2017 Emerging Markets Equities Outlook
TOM BUTCHER: David, what were the most surprising events in the emerging markets in 2016?
DAVID SEMPLE: A couple of things come to mind in summarizing 2016. First is the rise of populism around the world which, in and of itself, is an interesting phenomenon. If it results in protectionism, clearly, it won’t be very good news for the open economies of emerging markets that depend on trading with the developed markets and with each other. So that is a potential negative, although hopefully we will see politicians come to their senses and realize that the free movement of trade and people is generally a good thing for most economies — although we obviously should be concerned about how it leaves some people behind in developed markets.
The other thing is that, after many years of underperformance, the value/cyclical part of the emerging markets universe actually did very well. Highly cyclical companies in sectors such as steel, cement, iron ore, and energy all performed strongly. As you know, that is a bit of an obstacle for our strategy, because we rely very much upon structural growth — visible, persistent growth — and we really steer away from cyclical situations because, apart from anything else, it is very hard to time the economic cycle.
BUTCHER: What is your outlook for 2017?
SEMPLE: There is a significant level of uncertainty out there, and I think people are naturally cautious as we move into 2017. People are waiting to see, for instance, how much political rhetoric gets translated into actual, implementable policy action. Concurrently, the strengthening U.S. dollar could be problematic although, as far as I can see, the dollar is getting to be quite overvalued, particularly against emerging markets currencies. Nevertheless, a strong dollar tends to be a challenge for the asset class.
If interest rates continue to go back up globally, it may or may not be bad news. That depends on whether higher rates are a result of better global growth. If rates go up simply because there is inflation without the growth — in other words, some form of stagflation — then that is not good news for emerging markets.
While this sounds very negative, there are also some very positive things out there. As we moved through 2016, it became apparent that emerging markets companies were going to achieve the earnings forecasts made at the start of the year. That is in stark contrast to the last three or four years, where there was substantial disappointment on the earnings side.
And for the companies that we look at in the structural growth part of the universe, I am very impressed with their earnings performance in 2016. Looking into 2017, I think that is likely to be the case again. This is our primary reason for optimism. Although many macro uncertainties are still out there, we are hoping for a good 2017.
BUTCHER: In terms of specifics, are there any growth spots or countries or even industries that you see as particularly attractive opportunities?
SEMPLE: There are many things going on in different places and, as you know, our investment approach focuses on individual companies. But there are a couple of countries I would like to mention.
The first is India, where there has been significant change. One of the things India has done is to implement a goods and services tax, which is targeted to be rolled out in 2017, but will probably be implemented somewhat gradually.
The other thing is demonetization, which is the government taking certain large-denomination currency notes out of circulation and replacing them with new, smaller-denomination notes. The main point behind this is to bring a good portion of the country’s so-called black economy into the official sector. Under demonetization, you have to deposit your old notes in the bank and get new notes in return. That means that many unofficial transactions — and there are a substantial amount of cash transactions in India that are not recorded for taxation purposes, or whatever — will become part of the official sector, and that is good in the long run for India.
The second country I will mention is South Africa, an area where we had more money at the end of the year than at the start. We are not big fans of the macro environment there but, as I have said before, South African companies have some of the best management teams in emerging markets. And in particular, with an all-cap strategy, we have been able to find small- and mid-cap South African companies where we have a high degree of confidence in the management, governance, and capability. We have a number of South African stocks that fall into the structural-growth-at-a-reasonable-price sweet spot that we try and achieve, often on the smaller side of the capitalization spectrum.
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The Emerging Markets Equity strategy is subject to the risks associated with its investments in emerging markets securities, which tend to be more volatile and less liquid than securities traded in developed countries. The strategy's investments in foreign securities involve risks related to adverse political and economic developments unique to a country or a region, currency fluctuations or controls, and the possibility of arbitrary action by foreign governments, including the takeover of property without adequate compensation or imposition of prohibitive taxation. The strategy is subject to risks associated with investments in derivatives, illiquid securities, and small or mid-cap companies. The strategy is also subject to inflation risk, market risk, non-diversification risk, and leverage risk. Please see the prospectus and summary prospectus for information on these and other risk considerations.
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