Notes on Emerging Markets

Transcription

1 January 11, 2013 Investment Team Update July 28, 2016 Notes on Emerging Markets PERSPECTIVE FROM TEMPLETON EMERGING MARKETS GROUP Mark Mobius, Ph.D. Executive Chairman Templeton Emerging Markets Group EXECUTIVE SUMMARY Latin America is structurally attractive given its positive demographics with a growing middle-class, low-cost production of key commodities and improving reform momentum. Stock and currency markets have corrected sharply in Latin America during the last few years. Strong earnings growth appears to provide a strong base for recovery of Latin American stock markets, in our view. The recent round of elections in many Latin American countries, particularly in Brazil and Argentina, show that a promarket reform agenda is gaining traction around the region. The reform agenda includes attracting private investments, caps on government spending and improvements in the overall regulatory framework for doing business. We believe the generally pro-market reforms should increase the productivity of the labor force and improve the efficiency of public spending. In our view, consumer confidence likely will increase if reforms shift lower income segments of the population toward the middle class, as we believe they will. We like select areas within the consumer sectors, financial services and commodities. Latin American Fundamentals We view Latin America as a land of opportunities and our case for investing in Latin America starts with a set of favorable structural fundamentals: a young population with a growing middle-class, low-cost production of key commodities, and a turning point in economic and political reform efforts. The median age in Latin America is 29 years, compared to 41 years in Europe and 38 years in the United States. 1 The younger population also features an expanding middle class with a pentup demand for goods and services, and a low penetration of credit. In Latin America, the average private debt-to-gdp (gross domestic product) level is 72%, while the average is 94% in emerging Europe, 149% in emerging Asia 149% and 184% in developed markets. 2 Private debt-to-gdp levels differ by country (Chile is close to 150% while Argentina and Mexico are below 50%) but the average for Latin America is low. 3 Latin America is a major low-cost commodity producer with vast resources, in our view. The region s percent of world exports of soybeans is 55%, copper is 53%, sugar is 51%, coffee is 39% and iron ore is 22%. 4 We believe commodity exports will continue to be a major economic catalyst for Latin America as the trend of urbanization in emerging markets continues, particularly in India and China. Many Latin American countries show up quite low in ease-ofbusiness rankings by the World Bank. While emerging market counterparts Singapore, South Korea, Hong Kong, Poland and the Czech Republic are ranked highly, Argentina, Ecuador and Brazil, among other Latin American countries, rank quite low. 5 In our estimation, those rankings are a reason to believe there is tremendous room for improvement. Recent events give us hope that positive changes are forthcoming, particularly given recent political events in Argentina and Brazil. Not FDIC Insured May Lose Value No Bank Guarantee

2 Latin American Equity Markets We believe the solid fundamentals and improving political conditions are positive catalysts for Latin America s equity markets to rebound from a multi-year weak stretch. Emerging markets in general have underperformed developed markets for nearly three years (as of May 31, 2016). However, the weakness in Latin America stretches back nearly five years (for example, Brazil was down 76%, Argentina fell 67% and Colombia fell 63% in US-dollar terms for the period May 31, 2011 May 31, 2016). 6 Therefore, we are coming from a notably low base in terms of five-year stock market performance. A significant part of the region s equity-market performance during the past five years is related to the weakening of local currencies. However, we now see a positive turn in some Latin America currencies, due in part to political and economic reform agendas. In addition, the general earnings picture for Latin American companies is improving. The 12-month forward EPS (earnings per share) growth is 10% for the MSCI Emerging Markets Index, while the growth rate is around 38% for the MSCI Emerging Market Latin America Index and 52% for the MSCI Brazil Index. 7 These earnings estimates are for the next 12 months, so we believe that the region is coming to a positive turning point in expectations. Comments on Specific Latin American Countries Brazil The current economic contraction in has been the sharpest ever experienced (the economy has contracted by 4% for two years in a row). 8 However, we are expecting a bottoming out of the economy and we can see improvement in leading indicators, such as confidence expressed by consumers and entrepreneurs, and improved sentiment regarding investing. In our view, the political transition Brazil currently has an interim government and is awaiting the final impeachment of its previous president, Dilma Rouseff is providing confidence and an agenda of reforms for the government and regarding regulations in the country in order to attract private investments. The political realities we have seen in the past few years could be prolonged, but the last few months have shown a significant support in Congress and among Brazil s population for a reform agenda that modernizes the state and economy. We are optimistic about the reform agenda in Brazil. The first steps taken by the interim government were a cap on government expenditures based on inflation and a pension fund reform proposal. We believe both reforms are quite important. At the same time, we believe the current level of debt gives the necessary incentive to privatize auction concessions and review restrictive investment laws (e.g., further release the oil sector from the monopoly Petrobras holds on some fields, and foreign ownership restrictions of airlines and farmland). In addition, low oil revenues accelerated a change in Brazil s oil industry laws aimed at ending the Petrobras monopoly on so-called pre-soft reserves, which may unlock new auction rounds and potentially jumpstart a stagnant energy sector, due to the dire financial situation of Petrobras. We also believe that the appointment of an experienced team in key positions (including the economic team and heads of statecontrolled companies) adds a lot of credibility to the transitional government. Therefore, we are optimistic that reforms undertaken will be structural in nature and will dramatically change investor confidence regarding doing business in Brazil. Argentina Argentina is also top of mind for many investors as the country s new president, Mauricio Macri, has swiftly implemented some reforms in his first months in office. He successfully negotiated with international holdout creditors and released many of the utility and telecommunications tariffs that were frozen for over a decade. The moves by President Macri allow investment to come back to Argentina. Moving back to a floating exchange rate regime also has a significant impact; for example, farmers were holding out crops because prior currency controls made the exchange-rate wrong for them. The reforms put in place are a good first step, especially given the speed in implementation, but they were low-hanging fruit and we expect tougher reforms going forward. Given the historic relationship between Argentina and Brazil, we believe both countries will be a good influence on each other, so we are optimistic. Mexico Mexico started its reform agenda a few years ago, putting the country in a good spot. Just to highlight a few, the government moved to break up monopolies, open up the utilities sector and energy sectors, as well as education and labor reforms. We believe low crude oil will help to accelerate the government s plan to open up the oil sector, allowing more private investment in order to help the state-owned petroleum company Petróleos Mexicanos. Today, the consumer sector is doing well, inflation is low and employment is high; the consumer sector is also aided by remittances from the United States. Mexico has also done quite well in positioning itself as a manufacturing hub for the United States. The cost of labor in Mexico is cheaper than China, so not only is Mexico well-positioned geographically in the supply chain, it is an inexpensive place for manufacturing. While the country has gained market share, it still trails China; we believe Mexico can still increase exports to the United States. Republican presidential nominee Donald Trump s comments regarding Mexico have raised concerns. We just visited Mexico and believe that the integration driven by the North American Free Trade Agreement has been deep and unlikely to be reversed. The Trans-Pacific Partnership trade agreement will add another layer of integration with North American countries. Undoing such trade agreements will be hard for any US president to achieve without the approval of Congress. Notes on Emerging Markets 2

3 Drug-related violence is a risk, but we believe the government has a good grasp on the violence as it has centralized police action and coordinated with the local municipalities and the state. Another issue in Mexico is the small number of stocks listed, although we believe the country has a strong system. In our view, a significant opportunity exists for an increase in the depth of the equity market. Peru Peru has been one of the fastest growing economies in Latin America with a very stable political system. The country recently held elections and the newly elected president Pedro Pablo Kuczynski is expected to increase the pace of reforms. Among the expected reforms are plans to move more people into the formal economy, to accelerate the opening of the private sector, and to increase productivity. President Kuczynski also plans to considerably increase infrastructure investments. Peru is quite a dollarized country (by constitution Peruvians can have a foreign currency bank account), which is pointed out as a potential risk. However, we believe Peru s central bank is strong and the country has an open economy, which has allowed the country to raise money from abroad in the past. The commodity downturn in the last few years slowed Peru s economic growth, although it has continued to grow quite substantially in comparison to the rest of the region. What is interesting is that the driver for the mining sector has been the expansion of volumes, rather than commodity prices. Therefore, we anticipate many projects coming on stream in 2016 and in the next couple of years, which we believe will support Peru s economic growth. Colombia The peace negotiations between Colombia s government and the FARC guerrillas will likely end a multi-decade war and bring further investment confidence, in our view. Many regions of the country that were previously inaccessible for investments may become open (e.g., for farming and oil exploration). The Colombian government wants to boost infrastructure investment, including in many of the isolated regions. In the current phase, we see offers to build many roads and we believe the private sector should have a prominent role to play. Overall, the peace agreement is quite an important mark for the country and will be a significantly positive factor for us when looking for investment opportunities. Chile Chile historically has been ahead of other Latin American countries in terms of reforms and market movements. Recently many proposed reforms were viewed as negative for business confidence. That the whole country, the Congress and even the administration decided to slow down and change some of the original proposals was a positive, in our view. We expect Chile to maintain a stable environment for business. Consumer confidence is starting to show signs of pickup. Commodity prices are especially important for the country, as are investments in the mining industry. Overall, we believe Chile will continue to be a good place to do business. Venezuela Venezuela is quite behind the region given the lack of political change in that country. We believe the sole reliance on oil will eventually force a political change. A Sector View of Latin America The change in political leadership in many Latin American countries, following a period of some populist government, has brought hope for change. The changes are largely reforms to open up economies, increase the productivity of the labor force and improve the efficiency of public spending. As a result, we see a strong wave of mergers and acquisitions, privatizations and new pro-market regulations. In our view, such reforms should improve infrastructure investment, increase consumer confidence and continue to shift lower income segments of the population toward the middle class. Based on this view, we like sectors that benefit from the secular income class move, such as consumer names in retail and in food and beverage. Given the low penetration of credit in the region, plenty of room exists for financial services to grow. We also favor commodity stocks that benefit from vast and low cost quantities of reserves in the region, such as farming, with extensive arable land and good weather. Notes on Emerging Markets 3

4 WHAT ARE THE RISKS? All investments involve risks, including possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. IMPORTANT LEGAL INFORMATION This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as of the publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. All investments involve risks, including possible loss of principal. Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments ( FTI ) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FTI affiliates and/or their distributors as local laws and regulation permits. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction. Issued in the U.S. by Franklin Templeton Distributors, Inc., One Franklin Parkway, San Mateo, California , (800) DIAL BEN / , franklintempleton.com - Franklin Templeton Distributors, Inc. is the principal distributor of Franklin Templeton Investments U.S. registered products, which are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.. Notes on Emerging Markets 4

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Source: United Nations, Source: Bank for International Settlements, Private non-financial sector debt-to-gdp. 3. Ibid. 4. Source: International Trade Statistics, Share of world export market (in terms of value). Copper includes copper ores and concentrates; iron includes iron ore and concentrates; sugar includes cane or beet sugar and chemically pure sucrose, in solid form; molybdenum includes molybdenum ores and concentrates. 5. Source: The World Bank, IFC Doing Business: Measuring Business Regulations, Economies are ranked on their ease of doing business, from A high ease of doing business ranking means the regulatory environment is more conducive to the starting and operation of a local firm. The rankings are determined by sorting the aggregate distance to frontier scores on 10 topics, each consisting of several indicators, giving equal weight to each topic. The rankings for all economies are benchmarked to June The above mentioned countries captures Latin American markets as compared with other select emerging markets. 6. Source: FactSet, May Data for Brazil, Colombia, Chile, Peru, Mexico and Argentina are represented by their respective MSCI country-specific indexes. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. Indexes are unmanaged, and one cannot invest directly in an index. 7. Source: FactSet, Institutional Brokers Estimate System, 6/28/16. EPS = Earnings per Share. Developed markets as represented by the MSCI World Index; Emerging markets as represented by MSCI Emerging Markets Index; Latin America as represented by MSCI Emerging Markets Latin America Index; Brazil, Colombia, Chile, Peru, Mexico and Argentina are represented by their respective MSCI country-specific indexes. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. Indexes are unmanaged, and one cannot invest directly in an index. 8. Source: FactSet, Economist Intelligence Unit, 5/9/16. There is no assurance that any projection, estimate or forecast will be realized. Please visit to be directed to your local Franklin Templeton website. Copyright 2016 Franklin Templeton Investments. All rights reserved. 7/16