4TH QUARTER 2014
MARKET REVIEW & ALLOCATIONS REPORT MILLTRUST GEMMA UCITS MODEL PORTFOLIO
0
TH
4 QUARTER GLOBAL EMERGING2014 MARKETS EQUITY
ALLOCATIONS SUMMARY OPTIMAL COUNTRY ALLOCATIONS The graph below shows the final output of our proprietary Strategic Regional Allocation Model (long-term) and Tactical Regional Allocation Model (short- to medium- term). Both models are updated monthly. Optimal Country Allocation Breakdown 40% 35%
Allocation %
30%
29.2%
25%
20.0%
20%
19.1%
17.6%
15%
14.1%
10% 5% 0% China
India
ASEAN
LatAm ex-Brazil
Brazil
Summary:
China
India
ASEAN
LatAm ex Brazil
Brazil
Optimal Allocation:
29.2%
20.0%
19.1%
17.6%
14.1%
Range:
24%-35%
15%-25%
14%-24%
13%-23%
10%-20%
FUND ALLOCATIONS We use our model recommendations to shape our allocations to our underlying Funds.
Funds:
Milltrust Greater China Fund
Milltrust India Fund
Milltrust ASEAN Fund
Milltrust LatAm Fund
Milltrust Brazil Fund
Existing Allocations (as of Sept 30th):
21.0%
27.5%
19.5%
22.8%
9.1%
New Allocations:
23.5%
25.0%
19.5%
22.8%
9.1%
Action:
Increase by 2.5%
Decrease by 2.5%
No Change
No Change
No Change
Summary:
The China exposure remains at the low end of our optimal allocation range (24%-25%), whereas India shifts to the top of the range (15%-25%). Our exposure to ASEAN and Latin America as a whole remain on target.
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4 QUARTER GLOBAL EMERGING2014 MARKETS EQUITY
COUNTRY SCORECARDS TACTICAL REGIONAL ALLOCATION MODEL (TRAM)
China
Greater China
India
India
Indonesia
ASEAN
Malaysia
ASEAN
Philippines
ASEAN
Thailand
ASEAN
Brazil
Brazil
Chile
LatAm ex Brazil
Colombia
LatAm ex Brazil
Mexico
LatAm ex Brazil
Peru
LatAm ex Brazil
Structural Reform
Political Review
Monetary Policy
Foreign Exchange
Sentiment
External Balance
Consumer Confidence
Demand
Foreign Exposure
Trending upwards, Positive
Neutral
Growth
Country/Region
Momentum
Country
Valuation
Trending downwards, Negative
STRATEGIC REGIONAL ALLOCATION MODEL (SRAM) Growth & Opportunity Set
Secular Trends
Political Risk
Economic Risk
Financial Risk
China
1.55
0.68
-0.62
0.85
0.91
India
0.30
-0.39
-0.60
-0.81
-0.38
ASEAN
0.09
0.02
-0.13
0.15
-0.24
Brazil
-0.81
0.10
-0.17
-0.60
0.20
LatAm ex Brazil
-0.35
-0.12
0.48
-0.01
0.06
Regions
TH
4 QUARTER GLOBAL EMERGING2014 MARKETS EQUITY
COUNTRY ASSESSMENTS
COUNTRY REVIEW & OUTLOOK Country
China
Short Term Outlook Assessment
=
Recent data has shown that the pace of China’s recovery has slowed slightly but the economy is still trending upwards with the possibility of more ‘mini stimuli’ to come as required; we do not discount the prospect of interest rates or RRR cuts in the future. Valuations in China are still very low with some clear upside as the recent government reforms start to take effect; these include the ongoing anti-corruption drive, the SOE reform which will include partial privatization in a bid to attract private investment and increase shareholder value and the Stock-Connect which will start the integration of the exchanges within the Chinese territory. On the downside, we are still concerned about the property market and are actively looking for signs that the market is stabilizing.
India
India is no longer ‘fragile’. Its current account deficit has reduced to a manageable level, economic and earnings growth are accelerating, there is a new wave of infrastructure projects on the agenda and the ‘Modi effect’ is driving both foreign and domestic sentiment. Despite the run-up in equities this year, the valuations are still at 10-year averages with P/E ratios still at half of what they were at the peak of the market in 2007/2008. Whilst we are positive on India, we are closely monitoring the government’s next actions as they will have to start delivering on their promised reforms, particularly in the taxation and labour markets, in order for the stock market rally to be sustainable. India’s food inflation is another highly sensitive and relevant issue in India given that about 25-30% of India’s population spends more than half of its monthly household income on food.
Indonesia
Despite GDP growth recently slowing to its weakest pace in 19 quarters and its current account deficit making it vulnerability to global monetary conditions, Indonesia is providing a lot of medium term optimism. There is increasing noise about spending more money on infrastructure and manufacturing which will help reduce Indonesia’s over-reliance on commodity exports, reducing the fuel subsidies which should help ease the current account deficit, and implementing some significant SOE, education and tax reforms. Consumer stocks should benefit as Indonesians’ spending power improve. There are a lot of positives here, some of which have already been priced in the markets. We will also be carefully monitoring the funding and implementation of these reforms.
Malaysia
Malaysia is the second fastest growing economy (tied with the Philippines) in Asia after China with 2nd quarter growth of 6.4%. Much of this growth has been consumption-led which in turn has been primarily funded by debt (household debt is very high at 86% of GDP). This is unsustainable given the existing income levels so we expect some contraction. Especially as Malaysia is also entering a tightening phase. In the meantime, doing business in Malaysia is getting better as companies continue to benefit from the government’s mission to reduce bureaucracy. The big agenda item is the government’s Goods and Services Tax to be applied from next April. The aim is to significantly reduce the size of the shadow economy and provide new sources of revenue for the government. There are risks to higher inflation here.
Philippines
=
The Philippines continues to be one of the bright prospects in the region with strong growth (2nd highest in Asia) providing the central bank with more leeway to adjust monetary policy and to support growth by increasing spending. Whilst China and the other Asian economies (except Malaysia) are loosening to stimulate growth, the Philippines are going in the opposite direction with expectations of further rate increases. We expect the economy to continue to expand over the coming quarters due to an increasingly competitive manufacturing base, higher exports
GLOBAL EMERGING MARKETS EQUITY (electronics, agriculture), and strong local demand. Despite the strong macro picture, the valuations are very expensive (nearly 2 standard deviations from long term average), so we will proceed with caution.
Thailand
Thailand, which avoided a recession earlier this year, has provided some short-term optimism with the improved political stability boosting consumer confidence (at a 13-month high) and business sentiment. The new government will be adopting an expansionary fiscal policy to help the economic recovery with structural reforms also expected. Whilst consumption and investment have started to recover, exports remain weak and the political uncertainty will be set to return once the junta steps aside in late 2015. Valuations are still high due to depressed earnings, but earnings growth is anticipated.
Brazil
Brazil provides a mixed bag of both negative trends (shrinking economy, high inflation, very tight monetary conditions) and positive trends (record low unemployment, promise of market and business friendly structural reforms). What is clear is that reform is desperately needed to stimulate the economy. The upcoming election in October will provide a key catalyst for the future of the economy. An opposition win would most likely lead to a sharp rise in the Brazilian stock market and encourage businesses to invest and expand more. Should Dilma, the incumbent, win, the markets will likely fall further as her market ‘unfriendly’ interventionist policies would be set to continue. In reality, regardless of who wins, there will be challenging times ahead.
=
Chile
Chile’s economic growth has been on a downward trend led by a slowdown in consumption, uncertainty around the impact of the recent fiscal reforms on future investment and growth and a decrease in copper prices. We believe the reforms are a case of ‘short term pain, long term gain’; the government’s new tax reform, for instance, is likely to improve Chile’s medium to long-term outlook as the reform revenue gets re-invested into the economy. 2015 is likely to be a better year as the economic deceleration bottoms out in 2H 2014.
Colombia
Despite the slowdown of the commodity boom which negatively impacted commodity-exporting countries like Colombia this year, Colombia has outperformed its regional peers and has become the fastest-growing of the major Latin American economies with consensus for next year’s growth in the 5% range. A key driver for the coming years will be the country’s large infrastructure program centered on building new roads. The prospect of a peace deal with the rebels, whose attacks on oil infrastructure earlier this year significantly affected output, would also be a very welcome development. Moody’s upgraded Colombia this year to Baa2 (same as Brazil).
Mexico
We have a positive outlook for Mexico as several indicators have shown a recovery in the economy. Increasing demand from the US, an accelerating manufacturing sector, the opening of the energy sector to private investments, forcing competition in the telecoms market as well as labour, education and financial reforms will all provide the Mexican economy with a tailwind going into next year. The forecasted growth for next year is 3.7%, following last year’s 1.1% and this year’s target of 2.7%.
Peru
Peru, like Colombia, is a medium-sized commodity exporter with an open-market economy in Latin America. Unfortunately for Peru, its main exports, gold and copper, suffered significantly from weaker prices and softer demand particularly from Asia. Peru is now amidst the worst economic deceleration in five years with possibility of entering in a recession. The Central Bank is likely to continue a loosening monetary policy in the hopes of triggering the recovery process. Growth is still likely to be around 4% which isn’t two bad these days, just not the 6-plus% that Peru has enjoyed over the past decade.
GLOBAL EMERGING MARKETS EQUITY VALUATION & MOMENTUM
Country
Region
Valuations
Momentum Price
Earnings
Brazil
Brazil
Cheap
Oversold
Negative
Chile
LatAm ex Brazil
Cheap
Neutral
Neutral
Colombia
LatAm ex Brazil
Cheap
Oversold
Neutral
Mexico
LatAm ex Brazil
Neutral
Neutral
Neutral
Peru
LatAm ex Brazil
Neutral
Oversold
Negative
China
China
Cheap
Neutral
Neutral
India
India
Neutral
Neutral
Neutral
Indonesia
ASEAN
Expensive
Neutral
Neutral
Malaysia
ASEAN
Neutral
Neutral
Neutral
Philippines
ASEAN
Expensive
Neutral
Neutral
Thailand
ASEAN
Expensive
Neutral
Neutral
GROWTH
Growth rates look the most attractive in Asia. Latin America, a continent of more commodity focused economies, has felt more of the impact from the slowdown in the commodity boom. Not listed below are Thailand (+0.4% GDP Growth, +180% change) and Brazil (-0.9% GDP Growth, -147% Change). The Central Bank of India forecasts a 5.5% GDP growth for next year and the expectation is to not need to lower interest rates to reach this target. This is positive given India’s current ‘war on inflation’.
30% 20% 10%
Philippines Malaysia
0%
1%
2%
3%
4%
5%
-10% -20%
Chile
Mexico
-30%
Chile and Peru) are commodity-focused economies which suffered from the commodity slowdown.
-50%
-70%
6%
7%
Colombia
Colombia, also a commodity-exporter, was less impacted as oil and coal, their main exports, were less affected.
-40%
-60%
China
Indonesia
0%
3 month change
India
Peru Annual GDP Growth
8%
GLOBAL EMERGING MARKETS EQUITY DEMAND Manufacturing activity and industrial output can be a useful proxy for consumer demand, given how sensitive the manufacturing sector is to consumption. We look at both Industrial Production and PMI numbers. Purchasing Managers' Index Contraction
4%
Expansion
Industrial Production
Brazil
3%
India
2%
China
3 month change
1%
Mexico
0% 49
49.5
50
50.5
51
51.5
52
52.5
53
-1% Despite the drop in Industrial Production, China is still expanding, albeit at a slower pace. The government is on standby with more stimulus if required.
-2% -3% -4% -5%
Indonesia
-6% -7%
Latest
Prior
Chile
-4.1%
0.9%
Brazil
-3.6%
-7.1%
Thailand
-2.7%
-5.3%
Malaysia
0.5%
7.0%
India
0.5%
3.4%
Indonesia
1.4%
6.7%
Colombia
1.6%
-0.6%
Peru
1.8%
2.0%
Mexico
2.1%
2.0%
China
6.9%
9.0%
Philippines
7.7%
10.8%
PMI
CONSUMER CONFIDENCE
Increasing confidence
This questionnaire focuses on the consumer’s current financial situation and on expectations about inflation, unemployment, wages and major purchases for the next 6 months. The value 100 indicates no evolution in consumer’s sentiment, a value over 100 indicates increasing confidence and a value under 100 indicates low expectations.
The ‘Modi effect’ in India and the ‘Jokowi effect’ in Indonesia have created a strong uplift in expectations 140 for higher standard of living.
With very low unemployment, the Brazilian household is still maintaining a relatively good standard of living. Malaysia is at a turning point as household debt reaches uncomfortable levels. We feel there is some downside risk here.
120
The Mexican government’s first year in office was unpopular, but we expect consumer confidence to rise.
100
Low expectations
80
60
40
20
0 India -20
Indonesia
Brazil
China
Malaysia
Mexico
Thailand
Peru
Chile
Colombia Philippines
GLOBAL EMERGING MARKETS EQUITY EXTERNAL BALANCE
Given we are likely to enter a phase of tightening monetary conditions with the US looking more likely to tighten earlier than expected, we are paying particular attention to countries with current account deficits which are likely to be more vulnerable in these conditions. However, we also look at the level of foreign direct investment versus current account deficits. A current-account deficit is likely to be more manageable if it is financed by foreign-direct investment. FDI vs Current Account
Current Account (% of GDP)
80,000
Last 12 Months Peru
-4.96%
Colombia
-3.59%
Brazil
-3.49%
Indonesia
-3.02%
Chile
-2.34%
Mexico
-1.95%
India
-0.98%
Philippines
0.94%
China
1.77%
Malaysia
2.60%
Thailand
3.22%
With the Indian economy recovering nicely this year, we could expect to see a slight increase in the current account deficit as India starts buying more machinery and capital equipment to support the infrastructure projects.
60,000 40,000 20,000 Brazil
Indonesia Mexico
India
Colombia
Peru
Chile
(20,000) (40,000) (60,000)
Reduction of fuel subsidies which should help ease the current account deficit in Indonesia.
(80,000)
Current Account
FDI
FOREIGN EXPOSURE We look at the ‘FX reserves to short term external debt and current account balance’ ratio (the latter is known as a countrys’ gross external financing requirements) to anticipate each country’s ability to meet their foreign payments and debt obligations and to ultimately assess their credit health. 15%
India Thailand 10%
India’s foreign-exchange reserves are near record highs which should provide them with some protection should there be a repeat of the EM turmoil. Meanwhile, India’s credit rating outlook was raised to stable from negative by Standard & Poor’s.
3 month change
China Indonesia
5%
Mexico
Brazil
Brazil may be ‘fragile’ but it has a healthy FX reserve balance to deal with sharp capital outflows.
Malaysia
0% 0%
200%
Colombia
400%
600%
800%
1000%
Peru
-5%
Chile
-10%
Fx Reserves / (Short Term External Debt - Current Account Balance)
1200%
1400%
Philippines
GLOBAL EMERGING MARKETS EQUITY SENTIMENT The blue circle below highlights countries with positive sentiment which is typically where we see an upward trend in markets and currencies. 2%
China
0%
3 month change - Currency
-5%
0%
5%
Malaysia -2%
Thailand 10%
15%
20%
Indonesia Philippines India
Peru
Mexico
-4%
Positive Sentiment -6%
Colombia -8%
Chile Sentiment can change very rapidly in Brazil depending on the election results. The incumbent would be market un-friendly.
-10%
Brazil
-12%
3 month change - Equity Market Index
FOREIGN EXCHANGE Whilst we do not hedge currencies, we do look at currency valuations to determine whether a currency is under- or overvalued. We compare the weighted average of a country's currency relative to an index of 61 currencies adjusted for the effects of inflation (Base year 2010), also known as the real effective exchange rate (REER). In the graph below we compare the current REER to its 3-year average. Overvalued
4.00%
% Change in REER from 3 year avg.
2.00%
0.00% Chile
Indonesia Colombia
India
Peru
Brazil
Thailand
Malaysia
Mexico
-2.00%
-4.00%
The Indian Central Bank has repeatedly intervened, keeping the rupee around the Rs60 per dollar mark. Expectations are for the rupee to appreciate once the central bank stops buying dollars.
-6.00%
-8.00%
Undervalued -10.00%
Philippines
China
GLOBAL EMERGING MARKETS EQUITY MONETARY POLICY Looser Environment
Tighter Environment
4.00%
2.00%
0.00%
(GDP Growth - Policy Rate)
Brazil
Indonesia
India
Peru
Thailand
Mexico
Chile
China
Colombia Philippines Malaysia
-2.00%
-4.00%
-6.00%
-8.00%
-10.00%
On Sept 3rd, Brazil’s central bank kept the benchmark interest rate unchanged at 11 percent for the third straight meeting. The central bank expects inflation to start converging to 4.5% in 2016 if monetary conditions are maintained. Brazil is simultaneously plagued with low growth; expectations are for 1% growth next year. There is a consensus belief that structural reform must be implemented to lift the country out of the recession.
-12.00%
We regularly monitor actual versus target inflation rates to help anticipate future monetary conditions and Central Bank actions. Inflationary pressure leaves little room for looser monetary policy at home to offset rising global interest rates.
9.00 8.00
Latest Monthly %
7.00
Both India and Brazil are at the top of their inflation target zones with India looking to reduce inflation by another 2% by the end of next year. Brazil find themselves in an unwelcome phase of stagflation, increasing inflation and low growth.
6.00 5.00 4.00 3.00 2.00 1.00 -
Country Inflation
Target Inflation (maximum)
GLOBAL EMERGING MARKETS EQUITY POLITICAL REVIEW
2014 was an important election year for the developing world. Nearly everyone voted this year and some countries even voted twice.
We have highlighted below some of the key election results and assessed their market impact. All the eyes of the world are on the Brazil election s in October. Neves is market friendly, Dilma (the incumbent) is not.
Country
Election & Date
Likely Win
Who Won
Indonesia
Parliamentary (Apr-14)
Opposition
Colombia
Presidential (May-14)
Incumbent
India
Presidential (Jul-14)
Opposition
Indonesia
Presidential (Aug-14)
Opposition
Brazil
Presidential (Oct-14)
Mkt Friendly
Too close to call
STRUCTURAL REFORM Structural reform is essential to boost productivity and therefore sustain growth. This year we are seeing a strong push by some countries to carry out the necessary reforms, particularly, China, Indonesia, India, Brazil, Mexico and Chile.
China
Malaysia Tax Reform
Mexico
SOE Reform Shanghai-Hong Kong Link
Labour Reforms
Indonesia SOE Reform Education Reform Tax Reform
Education Reforms Telecom/Media Reforms Energy Reforms Fiscal Reforms Political Reforms
Chile
Tax Reform
Colombia Infrastructure Program (New roads)
Brazil
Financial Reform
Infrastructure Reform
India
Railway Reform Infrastructure Reform Financial Reforms
GLOBAL EMERGING MARKETS EQUITY
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