8 minute read
Ed's Rant
A planetarymis-alignment
Emerging markets are feeling the effects of Donald Trump’s wildly erratic behaviour, says Michael Wilson. But has the President inadvertently created a unique buying opportunity? And is it all written in the stars?
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Ben Graham never had many doubts about the importance of looking beyond the market’s fickle valuations. Don’t waste too much of your time examining the momentary fundamentals behind a particular investment, he said – just focus instead on Mr Market’s daily price, which might be well out of whack with the real situation for all kinds of reasons, and choose your moment to lock into a long-term investment if it looks likely to be a keeper.
Looking at the overall state of emerging markets today, it’s hard not to reflect that Mr Graham had it easier than we do in this internationalised world, a world where money can be moved from one hemisphere to another at the push of a button. When we look at the soaring economies of China, India and much of the Pacific region, of course, there’s absolutely
no question that the underlying economic oomph is there in abundance. China’s economy is set to grow by 6.6% this year; India’s by 7.3%; the Philippines by 6.4%; Malaysia by 5.6%; and Indonesia by 5.3%. At a time when none of the global majors is pulling in more than 2.5% or thereabouts, what’s not to like?
One question, two answers
That’s a question with two answers, unfortunately – a logical one and a market-risk one.
The logical answer is a simple slam-dunk for the optimistic view that the vast population growths in South Asia and the rapid advance of urban consumer cultures in the rest of the developing world can literally guarantee a demand growth of a kind that developed nations can only dimly recall. And for the fact that low
domestic wages and sometimes currency pegs have allowed third world exporters to undercut their Western counterparts on the price front. (Hey, not even Donald Trump can be wrong about everything…) We could also point out that China, for instance, is bringing in so much foreign currency at present that it could afford to bankroll the American government’s deficits almost single-handedly – and that it would be a fool who chose to disrespect his banker. (err, wouldn’t he?)
The market-risk argument, however, has been running all the other way this year. (There, I’ve said it.) The awkward fact is that the MSCI Emerging Markets index (MSCIEF) dropped into technical bear territory during mid-August, having lost 20% of its value in US dollar terms since the start of 2018.
And that we can’t just blame the index’s slide on the much stronger dollar, which has unquestionably reduced the relative value of non-dollar markets – and which has also sucked away a lot of loose money from EMs toward the United States, where interest rates and yields are getting better.
No, what we also have to face is that some parts of the emerging world are facing challenges that we can’t, in all honesty, blame on Donald Trump, much though we’d like to. Turkey’s recent slide into economic chaos has been a self-inflicted wound caused by an erratic Turkish president who plainly believes that a man can fly, and that you can run a fiscal policy without knowing anything about fiscal economics. Argentina’s awful foreign debt crisis is the result of long decades of wishful inward thinking, and Venezuela’s complete economic meltdown reflects a different kind of political brutality that ill befits the country with the world’s biggest proven oil reserves. (Yes, you read that correctly.)
Now, none of these smallish countries has the weight to shift global equity valuations by 20% - unless, I suppose, they triggered an avalanche that had been brewing for many years. But the fact remains that international equity investors have been running the other way this year. In May, according to the Institute of International Finance, foreigners
dumped a combined $12.3 billion of bonds and stocks from EMs, of which $8 billion was pulled out of Asia and $4.7 billion from Africa and the Middle East.
In June, the IIF added, the outflows grew by another 25%, with most of the damage occurring in China. And although there was still a $46 billion net inflow of portfolio funds into the world’s emerging markets during the first five months of 2018, any comparison with the year-earlier figure of $134 billion did make it clear that something was up. But what?
The view from Venus
I had an amusing conversation recently with a star-gazing friend who reckons that the behaviour of the planetary bodies directs everything that goes on in the world. (Or on earth, anyway.) And she explained to me that the stars and the planets are currently all out of line, and in particularly stressful ways that haven’t been seen for many years.
During August alone, she said, Mercury, Mars, Saturn, Neptune, Pluto and Uranus were all retrograde. That was a combination, she said, that spreads rebellion and chaos, resentment and maybe violence among people who feel themselves to be disempowered. I sighed, nodded, and took another hefty swig from my drink.
But all that uncertainty, she added, was due to change. By 23rd August, she said, the sun would have left the unpredictable Leo and moved into the more sensible, diligent world of Virgo. Meanwhile, she said, the movement of Saturn into Capricorn, and Uranus into Taurus, would soon complete the set-up for a saner world in the final quarter of the year.
I don’t know about you, but that’s the kind of tosh that I’d like to take more seriously than I do. Personally, I’ve got my own eyes set on 6th November, when Donald Trump’s rabidly nationalistic mid-term election campaign finally comes to an end, and when we might get something closer to normal thinking replacing the foamflecked trade nonsense that Mr Bump has been spouting recently. That in turn ought to engender a calmer approach to trade and investment, assuming that China and Europe and the rest have managed to land enough counterblows on the Prez to force his advisers into taking him aside for a quick lesson in trade economics. And if that happens, there’s a good chance that the emerging markets of the world will be more than ready to seize the upside
Of course, it might not take that long. Even as I write, the growing howls of dismay from Chinatariffed American farmers, car and motorbike manufacturers, whiskey distillers and even technology producers are getting more insistent about the downsides of being locked out of their respective export markets.
Some are trying to remind Trump that America will have no essential rare earths and minerals for its tech gizmos unless it starts to behave more nicely toward Africa and China, which produce and control 90% of the world supply.
I could go on about the dark warnings from the US Treasury folk who hint that China’s $1.2 trillion of US government bonds (along with Japan’s $1.1 trillion) would be enough to sink the greenback if Beijing’s central bank were ever sufficiently annoyed to sell them. That would be a distant likelihood, of course, because it would also hurt the renminbi yuan; but heck, we have a profoundly ignorant and angry man in the White House who just doesn’t see either the lines in the sand or the landmines that lie just beyond them.
Back to the future
So it’s back to Ben Graham for our final thoughts, I suppose. As the great man might have observed if he’d been around today, the strong medium-term fundamentals of most current emerging markets (excluding, perhaps, South America and parts of the Middle East) are being railroaded by an externally-instigated insanity that seems to defy either logic or control. And that’s a potential opportunity that’s worth watching.
Agreed, the mood seems likely to stay unsettled for as long as the Prez continues to believe that a
trade deficit to China is an act of Chinese aggression, rather than that America can’t compete on price and that its own consumers simply don’t want to stop buying cheap Chinese products.
So the question is, is this a buying opportunity for the brave? Or is it a warning to keep our hands off until things get a bit clearer?
Fund managers are very sensibly reminding us that it’s dangerous to simply brush over the problematic issues in our rush to embrace the EM opportunity. Before we assume that everything will quickly return to the longterm mean, we need to at least acknowledge that China’s trade expansion has shifted the earth on its axis in ways that President Trump has yet to understand, let alone accommodate.
And that the rise of non-OPEC oil production has altered the strategic importance of countries like Russia or Venezuela or the United States itself, in ways that we have yet to grasp. Our historical statistical models from the last 50 years aren’t built to cope with the risk parameters that we’re dealing with now.
Risks and valuations
There are other, highly specific issues that we shouldn’t ignore lightly. China’s semi-state-owned banks are carrying hideous levels of secret and undeclared
bad debts that could threaten Beijing’s consumption boom – although, in fairness, we should add that China’s mandatory bank reserve levels (about 15% of lending) are well in excess of international requirements and should be able to handle a lot of the strain if the worst should happen. More seriously, perhaps, China’s foreign debts are nudging 300% of GDP, broadly the same as Japan - but with a much more powerful economy…..
Bombay is not perfect either, although that shouldn’t worry an experienced stock-picker. The sorry historical memory of endemic industrial corruption still endures, even though safeguards are now in place. And restrictions on foreign investment in key industries still persist, which is awkward to say the least. Yet both of these markets remain highly liquid - and at a time when the dollar valuations of both the rupee and the yuan have been under pressure from a strengthening US dollar, that’s all good news.
And so, of course, to valuations. Some investors are understandably bothered by the sky-high price tickets which are often attached to fast-growing emerging markets – apparently without reflecting that a share price ought to be priced to account for that future growth. Even so, I was somewhat surprised
to read last autumn that Bombay is now the most expensive stock market in the world – with the trailing p/e on the Sensex hitting 24.53, compared with 19.67 for the Dow Jones, 23.3 for the UK All-Share, and just 17.04 for the Shanghai Composite.
That, the Economic Times of India claimed, had been happening because of a short-term ripple.
Foreign investors who’d been taking profits on Indian stocks all year, it said, had been unexpectedly tempted back into the market by a sudden strengthening in the rupee that had added new eastern promise to the prospective gains that could be had from their Bombay holdings. By May 2018, moreover, the Sensex was on a still-impressive trailing 23.5, which equated to roughly 19 in forward terms. So not so expensive after all.
Another thing that impresses me these days is the sheer local expertise of skilled fund analysts. In June 2017, Morgan Stanley set a target of 34,000 for the Sensex by mid-2018. And whaddayaknow, when the index closed at the end of June it was at 35,400 - picking up further to 37,000 as the end of July approached. Wow. Just wow….
Conversely, and less happily, Morgan Stanley were similarly successful in their downmarket projections for China and Hong Kong, where a projected 18%
growth in the Hang Seng was trimmed to 12% by the brute force of events. The irony here is that MS’s 18% estimate would have been looking excellent back in January, before President Trump’s talk of trade wars started to look like a reality: alas, however, two crunching downward sweeps had knocked a full 14% off the valuations by the end of July 2018.
So how did it go for China itself, then? Well, MS understated the gloom with its prediction of a 0.5% annual drop in the Shanghai index by June 2018. In practice it had lost 10% due to Trump’s tariff sanctions, and by late July the market had pretty much resumed the 2,900-ish levels of 2010-2012. Having sorrowfully consigned its midsummer-madness peak of mid-2015 (5,166, since you ask) to the record books.
Will those peaks ever return? For sure they will. Not everywhere, perhaps, but the reversion to the mean is surely bound to hold. There is a worry that a sudden exodus from the US could spark another huge, swamping wave, but my 40 years of antenna-twitching don’t think that’s very likely.
But when do we get to see the upturn, exactly? Well, I have a good friend who can sell you some special interplanetary crystals on a piece of string…..
