Domestic Demand Insulates Impact of Global Uncertainty
David Semple, Portfolio Manager
October 18, 2019
The third quarter was slightly more challenging for emerging markets, driven in part by the twists and turns in global trade rhetoric. In addition, we continued to see revisions downwards in global growth balanced by monetary policy movements, i.e. reductions in rates, around the globe.
While expectations for economic growth in China have been declining, there are signs that some of the stimulus, particularly the infrastructure/fixed asset investment-type of stimulus, is starting to gain a little traction. The services sector, however, continues to be relatively robust in our view. Markit’s purchasing managers’ index (PMI) showed improvement over the quarter with, notably, new orders having picked up. Meanwhile, though, imports of goods from the U.S. continued to be weak, in part driven by a buyers’ strike on the agricultural side, these buyers being SOEs. At the very end of the quarter, obviously, there was also some concern about mooted restrictions on Chinese companies listing in the U.S., as well as pressure to exclude them from globally-used indices.
In India there has been weaker than expected growth, in part because of a continuing credit crunch linked, among other things, with concerns around the creditworthiness of counterparties, including some non-bank financials and property companies. The extension of credit to them has dried up, which creates, in and of itself, an exacerbated credit crunch, with fear only making the situation worse.
However, in an attempt to get ahead of the curve, the Indian government, which has been criticized in the past for doing too little, made a bold tax move to reduce corporate tax rates substantially. The question is whether this effectively translates into increased demand. There is some skepticism and thought that any cash saved may simply go into the corporate coffer, and that spending does not increase—instead, debt gets paid back, balance sheets get better, but there is no immediate impact on demand.
While we continue to see uneven, but forward, progress in Brazil in terms of President Jair Bolsonaro’s policy prescription, it remains broadly market-positive. Entitlement reform, in a relatively intact form, appears to be moving through the legislative process. Attention turns now to other areas like privatization.
Turkey continues to be a surprise for some this year. Inflation is definitely coming down, interest rates are coming down and the situation appears to be normalizing, although it is still somewhat fragile.
Emerging Markets Equity Outlook
We currently see the outlook as uncertain. The tug of war between economic growth and monetary policy globally and the policy direction from the U.S. in particular are concerns. We believe the overall move to cap out globalization is not positive for emerging markets. While China’s economic growth is likely to move downwards, this is not something either unpredicted or deeply concerning for the VanEck Emerging Markets Fund’s very idiosyncratic, domestic demand-driven, individual stocks.
While balance sheets continue to have higher cash levels and cash flows continue to be very strong, the issue is what companies do with these flows. Valuations are modestly cheap to very cheap, depending upon where you look. This is particularly the case for small caps, which may continue to underperform. Commensurately we believe their valuations can be quite compelling.
Since we want the whole opportunity set to be available, it remains market-cap agnostic. In our view, great companies are available at very good valuations that continue to address nascent areas of demand in emerging markets that, thankfully, are not predicated upon global trade.
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