After our webcast last week, we received quite a few questions about how the reduction of quantitative easing programs in the U.S. will affect emerging markets.
Emerging markets: The backdrop
Equity indices in emerging markets countries have underperformed those in developed regions. Year to date, the MSCI Emerging Markets (EM) Index is down 14% compared to a gain of 6% for the MSCI Developed Market Index (as at June 21, 2013). On top of this, many emerging markets currencies are depreciating against the U.S. dollar and some, such as the Indian rupee and Turkish lira are at all-time lows.
Several factors are at play here. In the last five years, a lot of speculative money flowed into emerging markets because of subpar growth and low interest rates in the U.S. and Europe. Emerging markets benefitted significantly from the avalanche of liquidity. Now, with the U.S. economy slowly recovering and the Federal Reserve (the Fed) signaling a “tapering” of quantitative easing, higher U.S. interest rates and a stronger U.S. dollar are on the horizon.
In addition, many developing countries are seeing slower than expected growth and political unrest. As a result, emerging markets have low trading volume, movements are magnified and we are seeing profit taking and money flowing out of emerging markets.
We expect these markets to remain under pressure in the near term.
Trimark Emerging Markets Class
With all of this as a backdrop, the logical question is, “Why should I bother with Trimark Emerging Markets Class if the outlook for the region is negative?”
The answer is quite simple: Because the opportunities are there.
At any given time, there’s a popular trend dominating stock market discussion. You just have to avoid drinking the Kool-Aid of the day. If it’s not the Fed Kool-Aid, it’s BRIC* Kool-Aid or precious metals Kool-Aid – there are plenty of flavours to choose from.
We are not the index
We are not making country bets. We are selective. We choose only 50 to 70 high-quality companies in the emerging markets around the world.
The companies we invest in are participating in the growth of smartphones, enabling market penetration of credit cards, providing better medical care, supplying reliable power sources to avoid electrical blackouts, and more. These strong businesses don’t stop just because the Fed announces plans to end quantitative easing programs.
These companies continue to generate strong free cash flow and don’t rely on share issuance or debt markets to grow.
As you may know, our investment approach is “business people buying businesses.” We have regular conversations with senior management teams from world-leading businesses and none of them have let what happened in the region’s capital markets deter their business plans. They are able to ignore the noise created by capital markets players because they know they are investing for longer-term prosperity. In fact, they, like us, view this panic as a potential opportunity to buy at attractive prices.
To avoid the ever-changing flow of Kool-Aid out there, we are methodical and disciplined in deciding how much we are willing to pay for growth. Remember when the China Shanghai Composite Index was trading at 59x P/E** in October 2007? Or when India’s SENSEX was trading at 22x P/E in the same month? No one could get enough. It wasn’t a lack of growth. These economies were growing at high single digit rates (any developed market would be jealous). But it was a clear case of investors being overly optimistic and forgetting about dollars and cents.
We are patient investors, in terms of both waiting for our opportunity to invest in a company and seeing our investment thesis to come to fruition. The MSCI EM Index is now trading at close to 10x P/E,(as at June 21, 2013) below that of the developed market.
We are slowly revving our engines.
My colleague Jeff Feng and I are always happy to answer questions about the emerging markets space. Please feel free to leave a comment below with any questions or thoughts you have.
*BRIC refers to the countries of Brazil, Russia, India and China.
**Price-earnings (P/E) ratio, the most common measure of how expensive a stock is, is equal to a stock’s market capitalization divided by its after-tax earnings over a 12-month period.
Learn more about the Trimark Investments team.