris: (Sonal) perhaps something that I suspect is on combined of quite a few of those client styles. And today is the election, which is now four weeks away. How are we thinking about the bearing that it might have, depending on the outcomes, maybe first, since we were just talking about US and China relations through that lens, but also any other areas where we think it might have a bearing on the outlook for emerging markets more broadly?
(Sonal Tanna): Yes, I mean, I by no means a political expert, but I'll try my best to give you my view as I see it for emerging market. So firstly, I think the market consensus is that regardless of who wins, the US, China tension or protectionism is on the rise.
To that degree, it may play out in different ways. So obviously, the President Trump it's been much more around terrorist and like trying to resolve situations through that. It may be in a different setting.
It's Biden setting, it may be more around things by access to specific industries opening up of markets and around the human rights situation might come into play. But I think it's safe to say that the market, or at least the companies ensures that we look at, are prepared for effectively, what could be a continued environment of higher than historic tensions between the two countries.
Now, in terms of the impact of the election, I think it's going to be ultimately basically getting through the elections. I think, is going to split the market and level of comfort, because we've already priced some of this in, regardless of who the winner is. We sort of feel that we can put it behind us and start to move forward. I think China also can maybe come back to the negotiating table, knowing a little bit more knowledge and clarity around who the decision makers will be and try and think about what to do going forward.
So I would say that it would be almost better to have the elections behind us and then move forward. At least from a China perspective. And I think the other thing is that at this point, bigger factors, like what is happening around companies specific factors, what is happening to growth globally, is going to be very important.
So any further stimulus in the US or that is similar to global growth, I think will be very, was combined emerging markets, generally, were being a lot more reliant on global growth, picking up from the lows of this year.
Tim Morris: We've spent quite a time talking already about a variety markets. But we haven't really touched on any of the more commodity sensitive countries that I think investors are associated a bit closer to commodities. And maybe if we could just share for a moment our views on Brazil and Russia.
(Sonal Tanna): Yes, so maybe I'll start with Russia. The issue, there has been number one around the economic impact from the fall that we've seen in oil prices with Russia is obviously a lot more reliant on oil prices.
Now, actually, funnily enough, you know, Russian companies are actually at the favorable end of the cost curve. In terms of lifting costs, they benefit from the currency mismatch of having the old price in dollars. And obviously, their capital costs, et cetera being in rubles.
So that's one of the things that we think about when we think about Russian energy companies on a relative basis. And do see them in somewhat of a positive light.
The other thing is obviously, the impact that a weaker oil price has on some of these currencies like the Russian ruble. And how that might translate through to things like inflationary pressures, et cetera in the domestic economy.
I think what we are seeing so far, again, similar to what I mentioned, in terms of post lockdown activity level picking up. We are seeing that in places like Russia as well. It's going to be a little bit more challenging.
But the good thing is that from a fiscal perspective, Russia went into this in pretty good shape. So this really had our fair share of crisis in Russia, historically, they've been somewhat better position from a balance sheet perspective at a country level.
And the companies, at least some of the natural resources, the miners in these energy companies would be relatively well positioned. Despite Before in energy prices, given their end cost basis.
Brazil, it's been kind of interesting. Obviously, the virus impact has been pretty large from Brazil. And we actually saw the market been pretty volatile. We've had a very encouraging buying opportunity.
In Brazil was the end of March where valuations to be extremely attractive. And more recently, I suppose the focus has shifted towards the reform and the difficulties politically in terms of getting both reforms through.
But I do think, again, that what's interesting about Brazil is you are seeing, even though this a very good pickup in activity.
Not pattern, same levels where we started the secular we look at some of the particular satellite data, et cetera, we look at things like navigation, app usage, car rental recovery, we're seeing a pretty good pick up there.
We do think that the sort of reform negotiation is nothing new for Brazil. We've seen that over the last few years, the direction of travel is certainly positive. And lastly from a opportunity perspective, we are seeing some pretty encouraging developments, both in the traditional sort of sectors, but also a lot of new economy, companies also emerge in a market like Brazil.
So from an investment perspective, I still think there are some good opportunities coming up.
Tim Morris: One question that we get a lot from clients about the asset class and particularly given some of the headwinds from a performance perspective over the past few years for US dollar based investors is, do we think that that persists? And what role do you think that the US dollar plays? And you mentioned already, particularly for Russia, but maybe perhaps more broadly, for the asset class? Do we think that that's a trend that continues in the long term?
(Sonal Tanna): So when we think about the big picture, we think about emerging market currencies, we have to think about it in terms of inflation differentials. And clearly, that does mean that you end up with emerging market currencies, giving back a little bit each year.
If you think about it from a long term perspective, but I think there is intuitive experts around the dollar. And it's not been said in terms of the US fiscal deficit and what that may mean for the dollar.
I think, for us, as investors, a weakening dollar is certainly very positive for emerging market investors. That unquestionable, but to be honest, even if you have a stable US dollar, that is certainly a level we can get quite a positive environment from.
Looking at our currency framework and our currency models. We don't imagine market being extremely cheap right now. But there are certain areas where you are seeing signs of stress and that would be countries with some more of the structural challenges around the economy, et cetera.
So I would say something like Turkey, again, would be a good example, where you are seeing the currency get a lot more attractive.
But overall, I wouldn't say that emerging market currencies looks practically cheap at this point. They're probably slightly cheap to fair value.
Tim Morris: So thank you very much for your time today and for the insights.
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