Beyond Bulls & Bears Bulletin

Transcription

1 July 2018 Beyond Bulls & Bears Bulletin INSIGHT FROM FRANKLIN TEMPLETON INVESTMENTS MANAGERS IN THIS ISSUE: The articles in this issue are as at 26 July Hasenstab: How AMLO and Mexico Can Avoid a Populist Fate: Markets had largely expected Andrés Manuel López Obrador to emerge victorious in Mexico s presidential election on 1 July, but only now are the longer-term implications of the new political mandate beginning to take shape as he awaits inauguration on 1 December. Dr. Michael Hasenstab, CIO of Templeton Global Macro, offers his analysis of what may lie ahead for Mexico and explains why he thinks the new president should be wary of repeating the populist agenda of other Latin American leaders in recent history. Perspectives on Disruption: As our analysts and researchers travel the world surveying businesses, they hear a lot about disruption the ability of new oftentechnology-backed companies to disrupt the status quo. Yet our experience and insight tell us that disruption stretches beyond the realm of technology alone. Stephen Dover, head of equities at Franklin Templeton Investments, gives three examples of disruptions outside the tech sector. Sukuk s Journey into the Financial Mainstream: Investors looking for fixed income exposure in their portfolios have tended to focus their attention on conventional sovereign and corporate bonds. Dino Kronfol, chief investment officer, Franklin Templeton Global Sukuk and MENA Fixed Income Strategies, thinks sukuk bonds that comply with Islamic law is steadily making its way into the financial mainstream. Here, he explains why this is no longer an overlooked asset class, and debunks some myths associated with this investment area. Hasenstab: How AMLO and Mexico Can Avoid a Populist Fate Michael Hasenstab, Ph.D. Executive Vice President, Chief Investment Officer Templeton Global Macro Andrés Manuel López Obrador s (AMLO s) populist ousting of the PRI (Institutional Revolutionary Party) government creates some political uncertainties. However, we believe AMLO s team has done a sufficient job of reassuring investors that it will transition the government in an orderly manner, to maintain economic and financial stability. That s a good start from the incoming government, in our view. Financial Discipline vs. Populist Impulses History offers us a number of examples of populists in Latin America who abandoned market-friendly policies to the detriment of their countries, notably including Dilma Rousseff in Brazil, or the Kirchners in Argentina. While AMLO has shown some populist impulses, such as expanding pension benefits or broadly handing out scholarships, his team appears aware of the pitfalls that often await governments that disrupt confidence in their country s financial markets. Over the last few weeks, AMLO s team has vowed to uphold fiscal discipline and maintain the independence of the central bank. AMLO has also indicated he would not reverse a number of critical reforms carried out by his predecessor, such as the privatisation of the energy sector. Certainly a lot of actual policy remains to be seen, but the team s initial attentiveness to capital markets and the business sector is an encouraging sign. Additionally, AMLO did run relatively responsible fiscal policy during his tenure as mayor of Mexico City. How Well Will AMLO s Political Alliances Hold? Nonetheless, there are some concerns for the incoming government. The left-wing Morena party, which AMLO founded in 2014, contains a number of unknown newcomers who lack previous political experience, including activists and celebrities. His governing coalition in Congress, Juntos Haremos Historia, enjoys a majority in the Chamber of Deputies, controlling 62% of

2 Hasenstab: How AMLO and Mexico Can Avoid a Populist Fate continued the seats, but is composed of politically contrasting allegiances between the Labor Party (PT) and the social conservative PES party. AMLO s popularity appears to be the glue binding these disparate political factions together, but it remains to be seen how those alliances will hold together on actual policies, particularly if AMLO s popularity wanes. Even the Morena party itself, which now has the highest number of seats in both chambers of Congress, has little experience whipping votes. We believe it will be important for the government to uphold recent reforms and to also pursue new reforms if Mexico wants to expand its economy and continue attracting investment. A Largely Positive Response from Markets So Far But despite some of the longer-term political uncertainties following the election, markets have largely reacted positively in recent weeks. Much of that can be attributed to the central bank (Bank of Mexico) continuing to run orthodox policy in the background of the election. Notably it raised its policy rate 25 basis points (bps) on 21 June to 7.75%, while indicating that it intends to further support the peso and keep inflation expectations anchored. The Mexican peso has responded by strengthening 10% against the US dollar from 14 June to 15 July, while markets have priced in another 25-bp rate hike at the 2 August meeting. On the whole, a number of questions linger for the incoming Morena-led government, but we don t expect major disruptions to the institutional strength of the country, or its economy. Investors should recall that the Mexican government has run appropriate fiscal policy for the last two decades, while protecting the independence of its central bank, and maintaining a free-floating exchange rate. We don t see those institutional constructs being disrupted. Our Outlook for Mexico Remains Positive Additionally, Mexico s economy has remained largely resilient the country has one of the most open economies in the world, benefitting from free trade agreements with the United States, Canada, Japan, Central America and the European Union. It also significantly benefits from upswings in the US business cycle. Renegotiations of the North America Free Trade Agreement (NAFTA) remain an ongoing concern, but are not likely to derail the extensive systems of trade between Mexico and the United States, in our view. Overall, we continue to have a positive outlook for the country. We remain focused on investment opportunities in Mexico s local-currency market, as the peso remains undervalued while yields in the front-end of the curve remain highly compelling at more than 7.5%. Perspectives on Disruption Stephen H. Dover, CFA Executive Vice President, Head of Equities Franklin Templeton Investments In recent years, we ve seen a number of developments that suggest investors should rethink what they thought they knew. Countless reports have focused on how new technologies, such as self-driving cars, will disrupt global industries. Yet some disruptions outside the domain of technology get much less attention. We highlight three disruptions for investors to think about when it comes to markets, economics and politics. Disruption #1: Shifting Global Consumption Asia is disrupting and breaking the dominance of the United States in terms of the global consumption pattern. In recent years, many Asian countries, especially densely populated ones, such as China, India and Indonesia, have seen a surge in domestic consumption. As the chart on page 3 shows, consumption is growing faster in these countries than in the United States, and this is creating more balance in global consumption than we have seen in the past. Beyond Bulls & Bears Bulletin 2

3 Perspectives on Disruption continued 12% 10% Consumption Growth in Asia Outpaces the United States Household Consumption Annual Growth Rate 8% 6% 4% 2% 0% US 2014 China India Indonesia Source: Organisation for Economic Co-operation and Development (OECD). Disruption #2: Inflation of Financial Assets Since the 2008 global financial crisis (GFC), global central banks around the world have pumped vast amounts of monetary stimulus into the global economy. Those of us who have studied economics thought that would lead to massive inflation across the globe. That hasn t happened yet, though we are starting to see signs of rising inflation in a number of markets. One of the reasons could be the massive expansion in global population, which is keeping labour costs down. That said, we ve seen a different sort of inflation not reflected in the typical consumer price indices stem from the global stimulus programme. We re referring to asset price inflation, as much of the stimulatory money from central banks went into the stock markets, real estate markets and other assets. That essentially created the wealth effect. People who held on to their assets after the GFC have done phenomenally well. For example, in the United States, average household net worth nearly doubled from US$105,000 in 2008 to US$199,000 in 2017, as the chart below shows. US Household Net Worth Since Global Financial Crisis US Household Net Worth (USD) ( ) Source: OECD Disruption #3: Populism In recent years, we ve seen a growing populist movement in the United States and Europe. In our view, this is a reflection of a rise in individuality alongside widespread mistrust in existing civil societies. Many people feel they have been left out and are starting to question authorities. That may be partly to do with changing demographics. For example in the United States, the disaffected older generation seems to have been one of the key contingents whose votes fuelled the victory of Donald Trump. His supporters included many individuals who found themselves less well-off than in the past. There s a similar story in Europe where the electoral success of populist parties has contributed to less certainty and more volatility. Coupled with rising levels of mistrust, we believe economic inertia in Europe and the United States has accelerated the rise in populism. In the past, the United States enjoyed an average 3% gross domestic product (GDP) growth rate over 10-year periods. As the chart below shows, however, we haven t seen that level of GDP growth in the United States over the past 10 years. US GDP Growth Since 2017 US Real GDP Growth (Annual Percent Change) Source: International Monetary Fund. Beyond Bulls & Bears Bulletin 3

4 Sukuk s Journey into the Financial Mainstream Mohieddine (Dino) Kronfol Chief Investment Officer Franklin Templeton Global Sukuk and MENA Fixed Income Strategies As the global debt market grew 9.7% in 2017 to reach an all-time high of US$237 trillion, 1 we think that figure masks an even more interesting story: sukuk issuance rose 45% over that same period and reached US$97.9 billion. 2 We think several factors could help boost the general perception of sukuk investment from a niche product into the financial mainstream. These drivers include large issuances by some of the Gulf Cooperation Council (GCC) 3 countries, plus participation from other countries like Indonesia, Hong Kong, the United Kingdom, Pakistan and Turkey, along with a first issuance of a sukuk in Nigeria. Sukuk Has Shown Low Correlation to Oil Prices Notwithstanding this growth, we consider global sukuk to be a misunderstood asset class. Misconceptions to which sukuk is often subject include assumptions that sukuk is susceptible to the headline risk associated with oil price volatility, or that it is solely concentrated in a few geographies. While a bulk of issuances in the global sukuk universe used to come from the oil-rich nations in the GCC and Malaysia, another oil exporting country, our research shows that the asset class isn t at the mercy of oil prices, and in fact, has a low correlation to oil. 4 The three-year correlation of global sukuk to crude oil is at the reality is that oil-price movement is unlikely to affect the global sukuk market. We would also challenge the notion that sukuk is an illiquid asset class. Individual sukuk issuances are becoming increasingly bigger, and more are getting listed on exchanges as a means to complement portfolios. In our experience, we ve seen a growing number of investors use sukuk as a potential portfolio diversifier, or to offer an opportunity to invest in areas of the market they might not be exposed to with more conventional bond holdings. The Future of Sukuk in Asia, the Middle East and Beyond Increasing foreign interest could be the key to further growth of the global sukuk market, in our view. With increased standardisation across the wider Islamic finance sector and a growing presence in non-muslim majority countries like the United Kingdom and the United States, we think more foreign investment in sukuk-issuing regions will further develop the industry. Appealing to a Wider Audience China, for example, could play a part in the future of global sukuk, as global Islamic centres, namely Malaysia, tend to cater to Chinese investors. Malaysia launched the first global sukuk issuance in 1990, and remains one of the largest markets for sukuk. Existing activity in Malaysia s sukuk market has been mostly confined to local currency (Malaysian ringgit) issuance. We think more foreign currency-denominated issuance could appeal to a wider audience on a global scale. That approach, alongside a regulatory regime that s supported by the central bank, could help Malaysia cater to the foreign demand we ve seen and facilitate a truly global role in the sukuk market. So, while the full extent of Chinese interest in this space isn t yet clear, we expect to see Chinese real estate and financial services companies likely among the big issuers in the near term. In our view, if Malaysia can tweak its sukuk market to meet foreign demand, it could be one of the sukuk success stories that solidifies Islamic finance into the mainstream. Beyond Bulls & Bears Bulletin 4

5 Sukuk s Journey into the Financial Mainstream continued Development of the Sukuk Market The GCC, and Dubai in particular, is another exciting investment destination where we see real potential for the growth of sukuk. While Malaysia continues to outnumber GCC countries in terms of sukuk issuances, mainly because it has a deeper domestic market with more developed insurance, pension and asset management industries, the GCC is an increasingly attractive hub for attracting foreign investment in Shariah-compliant investment products. One vital reason is because GCC sukuk issuances are typically dollar-denominated or pegged to the US dollar. We continue to see growing interest from local governments in issuing sukuks, as they are increasingly viewed as a viable option for funding and diversifying away from relying on oil revenue. Saudi Arabia raised US$9 billion alone in its first ever dollar-denominated sukuk sale this past year, 6 US$1 billion more than what the government was said to be planning to issue initially. Of the US$180 billion in corporate issuances so far this year globally, around US$10 billion of them have been from the GCC. 7 Though the industry continues to grow, albeit at a slow pace, the Dubai government has set a target to make the city the Islamic finance capital of the world, and is taking steps to achieve this agenda. In our view, Dubai could become a leading global hub for listing sukuk. Generally, the number of global sukuk issuances are on the rise. Total sukuk issuance in 2017 was valued at US$84 billion, compared to US$71 billion in In our view, we are on a positive trajectory and look forward to seeing how the sukuk market continues to develop against this positive backdrop. We think more collaboration between regulators, governments and industry bodies alike could boost this investment area further into the mainstream. What Are the Risks? All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets area subset, 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. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Such investments could experience significant price volatility in any given year. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. The technology industry can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants as well as general economic conditions. Investments in the energy sector involve special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector. Beyond Bulls & Bears Bulletin 5

6 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 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. 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. Authorised 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, authorised 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/ , authorised 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 authorised 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. Authorised 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 authorised and regulated in the United Kingdom by the Financial Conduct Authority and is authorised to conduct certain investment services in Denmark, in Sweden, in Norway and in Finland. Offshore Americas: In the U.S., 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 U.S. may be made by Templeton Global Advisors Limited or other sub-distributors, 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. CFA and Chartered Financial Analyst are trademarks owned by CFA Institute. 1 Source: Institute of International Finance, April Source: Standard & Poor s Global Ratings, January The Gulf Cooperation Council is an alliance between six Middle Eastern countries: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates (UAE). 4. Correlation measures the degree to which two investments move in tandem. Correlation will range between 1 (perfect positive correlation, where two items have historically moved in the same direction) and -1 (perfect negative correlation, where two items have historically moved in opposite directions). 5. Source: FactSet, as at 31 March Source: Ministry of Finance Saudi Arabia. 7. Source: Bloomberg, as at 31 December Ibid. Important data provider notices and terms available at Please visit to be directed to your local Franklin Templeton website. Copyright 2018 Franklin Templeton Investments. All rights reserved. 7/18