Diverse Performances within Emerging Markets in November

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1 Investment Team Update 30 November 2017 Diverse Performances within Emerging Markets in November EMERGING MARKETS INSIGHTS Three Things We re Thinking About Today 1. While there have been some concerns of a repeat of the 2000 Information Technology (IT) boom-and-bust, we believe that the likelihood of this is low as many companies seem to have built their businesses around sustainable trends and we don t see their competitiveness eroding in the near term. IT companies have been a key driver of stock market performance in emerging markets as well as globally in recent years. In the year-to-november 2017 period alone, the emerging-market (EM) IT sector was up 60%. Even so, near the end of 2017, IT valuations were at reasonable levels, in our view, as major IT companies have continued to report solid earnings growth and high cash levels. IT companies also benefit from the integration of technology to industries such as automotive and manufacturing, and from the growing demand for cloud computing, artificial intelligence, robotics and other technologies. 2. Oil prices rose above US$60/barrel recently, driven by stronger economic growth globally and disrupted supplies resulting from geopolitical issues and OPEC s (Organization of the Petroleum Exporting Countries) decision to extend supply cuts. We believe this trend could continue in : In the near term oil demand has continued to strengthen, and signs of shrinking global oil inventories could drive oil prices higher. While we remain constructive on the oil price over the medium term, we recognize that technology changes could lead to lower costs of production and, eventually, increased alternatives to fossil fuels. 3. Major differences remained unresolved after the completion of the fifth round of NAFTA negotiations in Mexico, raising doubts over whether an agreement can be reached by early next year. While this uncertainty continues to weigh on Mexican investments and the peso, Mexico s exports to the United States are expected to reach a record high for Further, Mexico s efforts to expand trade by pursuing the Trans Pacific Partnership-11, a new agreement with the European Union, and expanding the Pacific Alliance to include Australia, Canada and possibly Argentina, should benefit the Mexican economy. We see opportunities in a number of areas including financials, consumer staples and industrials, such as companies making automotive parts and steel. Market Performance (MSCI EM Index, USD) Cumulative Return Best Worst +South Africa (9.0%) -Chile (-11.7%) +Russia (3.4%) -Turkey (-7.9%) +Colombia (2.7%) -Qatar (-6.9%) Sector Performance (MSCI EM Index, USD) Cumulative Return Best Worst +Consumer Discretionary (2.8%) -Real Estate (-2.7%) +Health Care (1.9%) -Utilities (-2.5%) +Consumer Staples (1.7%) -Energy (-1.9%) Currency Performance (vs. USD) % Change Best Worst +South Africa (3.7%) -Turkey (-2.8%) +Malaysia (3.5%) -Chile (-1.8%) Outlook We believe many EM companies can grow faster than many companies in the developed world. EM equity earnings as a whole are benefiting not only from a cyclical rebound in many instances including Brazil emerging from a recession and a recovery in commodity prices but also the ongoing structural shift toward new economy sectors. These EM companies are catering to a dynamic domestic consumer base and gaining a larger share of global exports. In our opinion, Asia is one of the most exciting regions in emerging markets today. While commodity production and exports remain vital to many economies, the region is worlds away from its commodity-only trade legacy, especially in the case of China. China has moved from producing relatively low-end products to much more sophisticated ones such as electric cars, drones, robots and solar panels. Many of these companies have shown a high degree of innovation and sustainable growth. +Poland (3.3%) -Egypt (-0.3%) Source: FactSet, one-month period ending 30/11/17. 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 at 30 November 2017.

2 While we need to be mindful of risks such as geopolitical instability, tapering of quantitative easing in major developed economies, a possible slowdown in global economic growth and protectionist trade policies, we think EM stocks still hold much potential. In the current low-growth, low-yield environment, emerging markets can offer investors access to innovative, fast-growing companies trading at what we consider attractive valuations. Emerging Markets Key Trends and Developments Global equity markets advanced during November, supported by generally positive economic data around the globe. Emerging markets, however, lagged developed-market equities as investors focused on tax reform in the United States. The MSCI Emerging Markets Index edged up 0.2%, compared with a 2.2% gain in the MSCI World Index, both in US dollars. While solid fund inflows, stronger EM currencies and higher oil prices provided EM equities with some support, profit-taking in the IT sector and a rotation into financials in late November weighed on overall performance. Crude Oil Brent Global Spot December 2014 November 2017 USD/Barrel $80 $70 $60 $50 $40 $30 $20 $10 $ Source: FactSet, Commodity Research Bureau The Most Important Moves in Emerging Markets This Month In Asia, Singapore and Hong Kong were among the top performers, driven by strong returns in the financials and consumer discretionary sectors. In Thailand, significant local buying, driven by better-than-expected third-quarter gross domestic product (GDP) growth and a positive outlook on corporate earnings, led stock prices to appreciate in November. In contrast, Taiwan was one of the weakest performers as profit-taking in the IT sector impacted performance. India and Indonesia also ended the month with minor declines. Latin America was the worst-performing EM region in November largely due to weakness in Brazil and Chile. Sentiment in Brazil was adversely impacted by a lack of progress on social security reform, while in Chile, a closer-than-expected second-round presidential election result worried investors. In contrast, interest-rate cuts and higher commodity prices drove positive returns in Colombia and Peru. The Mexican market edged down in US-dollar terms despite a stronger peso as higher-than-expected inflation and a hawkish tone from the central bank raised concerns. Central European markets reported mixed performances with gains in the Czech Republic (supported by above-consensus GDP growth data), but declines in Poland and Hungary. The Russian market rebounded in November to become one of the topperforming markets in the region, largely driven by higher oil prices. At the other end of the spectrum, depreciation in the lira and rising inflationary pressures weighed on Turkish equities. South Africa was one of the best-performing markets in Africa and globally in November, lifted by an appreciation in the rand, as well as indications of victory for a more market-friendly candidate as leader of the ruling African National Congress, and thus most likely the next president of the country. The Egyptian market, however, declined despite reporting solid third-quarter GDP growth. Frontier markets outperformed their EM counterparts over the month. Vietnam, Kazakhstan and Kenya were notable performers. The Vietnamese market recorded double-digit gains driven by continued foreign investor interest and strong returns in the real estate, consumer staples and IT sectors. Higher oil prices supported stock prices in Kazakhstan, and easing political tensions buoyed the Kenyan market. In contrast, equities in Argentina were pressured by an unexpected rise in interest rates, and Kuwait also corrected. Diverse Performances within Emerging Markets in November 2

3 Regional Outlook Three-Month Period Ended 30 September 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 are 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. Diverse Performances within Emerging Markets in November 3

4 Regional Outlook, continued Three-Month Period Ended 30 September 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. Diverse Performances within Emerging Markets in November 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 Diverse Performances within Emerging Markets in November 5

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