Emerging Markets Bounce Back in October

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1 Investment Team Update October 31, 2017 EMERGING MARKETS INSIGHTS Three Things We re Thinking About Today 1. Our outlook for semiconductor companies remains positive, considering the sector s long-term growth trend, solid earnings growth and attractive valuations. Technological advances in areas such as computing, smartphones and automobiles, supported by innovation in both hardware and software, are driving demand for semiconductors. Semiconductor pricing has also improved with the market less cyclical than before. 2. We believe that emerging markets should be able to withstand the normalization of monetary policy in the United States and eurozone. While there has been some concern about rising corporate debt levels in some emerging economies such as China, the financial situation of most emerging markets remains solid. Further, a strengthening US economy would also bode well for emerging markets given the interdependency between the United States and the rest of the world. 3. The most interesting part of China s 19th Party Congress was President Xi Jinping s vision and ambitious goal of modernizing China by 2035 and making the country the world s leading nation by For these goals to be met, China needs to maintain strong, sustainable growth, and it needs to address challenges such as the role of the state and state-owned enterprises in the market, high leverage levels and weakening demographic factors. We believe China has the potential to materialize President Xi s vision. Market Performance (MSCI EM Index, USD) +South Korea +India +Taiwan +Information Technology -Telecommunication Services +Health Care -Real Estate +Energy +South Korean Won +Indian Rupee +Peruvian Sol -Colombia -Pakistan -Mexico Sector Performance (MSCI EM Index, USD) Currency Performance (vs. USD) -Consumer Staples -Turkish Lira -Mexican Peso -South African Rand Source: FactSet, one-month period ending 10/31/17. Outlook We believe the recovery in emerging markets, which has been underway since 2016, is showing little sign of abating. Gross domestic product (GDP) growth in emerging markets is expected to continue to outpace that of developed markets, with the International Monetary Fund projecting growth of 4.6% in emerging economies versus 2.2% in developed markets in In 2018, growth in emerging economies is expected to strengthen further to 4.9%, while that in developed markets is projected to moderate to 2.0%. 1 Stronger economic growth should underpin and continue to offer compelling investment opportunities in the emerging-market (EM) asset class. There will be volatility ahead, but strong economic fundamentals combined with attractive valuations should make emerging markets less susceptible to negative global news flow. Furthermore, we see opportunities for the asset class to grow as many investors are generally underweight to emerging markets, below what we would expect given the proportion of global GDP and market capitalization that emerging markets represent. In our view, reallocations toward EM equities should support continued flows into EM strategies. In addition, EM currencies are, on average, still undervalued in our view. We see continued tailwinds coming from improvements in EM corporate earnings and EM equities generally continuing to trade at a discount to their developed-market peers. A note to our readers: Given the rapid changes that can take place in global markets, it is often difficult to provide up-to-date materials that address the most current situations. The following update is valid only as of October 31, Not FDIC Insured May Lose Value No Bank Guarantee

2 Emerging Markets Key Trends and Developments Improved global economic growth and supportive monetary policy continued to fuel market optimism in October. EM markets outperformed their developed-market counterparts during the month, with the MSCI Emerging Markets Index rising 3.5%, compared with a 1.9% gain in the MSCI World Index, both in US dollars. Following a pause in September, the EM asset class continued on an upward trend in October, driven by generally positive earnings growth, encouraging macroeconomic data, continued fund inflows and higher global commodity prices. Global Semiconductor Sales September 1997 September 2017 USD Billion $40 $35 $30 $25 $20 $15 $10 $5 $ Source: FactSet, Semiconductor Industry Association. The Most Important Moves in Emerging Markets This Month With the exception of Pakistan and Malaysia, Asian markets, as a group, outperformed their global peers. Easing geopolitical tensions between South Korea and China, and a strong won drove stock prices in South Korea. Positive sentiment in India was driven by the government s plans to re-capitalize state-owned banks. Strength in the information technology (IT) and financials sectors supported the Taiwanese market. In contrast, Pakistan was among the worst EM performers, as political turmoil continued to impact sentiment. Generally solid economic data supported performances in central Europe with Hungary, Poland and the Czech Republic among the top regional performers. The Russian market, however, lost ground, despite higher oil prices and continued monetary policy easing. Elsewhere, gains in Turkey were limited by depreciation in the lira. In Latin America, Chile and Peru recorded solid gains, but Colombia, Mexico and Brazil ended the month with declines. Monetary easing continued in Brazil and the congress voted against bringing corruption charges against President Michel Temer. Uncertainty in the NAFTA (North American Free Trade Agreement) renegotiation process and weak GDP data weighed on equity prices in Mexico. In Africa, although the South African market rose, it still underperformed its EM peers, pressured by concerns about a possible downgrade in credit ratings. Frontier markets ended October in positive territory but, as a group, lagged their EM counterparts. Argentina, supported by strong election results, Vietnam and Kazakhstan were among the top performers, while Mauritius and Tunisia declined. 2

3 Regional Outlook Three-Month Period Ended September 30, 2017 Market ( ) N (+) Investment Thesis Asia Bangladesh China Hong Kong India Indonesia South Korea Malaysia Pakistan Philippines Singapore Sri Lanka Taiwan Thailand Vietnam Europe Czech Republic Georgia Greece Hungary Kazakhstan Poland Romania Russia Turkey Ukraine Strong fundamentals, but political concerns and high valuations might affect some markets. All macro indicators seem positive, downside to investments appears low. Our overall outlook for China remains stable. Supply-side reforms have not only helped sectors that were facing overcapacity but also banking sectors, by reducing the nonperforming loans from state-owned enterprises in the affected sectors. We believe the strengthening renminbi has also relieved the fear of capital flight and rebuilt confidence in China for many overseas investors. Hong Kong may see a slowdown in the second half of 2017 following robust performance in the first half, as the factors driving that performance liquidity, Chinese economic growth and asset market booms may not be sustainable. Strong macro fundamentals, under-penetration and strong management talent make Indian corporations attractive to us, but fairly rich valuations with near-term earnings challenges make us neutral on the market. Economic growth should hold steady this year, recovering slowly. Politics will likely heat up in 2018 with the presidential election in April Macro indicators are sound but concerns on regulation and geopolitical risks are growing. Market valuations appear fair but may continue to increase on the back of positive earnings revisions and a strengthening ringgit. Short-term risks include crude oil price volatility and upcoming elections. Uncertainty remains with concerns on a political reshuffle and a high current account deficit. Stable outlook, with a potential upside if the tax reform package is passed in the Senate in September/October and if the government speeds up infrastructure spending. We anticipate political stability and improving gross domestic product (GDP) growth this year and next. Macro picture appears negative but could likely improve. Macroeconomic data is stable and positive. Geopolitical situation is relatively safer when compared with other countries in the region. However, we are carefully monitoring the strong currency and demanding equity market valuations. Our overall outlook remains stable to slightly positive. In our opinion, economic stability remains strong with a possible gradual improvement in economic growth. Annual GDP growth is likely to be above 6%, underpinned by resilient domestic demand, rebounding agricultural production, and strong export-oriented manufacturing. This is likely to be only partially offset by declining oil production. Stable to improving economies, but oil price dependence for some markets may be a consideration. Strong economy not currently reflected in stock market performance. We are carefully monitoring October elections if ANO gets majority, low risks to investors perception change and possible upside given reasonable market valuation, high yield and strong economic outlook. The central bank seems to have inflation and the currency more under control. GDP growth is strong and the government continues to push a healthy reforms agenda. Economy is still vulnerable, though, as a large part of GDP formation is correlated with Russia and 2018 expected GDP growth point to a recovery in Greece, so the past crisis might be well behind us. Balance sheet constraints for companies may be limiting the recovery, however. Relatively good macro outlook, stable political situation and discounted market valuation vs. broader EMs lead us to take a rather positive near-term outlook for the market. We have an overall stable outlook. Potential risks include oil price volatility. Strong economy, and we see no major visible risks to continued robust economic growth despite more conflict with the European Union. However, the recent rally means attractively priced opportunities may be limited. The government s populist reforms are pushing some macro indicators in the wrong direction: increased budget deficit, increased current account deficits (driven by consumer spending from unsustainable salary increases) and increased inflation. All these will likely put pressure on the currency and interest rates going forward, which may impact GDP growth starting In a stable oil price/ruble environment, domestic names should benefit due to earnings revisions and increased demand. Political situation should remain stable as no serious competition is expected in presidential elections next year. However, macro risks are high due to high volatility of commodities prices. With the current expansionary fiscal policy, GDP growth expectations for 2017 have increased to 5% 6%. There will be two elections in 2019, but we think Turkey should perform strongly until that point. Reform process may be slow but the country seems to be moving to a more stable political and economic environment. Valuations of listed companies are low and imply high cost of equity. cont d. The graphic reflects the views of Templeton Emerging Markets Group regarding each region. All viewpoints reflect solely the views and opinions of Templeton Emerging Markets Group. Not representative of an actual account or portfolio. 3

4 Regional Outlook, continued Three-Month Period Ended September 30, 2017 Market Latin America Argentina Brazil Chile Colombia Mexico Peru Middle East Kuwait Oman Qatar Saudi Arabia United Arab Emirates Africa Egypt Kenya Nigeria South Africa ( ) N (+) Investment Thesis Encouraging economic and political signs, attractive valuations. The economic recovery is gaining strength, which, combined with a favorable election outcome in October, should sustain asset performance into the next 12 months. The near-term outlook is challenging in view of 2018 presidential elections, which should bring higher volatility, although a favorable outcome is expected. Our long-term outlook is positive with a new president likely to continue promoting reforms. The likely victory of pro-market candidate Piñera should pave the way for a recovery in business and consumer confidence, supporting investment and consumption. The Colombian economy is showing encouraging signs with receding inflation and better consumer trends. Consumers seem to have assimilated the value-added tax (VAT) increase from its fiscal reform. The economy and, in particular, government finances should improve on the back of stable/increasing oil prices and better execution of its infrastructure program. Macroeconomic outlook is stable and equity valuations are slightly below historical averages. We believe Mexico s risk profile has increased with the ongoing NAFTA renegotiation (we expect a positive outcome) and the 2018 presidential election. The latter could lead to increased volatility given the tight expected race based on recent polls. GDP growth is expected to have bottomed this year after the economy was hit with the ramifications of the Oderbrecht scandal and abnormally high rains in the first half of the year. GDP growth should accelerate driven by a healthy consumer environment coupled with higher metal prices. Valuations for financial institutions and consumer names look attractive to us. Varied outcomes in different markets some affected by macro and political factors, others benefiting from reforms. Potential FTSE upgrade would be a positive catalyst for the market. This market s fiscal position appears stronger than its regional peers and hence more defensive. A persistent risk is political deadlock, which often leads to slower fiscal reforms and investments. Oman s economic situation remains fragile. Reforms are picking up but more needs to be done to decrease the fiscal deficit. Debt levels remain relatively low but are creeping up quickly, while foreign reserves are relatively low compared to regional peers. Risks include slowing economic growth, political conflict and deadlock, and continued weak investor appetite. Economic growth appears stable, and the National Transformation Plan is being redrafted to reflect more realistic targets. Within the region, the UAE is least dependent on oil revenues. Fiscal reforms have been successful, and we expect further reforms such as VAT implementation. However, the strong property sector needs to be monitored closely. Strong potential for improvement going forward, encouraging macro signs. Egypt has made a committed step toward economic reforms. It is witnessing receding inflation and a strengthening currency. If we look past the elections and assume stability after the result, Kenya will likely tick along at 4% 5% growth. However, we think the market has already priced in this potential outcome. The market is improving from a macro perspective with higher oil production, better oil price, steadying inflation, and a floating currency. Much depends on the ANC elective conference in December if the Zuma faction loses, that could be positive for South Africa. The graphic reflects the views of Templeton Emerging Markets Group regarding each region. All viewpoints reflect solely the views and opinions of Templeton Emerging Markets Group. Not representative of an actual account or portfolio. 4

5 TEMPLETON EMERGING MARKETS GROUP LOCAL KNOWLEDGE, GLOBAL REACH In a sea of overlooked and under-researched companies, there s no substitute for local market knowledge. Our on-the-ground investment team of over 50 portfolio managers and analysts across 20 countries distinguishes Templeton Emerging Markets Group from the crowd. Investors benefit from our networks of local business contacts, access to in-person company visits and real time response to local market events. Our global reach through Franklin Templeton Investments provides access to sophisticated risk management and trading resources. Portfolio management collaborates closely with the Performance Analysis and Risk Group, which provides detailed risk analytics to complement the team s assessment of risk exposures. 50+ portfolio managers and research analysts 15 years on average of industry experience 12 years on average with Templeton Mark Mobius, Ph.D. Stephen Dover, CFA Allan Lam, CPA Chetan Sehgal, CFA Carlos Hardenberg A FEW WORDS ABOUT RISK Special risks are associated with foreign investing, 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. To the extent a fund focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a fund that invests in a wider variety of countries, regions, industries, sectors or investments. Investing in smaller company securities that may have limited liquidity involves additional risks, such as relatively small revenues, limited product lines and small market share. Historically, these stocks have exhibited greater price volatility than larger company stocks, especially over the short term. A note to our readers: Given the rapid changes that can take place in global markets, it is often difficult to provide up-to-date materials that address the most current situations. The following update is valid only as of October 31, The significant growth potential offered by emerging markets remains accompanied by heightened risks when compared to developed markets, including risks related to market and currency volatility, adverse social and political developments, and the relatively small size and lesser liquidity of these markets. The information provided is not a complete analysis of every material fact respecting any country, industry, security or investment. Opinions expressed are those of Dr. Mobius and are subject to change without notice. Statements of fact have been obtained from sources considered reliable. Because market and economic conditions are subject to rapid change, his analyses are valid only as of October 31, His opinions are intended to provide insight as to how he analyzes securities and are not intended as individual investment advice. Performance information is historical and should not be considered predictive of future results. All securities investments fluctuate and involve risks. Investors should carefully consider a fund s investment goals, risks, charges, and expenses before investing. To obtain a summary prospectus and/or prospectus, which contains this and other information, talk to your financial advisor, call us at (800) DIAL BEN / , or visit franklintempleton.com. Please carefully read the prospectus before you invest or send money. 1.Source: International Monetary Fund, World Economic Outlook, October 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. Important data provider notices and terms available at Franklin Templeton Distributors, Inc. One Franklin Parkway San Mateo, CA (800) DIAL BEN / franklintempleton.com franklintempletoninstitutonal.com Copyright 2017 Franklin Templeton Investments. All rights reserved. 11/17