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Outlook 2017: positioning for growth in EM equities

Outlook 2017: positioning for growth in EM equities

While 2016 started with volatility in China when its domestic stock market plunged, but how will the asset class perform in 2017?

Citywire Selector asked leading managers for their views on what was next for the asset class and how to position to protect against uncertain outcomes.

Solid growth

James Donald, the head of emerging markets at Lazard Asset Management, said developing markets will be able to withstand interest rate rises and the outlook for Brazil will improve.

China’s economic growth continues to slow modestly as monetary and fiscal measures have been implemented, making a ‘hard landing’ scenario seem much less likely over the near term. After the impeachment of its president earlier this year, Brazil continues to work its way out of the corruption scandal and recession while focusing on critical structural reforms.

Should government officials be able to work together to enact measures to reduce the budget deficit, they will restore confidence in the economy, and business owners will start investing.

Recent discussions within Opec may lead to a floor in energy prices that could introduce further upside, or at least a stabilisation, in commodity prices. That could be the beginning of a major rotation into less expensive areas and even into commodity-oriented stocks.

After several years of emerging markets underperformance, we believe investors are looking for evidence of solid global growth, signs of an earnings recovery, very possibly the result of reaching a floor in commodity prices, and a gradual tightening of monetary policy by the Fed. If these conditions do occur, we believe the potential upside for emerging markets is significant.

Renegotiate Trade

Valuations on the verge of recovery

Citywire AA-rated Gary Greenberg, who is head of emerging markets at Hermes Investment Management, said exporters will have to renegotiate trade deals with the US.

Profitability hasn’t caught up with stock prices yet, but a range of other indicators are positive: the GDP growth differential between emerging and developed markets is widening, and in the emerging world capex and labour costs are declining, estimate revisions have stopped falling, free cash flow yields are attractive, commodity markets have recovered their composure and investor positioning remains light.

At the country level, Russia and Brazil should exit recession in the coming year, most Latin American nations are governed by market-friendly administrations, Chinese growth has confounded the bears (albeit at the price of ever more indebtedness), and India’s economy should begin to heal as banks repair their balance sheets and the agricultural sector recovers its poise after several years of drought.

Therefore in 2017 emerging market companies should become more profitable, though emerging market countries will become more differentiated. Carry trade economies (Brazil, Turkey, Indonesia and South Africa) will continue to experience competition from higher US bond yields. For exporters (Mexico, China, Korea, Taiwan), we expect renegotiation rather than rejection of existing trade agreements as the ‘Master of the Deal’ shows the world how it’s done.

Great companies with great business models, wherever they are, should find the economic environment supportive in 2017. Those countries avidly pursuing economic reforms will emerge much stronger from the current uncertainty. Valuations are once more very supportive of emerging markets, so we are constructive for the coming year.

Attractive valuations

Citywire + rated Greg Kuhnert, who manages several funds at Investec, said earnings are becoming more attractive and the valuation of companies is still cheap.

Asian companies are enjoying the strongest earnings upgrades in six years, driven by a cyclical recovery in materials, consumer discretionary and technology stocks. On the other hand, defensive sectors such as consumer staples, telecommunications and utilities are being left behind.

This is partly driven by an improvement in global economic indicators since February 2016, as well as a pick-up in Chinese growth, initially driven by a recovery in the property market and improving government infrastructure spending, but now broadening out to the manufacturing and services sectors.

Our portfolios are positioned for this recovery, with overweight allocations to consumer discretionary and technology stocks. We favour China, Korea and Hong Kong over South Asia, where an earnings recovery is below average.

Not only are we seeing better earnings revisions, but companies have also been surprising positively compared to expectations, and are improving their forward guidance. This is not just a result of low expectations, which were set at the beginning of the year, but also of an improvement in economic conditions.

Valuations remain attractive, with the region as a whole still seeing a large gap between Asia ex Japan and global price/earnings. Despite the sharp rally from lows in February 2016, the asset class trades at an 18% discount to the MSCI World Index (developed) against the historical discount of 8%, and still looks reasonable value on 14.3x earnings (Asia ex Japan), at the time of writing.

Short-term pain

Citywire A-rated Avinash Vazirani manages the Jupiter JGF India Select fund. He said, while India is suffering from the recent de-monetisation, the country will rebound in 2017.

De-monetisation is causing problems in the short term, given India is a predominantly cash economy, with 98% of transactions done with cash prior to this change. But it should also come with huge positive long term implications for the Indian economy.

The move will result in the transfer of wealth from holders of black money to the government. They government may use this money for increased spending on infrastructure or for increased benefits for poorer people who have a higher propensity to spend.

The government laid the foundation for this by opening nearly 270 million new bank accounts as part of their Pradhan Mantri Jan – Dhan Yojana (PMJDY – literally Prime Minister’s people money) scheme , which will help them get money out efficiently to people on low incomes.

The new Direct Benefit Transfer system, billed as the world’s largest social security system and likely to be next year, allows government to deliver benefit payments straight to beneficiaries’ bank accounts rather than funding subsidies.

It appears that the Goods & Services Tax (GST) will be rolled out by April 2017. The tax rate tier structure has been finalised and a draft version of the GST bill has been released for discussion in parliament. The benefits to India of this landmark reform are likely to be significant and far-reaching.

It will take a few months for these long term positive factors to develop, and in the meantime there will be some uncertainty. There is unlikely to be any GDP growth for the next two quarters, as consumer spending slows down due to the lack of liquidity. However the next few months will also bring some positives, such as a shift from physical to financial assets, which should benefit public sector banks and financial technology companies. 

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Avinash Vazirani
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142/144 in Equity - India (Performance over 3 years) Average Total Return: 5.17%
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