Q What is your outlook for 2020?
Many forecasts are essentially extrapolations of existing trends. This is often the basic weakness of forecasts, but seems particularly inappropriate at this time given 2019 has seen significant changes to the status quo.
Extreme uncertainty has been driven by the disruption from China’s rise to supremacy and America’s reaction with the trade war. Technology appears like it might bifurcate into these two worlds. Attention on the third energy transition from carbon to non-carbon has soared. Central bank intervention has created a world where US$13 trillion of bonds now trade on negative yields. Lastly, we have seen massive demonstrations in different countries across the globe.
The unifying concept behind these developments is that they are either a symptom or a cause of slowing or lower economic growth. This trajectory is cyclical, but also to some extent secular as we transition to the ‘new normal’ described above. Simply, a lower, slower growth world means potentially reduced long-term investment returns going forward. Against this backdrop, generating alpha will become all-the-more important.
Q What do these changing dynamics mean for emerging markets?
What most differentiates emerging markets from developed markets at this point is that the traditional rules of economics and markets do still apply to the former. For developed markets, banks can charge depositors and pay borrowers, interest rates can go negative, a large deficit is no longer a cause for concern and so on.
Looking at 2019, the conventional rules still apply in the more fragile and volatile world of emerging markets. Argentina’s and Turkey’s equity and currency markets faced significant volatility in response to a breach of traditional disciplines on price stability, fiscal and current account deficits. So a distinguishing factor of emerging markets is that the old rules still apply. Conversely, for developed markets, there is perhaps a whole set of new rules that mark a retreat away from the disciplines of the market.
Many emerging markets have spent decades experimenting with alternatives, such as communism and socialism, and have realised actually that those non-market measures haven’t historically worked. What has been striking this year is China not just reacting to the trade war with some retaliatory trade actions against the US, but also turning to the market for solutions. Such measures as opening up its asset management, insurance, life insurance, securities, investment banking and banking markets to foreigners; liberalising interest rates; allowing Tesla to break ground as the first foreign-owned car factory in the country; and setting up its own Nasdaq-style technology ‘STAR’ market. China has also eased ownership regulations on foreign investment into its securities markets. Importantly, it has not embarked on a wholesale government-led stimulus programme. This direction of travel is positive for China and particularly foreign investors, which bodes well for 2020.
Q How are you positioning your portfolio going into 2020?
It is noteworthy that China is now two-thirds of the size of the US economy, yet its stock market is only one-third of the size of the US stock market. Moreover, its weighting in the global equity market is only around 9% of the US weighting. We believe that over time the Chinese economy, stock market and index weighting will become all-the-more significant. So we remain overweight to China, while we accept there may be short-term volatility driven by external headwinds.
Brazil is another country where we are seeing an increased focus on how the market can help them achieve their goals. So we have just seen a R$100 billion social security reform, which is expected to make significant progress on repairing its public finances. A new administration is rolling back state involvement in the economy, taming state-owned banks, privatising infrastructure and so on. Reflecting our conviction, we have the highest weighting in Brazil than we have had at any time in the past five years.
Lastly, signs are emerging of improvement in places like India and South Africa. India has cut its corporate tax rate from 35% to 25% and to 15% for new manufacturing companies. The hole left in the budget from this is going to be filled by the sale of up to US$20 billion of state-owned companies. South Africa is beginning to consider private-led solutions to issues such as Eskom and South African Airways. However, we remain cautious and focus on bottom-up stock-picking as a driver of returns.
In summary, China looks set to remain a focus for us, while Brazil looks like a very interesting change story. More broadly, I think this pragmatic conventional approach from emerging markets bodes well for performance in these markets versus developed market performance as we look forward to 2020.
Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.
All investments carry the risk of capital loss.