Looking Past EM Headlines at Solid Micro Conditions
KRISTEN CAPUANO: Emerging markets equities have struggled a bit this year, particularly against U.S. equities. Here to discuss the reasons why is portfolio manager at VanEck, David Semple. David is the Portfolio Manager of VanEck’s Emerging Markets Equity Strategy. David, thank you so much for joining us today. Maybe we could just start with the reasons why, year to date, emerging markets equities have struggled a little bit. Maybe from your perspective tell us why.
DAVID SEMPLE: There’s a number of different reasons, they are interconnected, there is a similarity or a read-through from several different strands of issues. One is the U.S. dollar. The U.S. dollar being strong is generally bad news for emerging markets, particularly if it rapidly strengthens. And it has done this year. That tends to reduce earnings, reduce liquidity, and of course, reduce the returns to U.S.-based investors. Now, the other aspect of that is the ongoing tariff issues, the trade wars, the protectionism, whatever you like to call it. This is clearly, in my mind, a lose/lose situation, but emerging markets will probably lose more. And it’s become clear over time that the real target here is very much China, claiming unfair trade practices. But this is not an issue that will go away lightly and the fear of retaliation, of retaliation, of retaliation has certainly held back markets. And then finally, particularly in the early part of the year, as rates were rising, there was a concern about the increase in interest rates in the U.S. and that perhaps would draw money into the dollar. Although I think a lot of it has to do with repatriation of corporate profits. And the growth differential as well. The U.S. is clearly having a very strong growth period; I believe it’s towards the end of this cycle. And I think there’s been a number of things that have brought this growth period to the level it’s at just now. And looking forward into the next few years, I’m concerned about the fiscal situation in the U.S. and the implication that will have for the dollar: weaker dollar is good news for emerging markets. But the underlying issue is that the emerging markets corporates are still doing well. The micro issues are still doing fine. So there’s a lot of macro angst, but underlying it. And we’re stock pickers. We see a lot of good things going on.
CAPUANO: That’s great, thank you. So, it’s interesting that the market seems to have been moved by these kind of macro factors and trades. Let’s get back a little bit to growth. You mentioned that you think DM growth (developed markets growth) might be peaking versus emerging markets [EM] and emerging markets are poised to continue on its trajectory. Maybe talk a little bit about one or two countries where you see this most prevalent.
SEMPLE: Well, to be clear; the U.S. growth in particular is strong. There’s been a lot of concern about Chinese growth. And the Chinese government clearly wants to maintain a good growth going forward. Now, it’s natural that growth will decelerate in China. And I don’t think this is something to be worried about. We can quibble about how they measure it and whether it’s a real number or not. But the real economic indicators suggest that there is good growth going on in China. So we expect that to continue, I think we’ve moved into a relatively more easy phase in Chinese policy. It was tightening, and for good reasons, cleaning up the shadow banking system for instance. So we expect that to continue going forward.
Other countries have been a bit more challenged, particularly the countries that are capital demanders, in other words, have big savings and investment gaps. So they need to have capital inflows to square the balance of payments. Fortunately some of those countries are relatively small for the equity part of emerging markets. So they create a lot of headlines, countries like Argentina and Turkey, there’s a lot of febrile headlines about what’s going on there. But actually at the baseline, it’s important – “pay attention” – but it’s not that important for emerging markets equities. Getting the view right on China is much more important. And of course, as you know, for China it’s been a number one asset allocation mistake that emerging markets managers have made in the last decade is being underweight China. Maybe swayed by headlines. Maybe, you know, if they’re more index-oriented than we are, then what they’ve been able to invest in has not been particularly attractive. But there’s some great things to invest in, in China. It’s the world’s biggest consumer market. It’s the fastest growing major consumer market, by far the biggest ecommerce market, particularly mobile. It’s a great place to invest in, good quality consumption there. So we continue to find great opportunities there.
CAPUANO: That’s a great segue. So let’s stay with China for a minute, two questions. The first is valuations: if folks and investors are looking to get into emerging markets, what are your thoughts on valuations in China? And then given that this is kind of a stock picking environment, particularly when EM are struggling a little bit, maybe your favorite stock that the portfolio holds in China.
SEMPLE: Sure. I’m going to run the two answers together, as it were, from the two questions. Because when you look at China there’s definitely somewhat of a dichotomy between old fashioned China and the valuations you get there and the newer parts of China. So that will be the likes of Tencent1 and Alibaba. 2 So if you take the aggregate market as a whole, whether it’s the H-shares, which are listed in Hong Kong, or the A-shares which are domestically listed in Shanghai and Shenzhen. Those valuations overall are about as low as they’ve been. So there’s no premium for the A-shares generally speaking, versus other Chinese shares listed elsewhere.
The question, the concern that people had at the beginning of the year was particularly related to our version of the FANGs: so Alibaba and Tencent more than anything else. And those valuations have come down. We’ve been a long-term shareholder in a company like Tencent. We’ve owned it for pretty much the last decade. And throughout that period, people have periodically been telling me that the company’s too expensive. Don’t forget the time value for growth investing. With time comes a normalization of values, as a company grows, assuming that it grows at a good level. And it’s typical of the market myopia, that looking at the second quarter, Tencent has been guiding down because one of the hit video games PUBG, they’ve been unable to monetize it. It’s a temporary thing, there’s lots of other levers they can pull as a company in terms of advertising and cloud and Tenpay, and a whole slate of new games which they’ve just announced. So we feel very comfortable about it and trying to time this quarter by quarter is not the game we’re playing. We’re investors in this company for the long term. So it has come down. It’s at levels we think are extremely attractive now relative to its history. And so it’s a great opportunity for some of these larger stocks. But the smaller stocks as well. Sometimes people take these asset allocation decisions that are at a broad level, and it’s throwing the baby out with the bathwater. So here’s the baby. The small-cap stocks as well: small cap has underperformed in emerging markets generally, not just in China, over the last three years. We think that’s probably poised for a turn.
CAPUANO: Great, thank you. Lastly, you speak with our investors all the time and a lot of those investors are doing their client meetings or their second half planning. What would you tell them about your outlook for the remainder of the year for emerging markets?
SEMPLE: It’s: “Just relax because …” I mean that in the sense that there’s a lot of headlines. There’s always a lot of headlines in emerging markets, whether it’s Turkey or Argentina or Brazilian elections or something that’s happening in Venezuela. One thing I’ve learned over the years is that the headlines are things that people react to more. And the sort of twitchiness of that kind of investment behavior is not what we’re after. If you have a valuation discipline and a philosophy that you stick to, then volatility creates opportunity, not risk.
CAPUANO: David, thank you. For more information from VanEck’s portfolio managers, please visit us at vaneck.com/ucits/subscribe.