The third quarter of 2015 was one of the most difficult quarters I can remember for Asia and Latin America, as stocks and currencies tumbled. However, markets can change quickly, and the Invesco International and Global Growth team believes the fall in valuations has made our markets more attractive for long-term investors now than they were just three months ago.
Chinese corporations adjusting to “new normal”
China’s market was certainly turbulent in the third quarter, and there has been a lot of negative news flow. We believe China is undergoing a transformation toward maturity, and we expect to see the country’s economy grow well below the 7% growth rate we are seeing today1.
The property bubble and subsequent sell-off hit government expenditures. A weak property market in China means less government revenue to fund counter-cyclical spending, particularly on infrastructure.
With Chinese corporate profits slowing, Chinese consumer spending decelerated. As corporations adjust to the “new normal,” earnings revisions are continuing to be negative. The good news for the short- to medium-term is that China’s economy appears to be rebounding.
With the market pulling back, we are finding opportunities in China, particularly in the consumer staples space as valuations were hit. The pullback in China allowed us to add a new name to the portfolio – Kweichow Moutai Co., Ltd. (1.08% of Invesco International Growth Class and 1.09% of Invesco Global Growth Class as at September 30, 2015). Moutai is the premier brand in Chinese spirits and it is an integral part of Chinese culture. The business was started during the Qing Dynasty hundreds of years ago, and today the company has a 58% share2 of the high-end spirits market in China. The company is net cash, has best-in-class margins with an operating margin of over 70% and was trading at a significant discount to its own history and to global peers at only eight times3 its estimated enterprise multiple for 2016. The sell-off in local shares provided an opportunity to initiate a new position in the company.
Brazil pursues improvements, but recession likely to continue
We believe President Dilma Rouseff’s economic policies were a key factor in destabilizing the Brazilian economy since becoming president in 2011. Her misguided populist expansionary policies threw the country into a deeper-than-expected recession, with Brazil’s fiscal spending at the centre of its troubles. Weak industrial growth and consumer spending have reduced the tax revenues needed to balance the country’s fiscal account.
Today, however, we now believe that President Rouseff is generally trying to make better policy decisions. She has, in our opinion, appointed a market-friendly finance minister whose focus is on fiscal austerity. However, one of her biggest impediments appears to be political. With her approval rating falling to single digits, she lacks the political clout to push through the necessary reforms required, in our view. Her popularity and her ability to govern are so low that many have been calling for her impeachment. So today, President Rouseff’s attempts to pass a meaningful fiscal package have proven largely futile.
With the political chaos and the weak economic backdrop, Brazil’s sovereign debt was downgraded to junk status.4
Brazil’s currency, the real, has appeared to be in a state of free fall amid a macro backdrop that has gotten worse by the day. The real depreciated 27%1 (against the U.S. dollar) in the third quarter alone, and inflation is now at highs which were last seen more than a decade ago in Brazil’s tumultuous past. We expect gross domestic product growth will recover, but the recession will likely be extended another year.
Staying focused on quality gives us conviction in these types of environments. Risk does exist, but we are weighing it daily. Presently, given our belief that valuations already reflect Brazil’s weak economy, we are content with the weighting and positions we have there today.
Proving to be resilient is BM&F Bovespa, Brazil’s equites and derivatives exchange (1.22% of Invesco International Growth Class and 1.18% of Invesco Global Growth Class as at September 30, 2015). And we also hold BRF S.A., Brazil’s largest processed protein producer (0.69% of Invesco International Growth Class and 0.65% of Invesco Global Growth Class as of September 30, 2015), which benefits from the weaker currency.
Valuations present opportunities
As the dust settles after the tough third quarter, we are using this opportunity to improve the quality of the portfolio where we see dislocations in pricing.
To give you an idea about the attractiveness of our markets and how quickly they have changed, the MSCI AC Asia Pacific Growth Index was trading at 13.1 times its estimated price-to-earnings ratio (P/E) for the next 12 months at the end of June. At the end of September, that fell to 11.7 times P/E – a drop of over 10%.5 The drop in emerging markets was even more pronounced. So, our markets are clearly more attractive now versus just three months ago.
We have high conviction in our long-term EQV (earnings, quality, valuation) approach, which is based on bottom-up stockpicking and company fundamentals. We believe this is the right approach for the long term.