Emerging Markets Experience a Healthy Correction in May

Transcription

1 Investment Team Update 31 May 2018 Emerging Markets Experience a Healthy Correction in May EMERGING MARKETS INSIGHTS Three Things We re Thinking About Today 1. More than 230 China A-share companies will be added to the MSCI Emerging Markets Index on 1 June. Initially, the companies will account for only 0.4% of the index, but this will rise to 0.8% in September, when the inclusion rate is raised to 5% of the planned total. If and when all China A-shares are included in the index (100% inclusion rate), they could account for over 16%, bringing China s total weighting to over 40% of the MSCI Emerging Markets Index. The inclusion of A-shares, in addition to improving liquidity, could prompt increased company disclosure and better market accessibility, thereby enabling access to a wider range of companies in structural growth sectors such as pharmaceuticals, consumer and technology. 2. With rising US interest rates, we have seen the US dollar strengthen, which has traditionally been a headwind for emerging markets. However, the effects today are likely different than previous episodes of dollar strength, as today, most emergingmarket (EM) currencies have floating foreign exchange regimes, emerging markets in aggregate run a current account surplus, and intra- and inter-regional trade has taken on greater importance within the EM world. The direction of the dollar itself is far from certain should the US government aggressively pursue polices to boost exports and manufacturing, it may be inclined to promote a weaker US dollar. 3. Oil prices have been on a generally upward trend this year so far, reaching a multi-year high in May. A host of factors, including higher demand, shrinking global oil inventories and increased geopolitical risks have driven the surge in oil prices. However, Market Performance (MSCI EM Index, USD) Cumulative Return +China (1.9%) -Greece (-18.7%) +Russia (1.2%) -Brazil (-16.4%) +Taiwan (-0.2%) -Hungary (-13.9%) Sector Performance (MSCI EM Index, USD) Cumulative Return -Telecommunication +Health Care (1.7%) Services (-8.3%) +Information Technology -Financials (-6.8%) (1.1%) +Energy (-2.4%) -Industrials (-6.1%) Currency Performance (vs. USD) % Change +Russia (1.0%) -Turkey (-10.4%) +Indonesia (0.1%) -Brazil (-6.3%) +Qatar (0.0%) -Mexico (-6.1%) Source: FactSet, one-month period ending 31/5/18. recent reports that Organization of the Petroleum Exporting Countries (OPEC) and its allies may increase production led oil prices to decline slightly at the end of May. While we remain constructive on the oil price over the medium to long term, we recognize the elevated earnings risk and focus on companies with low production costs and strong balance sheets. Outlook We continue to have faith in emerging markets and believe they will continue to grow at a strong pace, fueled by robust trade and solid commodity prices. The rapid adaptation of information technology in emerging markets such as India and China have further propelled their strong growth. We continue to see improvement in the earnings power and cash flow of many EM companies. The impact of rising US interest rates, China s economic restructuring, stock valuations, market volatility and political events all play a role in our analysis of the development of emerging markets from where we are today. What we have seen so far in 2018 is a reminder that markets can be volatile, and we expect continued volatility this year. Nevertheless, we remain optimistic about the opportunities that we see in new economy sectors related to technology and consumption. EM companies have not only taken part in the technological revolution, but are also at the forefront, becoming global innovators in areas such as e-commerce, mobile banking, robotics and autonomous vehicles. This development has created investment 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 31 May 2018.

2 opportunities in a broad array of companies, ranging from internet firms to chip makers, hardware manufacturers and more. Rising wealth in emerging markets is another secular driver and we expect it to continue lifting demand for goods and services. Financials are also interesting to us, as improving macroeconomics in emerging markets create a potential tailwind for banks. Our investment approach in emerging markets is driven by fundamental research and rigorous stock selection, which emphasizes companies with sustainable earnings power and reasonable valuations. Geopolitical uncertainty may trigger bouts of market volatility, but these can also be opportunities for long-term investors to acquire shares in well-run companies at reasonable valuations. Emerging Markets Key Trends and Developments EM equities declined in May, while developed-market stocks finished moderately higher. Renewed global trade tensions, economic and political concerns, and a stronger US dollar contributed to investors shift away from emerging markets. The MSCI Emerging Markets Index declined 3.5% over the month, compared with a 0.7% gain in the MSCI World Index, both in US dollars. Global Oil Supply, Demand and Price April 2014 April 2018 Million Barrels per Day USD per Barrel $120 $100 $80 $60 $40 $ /14 6/14 8/14 10/14 12/14 2/15 4/15 6/15 8/15 10/15 12/15 2/16 4/16 6/16 8/16 10/16 12/16 2/17 4/17 6/17 8/17 10/17 12/17 2/18 4/18 Total World Petroleum Consumption (LHS) Total World Petroleum Production (LHS) Crude Oil Brent Price (RHS) Source: FactSet, Commodity Research Bureau (Oil Price), US Energy Information Administration (Supply and Demand). $0 The Most Important Moves in Emerging Markets This Month Asian stocks fell against a backdrop of economic and political concerns. Pakistan, Malaysia and South Korea registered the largest declines. Pakistan s shrinking foreign exchange reserves, rising external debt and general election in July stoked market caution. Malaysia retreated as investors grappled with the country s fiscal health and policy direction under a newly elected government. South Korea lost ground as friction between the United States and North Korea threatened to derail peace talks and revive tensions in the Korean peninsula. Bucking the downtrend, China advanced, lifted by better-than-expected manufacturing data and the upcoming inclusion of China A-shares in MSCI s equity indexes. Latin American stocks came under broad selling pressure, with Brazil, Mexico and Chile leading the way down. Brazil fell as labor strikes against rising fuel costs hit economic activity. Government measures to help reduce pump prices raised concerns about the country s ability to stay market-friendly. Mexico was hindered by political uncertainty ahead of a presidential election in July and a stalemate in negotiations related to the North American Free Trade Agreement (NAFTA). The United States imposed tariffs on steel and aluminum from Mexico and other major trading partners, prompting Mexico to announce retaliatory measures. Political instability in Italy and growth concerns weighed on European markets, with Greece, Hungary and Poland recording double-digit declines. Political turmoil and a currency crisis weighed on equity prices in Turkey. The Central Bank of Turkey held an emergency meeting in late May, raising a key interest rate by 300 basis points (3%) in an effort to stabilize the lira after a sharp devaluation during the month. Russia bucked the trend, however, ending the month with a gain, supported by higher oil prices, improving macroeconomic data and an appreciation in the ruble. Political optimism was short-lived in South Africa, as investor outflows and weakness in the rand led the equity market to fall. Frontier markets, as a group, recorded their worst monthly performance in close to a decade in May, and significantly underperformed their EM counterparts. Argentina was by far the weakest performer, declining more than 20% in US-dollar terms. Romania, Vietnam and Nigeria also fell. Concerns over the 2019 general elections and weak sentiment among foreign and domestic investors pressured returns in Nigeria. Vietnam continued to experience profit-taking following strong gains over the first quarter. Emerging Markets Experience a Healthy Correction in May 2

3 Regional Outlook Three-Month Period Ended 31 March 2018 Market Asia China India Indonesia South Korea Pakistan Taiwan Thailand Vietnam Europe Czech Republic Hungary Russia Turkey ( ) N (+) Investment Thesis Strong macro fundamentals, but political and trade concerns might affect some markets. The overall outlook for China remains stable but we need to be cautious as uncertainties are rising. Supply side reforms and deleveraging could help ease structural risks but rising trade tensions could offset the benefits of stronger global growth. Strong macro fundamentals, under-penetration and strong management talent make Indian corporations attractive to us, but fairly rich valuations with near-term earnings challenges lead us to maintain a neutral view on the market. Economic growth has been recovering slowly. However, politics will likely heat up in 2018 with the presidential election in April Macro indicators remain sound with recent signs of improvement in the geopolitical situation but concerns about government regulations remain. Uncertainty remains with concerns on a political reshuffle and high current account deficit. Cross-strait geopolitical risk has always existed and is well-known. Macroeconomic data remain healthy but inflation may start to rise, pressuring interest rates. A strong Taiwanese dollar continues to weigh on corporate earnings. Overall outlook remains stable, with gradual improvement in economic growth. Steady outlook. GDP above 6%, underpinned by resilient domestic demand, rebounding agricultural production, and strong export-oriented manufacturing, which will be only partially offset by declining oil production. Solid economies with attractive valuations, but political uncertainty may weigh on some markets. Strong economy not currently reflected in stock market performance. We are carefully monitoring the ANO party s political agenda, especially since it failed to form a coalition with other parties. Relatively good macro outlook, stable political situation and discounted market valuation versus broader emerging markets lead us to take a rather positive near-term outlook for the market. In a stable oil price/ruble environment, domestic names should benefit due to earnings revisions and increased demand. The political situation should remain stable following the re-election of President Putin. However, macro risks are high due to volatile commodity prices and the possibility of additional US/EU sanctions. With the current expansionary fiscal policy, 2018 GDP growth expectations have increased to 4%. There will be two elections in 2019, but we think Turkey should perform strongly until that point. The graphic reflects the views of Franklin Templeton Emerging Markets Equity regarding each region. All viewpoints reflect solely the views and opinions of Franklin Templeton Emerging Markets Equity. Not representative of an actual account or portfolio. cont d. Emerging Markets Experience a Healthy Correction in May 3

4 Regional Outlook, continued Three-Month Period Ended 31 March 2018 Market Latin America Argentina Brazil Mexico Peru Middle East Kuwait Qatar Saudi Arabia United Arab Emirates Africa Egypt Kenya Nigeria South Africa ( ) N (+) Investment Thesis Solid economic situation but elections in 2018 may lead to increased volatility in some markets. The economic recovery is gaining strength, which, combined with a favorable election outcome in October, should pave the way for the much-desired upgrade from frontier to EM status. Higher international rates, however, have punished the high-beta Argentine market. On balance, our outlook is positive. The near-term outlook is challenging in view of 2018 presidential elections, which could bring higher volatility, although we expect a favorable outcome. Our long-term outlook is positive with a new president likely to continue promoting reforms. Macroeconomic outlook is stable and equity valuations are below historical averages. We believe Mexico s risk profile has increased with the ongoing NAFTA renegotiation and the 2018 presidential election. The latter could lead to increased volatility given the tight expected race based on recent polls. Economic activity tends to remain strong leading up to presidential elections. Political uncertainty and additional problems in the construction sector led to a reduction in 2018 GDP growth forecast from 4.2% to 3.5%, despite high copper prices. Peru has been resilient to several episodes of low popularity of its presidents, which has not prevented the economy from growing at a steady pace. Varied outcomes in different markets some affected by macro and political factors, others benefiting from reforms and possible FTSE/MSCI upgrades. Potential FTSE upgrade could 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. Risks include slowing economic growth, political conflict and deadlock, and continued weak investor appetite. FTSE and the potential MSCI EM upgrades could be strong catalysts for the market. The country continues to have stable economic growth, while the National Transformation Plan and Vision 2030 is being redrafted to reflect more realistic targets. Within the region, the UAE is least dependent on oil revenues. Fiscal reforms such as the recent value-added tax (VAT) implementation have been successful. The economy boosts a robust service sector, and positive current account and fiscal balances. The strong property sector, however, needs to be monitored closely. Strong potential for improvement going forward, encouraging political and macro signs. Egypt has made a committed step toward economic reforms. It is witnessing receding inflation and a strengthening currency. With election results now validated and protests muted, 2018 economic growth is likely to be about 5%. However, we think the market has already priced in this outcome. The market is improving from a macro perspective with higher oil production, better oil prices, steadying inflation and a floating currency. The political change has significantly improved the country s prospects. The implementation of reforms and job creation could drive growth. The graphic reflects the views of Franklin Templeton Emerging Markets Equity regarding each region. All viewpoints reflect solely the views and opinions of Franklin Templeton Emerging Markets Equity. Not representative of an actual account or portfolio. FRANKLIN TEMPLETON EMERGING MARKETS EQUITY 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 80 portfolio managers and analysts across 20 countries distinguishes Franklin Templeton Emerging Markets Equity 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. 80+ portfolio managers and research analysts 15 years on average of industry experience 10 years on average with Franklin Templeton Manraj Sekhon, CFA Chetan Sehgal, CFA Emerging Markets Experience a Healthy Correction in May 4

5 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 at 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 US 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 US 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 US registered products, which are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation. Australia: Issued by Franklin Templeton Investments Australia Limited (ABN ) (Australian Financial Services License Holder No ), Level 19, 101 Collins Street, Melbourne, Victoria, Austria/Germany: Issued by Franklin Templeton Investment Services GmbH, Mainzer Landstraße 16, D Frankfurt am Main, Germany. Authorized in Germany by IHK Frankfurt M., Reg. no. D-F-125-TMX1-08. Canada: Issued by Franklin Templeton Investments Corp., 5000 Yonge Street, Suite 900 Toronto, ON, M2N 0A7, Fax: (416) , (800) , Dubai: Issued by Franklin Templeton Investments (ME) Limited, authorized and regulated by the Dubai Financial Services Authority. Dubai office: Franklin Templeton Investments, The Gate, East Wing, Level 2, Dubai International Financial Centre, P.O. Box , Dubai, U.A.E., Tel.: , Fax: France: Issued by Franklin Templeton France S.A., 20 rue de la Paix, Paris, France. Hong Kong: Issued by Franklin Templeton Investments (Asia) Limited, 17/F, Chater House, 8 Connaught Road Central, Hong Kong. Italy: Issued by Franklin Templeton International Services S.à r.l. Italian Branch, Corso Italia, 1 Milan, 20122, Italy. Japan: Issued by Franklin Templeton Investments Japan Limited. Korea: Issued by Franklin Templeton Investment Trust Management Co., Ltd., 3rd fl., CCMM Building, 12 Youido-Dong, Youngdungpo-Gu, Seoul, Korea Luxembourg/Benelux: Issued by Franklin Templeton International Services S.à r.l. Supervised by the Commission de Surveillance du Secteur Financier 8A, rue Albert Borschette, L-1246 Luxembourg Tel: , Fax: Malaysia: Issued by Franklin Templeton Asset Management (Malaysia) Sdn. Bhd. & Franklin Templeton GSC Asset Management Sdn. Bhd. Poland: Issued by Templeton Asset Management (Poland) TFI S.A., Rondo ONZ 1; Warsaw. Romania: Issued by the Bucharest branch of Franklin Templeton Investment Management Limited, Buzesti Street, Premium Point, 7th 8th Floor, Bucharest 1, Romania. Registered with Romania Financial Supervisory Authority under no. PJM01SFIM/400005/ , authorized and regulated in the UK by the Financial Conduct Authority. Singapore: Issued by Templeton Asset Management Ltd. Registration No. (UEN) E. 7 Temasek Boulevard, #38-03 Suntec Tower One, , Singapore. Spain: Issued by the branch of Franklin Templeton Investment Management, Professional of the Financial Sector under the Supervision of CNMV, José Ortega y Gasset 29, Madrid. South Africa: Issued by Franklin Templeton Investments SA (PTY) Ltd which is an authorized Financial Services Provider. Tel: +27 (21) Fax: +27 (21) Switzerland: Issued by Franklin Templeton Switzerland Ltd, Stockerstrasse 38, CH-8002 Zurich. UK: Issued by Franklin Templeton Investment Management Limited (FTIML), registered office: Cannon Place, 78 Cannon Street, London EC4N 6HL. Authorized and regulated in the United Kingdom by the Financial Conduct Authority. Nordic regions: Issued by Franklin Templeton Investment Management Limited (FTIML), Swedish Branch, Blasieholmsgatan 5, SE Stockholm, Sweden. Phone: +46 (0) , Fax: +46 (0) FTIML is authorized and regulated in the United Kingdom by the Financial Conduct Authority and is authorized to conduct certain investment services in Denmark, in Sweden, in Norway and in Finland. Offshore Americas: In the US, this publication is made available only to financial intermediaries by Templeton/Franklin Investment Services, 100 Fountain Parkway, St. Petersburg, Florida Tel: (800) (USA Toll-Free), (877) (Canada Toll-Free), and Fax: (727) Investments are not FDIC insured; may lose value; and are not bank guaranteed. Distribution outside the US may be made by Templeton Global Advisors Limited or other subdistributors, intermediaries, dealers or professional investors that have been engaged by Templeton Global Advisors Limited to distribute shares of Franklin Templeton funds in certain jurisdictions. This is not an offer to sell or a solicitation of an offer to purchase securities in any jurisdiction where it would be illegal to do so. 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. CFA and Chartered Financial Analyst are trademarks owned by CFA Institute. Important data provider notices and terms available at Please visit to be directed to your local Franklin Templeton website. franklintempletoninstitutonal.com Copyright 2018 Franklin Templeton Investments. All rights reserved. 6/18