The tide has finally turned in favour of emerging markets (EMs) as investors are now diverting their money from developed market such as US to EMs, market guru Mark Mobius said in an interview with CNBC-TV18.
Looking at the bigger picture for emerging markets, we are encouraged to see performance improving, and emerging markets generally outperformed developed markets in 2016, Mobius said in his latest blog. The MSCI Emerging Markets Index was up 11.2 percent, while the MSCI World Index was up 7.5 percent.
We think the stage is set for this trend to likely continue in light of growth projections that continue to outpace that of developed markets, he said.
The market capitalisation of emerging markets is now over 30 percent when compared with the total Mcap across world indices. Investors across the globe have now realised that they have been underweight on EMs.
According to the International Monetary Fund, gross domestic product (GDP) growth in emerging markets this year is forecast at 4.5 percent, versus 1.9 percent for the developed countries.
Among EMs, India does stand out. “India is growing at over 7 percent which is having an impact on investments in EMs,” said Mobius. “Currently, out overweight sectors in India are IT and consumer-oriented stocks, but don't have much exposure in telecom,” he said.
Commenting on the telecom stocks, Mobius said that we were always afraid of the government using telecom companies as a cash machine. “We have to see more stability in terms of licensing,” he added.
Risk Factors:
China-US Relationship is definitely a risk for the market in the year 2017, says Mobius. It looks like Trump might not be able to institute trade restrictions that he spoke about during his campaign.
China has always been a big question mark for so many people because people look at it through the eyes of Wall Street which is not the right way to do it, explains Mobius.
China is a planned economy. They decided what they want to do and they go ahead and implement it. They might face bumps along the way but they at the end of the day when they say 6 per cent growth that means 6 percent, said Mobius.
“I am pretty sanguine about China, but there could be individual problems. There will be companies which could that could go under or groups that go bankrupt which warrants caution especially at a time when the government wants to move towards the market economy,” explains Mobius.
Below is the verbatim transcript of the interview.
Q: How does it feel about emerging markets now because last four or five years has not been very satisfying, but the start of the year has been rocking.
A: It has been fantastic.
Q: But do you think we have finally turned the tide in emerging markets?
A: I think we have because everybody during the year's ending at the beginning of last year, the three years where we have been underperforming, everyone was concerned about interest rates in America. They failed to realise that interest rates do not necessarily determine the direction of the market. Logically, you would think that higher interest rates would mean lower market and vice-versa, but it has not always been the case in the last ten years at least. So, I think people are now beginning to wake up to that reality. And of course, they also realised that they were very underweight in emerging markets. So, it is coming back.
Q: But how much of it is momentum chasing because all markets are doing well now. So, there is an element of that surely the way exchange traded funds (ETF) are getting money. Do you think it is that or do you think there has been a decisive fundamental turn once again in emerging markets?
A: I think it is a number of things. First of all, I think people realised they were underweight and a lot of people do not realise that if you look at the global market place, the market capitalisation of emerging markets is now 30 plus percent of the total. So, if you are less than 30 percent, you are underweight. And if you look at exports, imports, gross domestic product (GDP), the share of emerging markets is now over 40 percent. So, that is one thing. People are going to wake up to that reality.
Second thing is people realise that, hey how long can the bull-market in America last particularly with the whole chains in the administration and so forth, because some people, as I do, feel that Trump could give a boost to American growth, but it is dicey. It is not clear what will happen. So, a lot of people, they realise, we made a lot of money in America, let us diversify. Where do you diversify to? Emerging markets, logical place.
And the third thing is that people are looking at growth and I know a lot of people have been worried about China growth, but they have already set a target at 6 percent which I think is achievable. But India is growing at 7 percent plus. So, that is having a big impact. Then, you have Brazil having this incredible recovery and Russia also had a big recovery. So a combination of all these things have led people to believe that maybe emerging markets is where they should be.
Q: But interestingly, you believe that the growth that you are speaking about in the emerging market space will be at the expense of America, not along with America? I mean the Dow and Emerging Market Index will not move in tandem, you think?
A: Two things now, the Dow is one thing, American GDP growth is another thing. Higher GDP growth in America will be good for everybody because it is the largest economy in the world. A lower or stable Standard and Poor (S&P) or Dow is probably good for emerging markets because people will realise that that market is not going to go up forever. So, we have got to look at both sides of the coin. The bottomline is that emerging markets average growth, this year, will be about 4 percent plus whereas developed markets will be maybe 1.5-1.6 on the average. So, that is a big difference.
Q: What do you hear from global investors now? Do you believe that they are saying they understand the rationale that you are presenting and they want to move some money and increase their weightage in emerging markets or are they saying we have been bitten once too many times in the past and that has made us very shy of emerging markets?
A: Of course, a lot of people are hesitant and as founder, John Templeton said, bull markets grow on pessimism and that is probably where we are now. People are thinking, not so sure. Maybe a lot of questions about China and debt and so forth, let us wait and see. But as you know, what happens is that once the markets begin to pick up speed, people want to jump on the train.
Q: What kind of vehicles are getting money now because when I speak to a lot of fundamental fund managers like you, they are saying maybe we are not getting the bulk of it. The bulk of it is still ETF kind of funds.
A: Absolutely right. This is a big challenge we are facing. As active managers, we are not getting the amounts that we should be getting under normal circumstances because the big bulk of the money is going into ETFs, index funds. That is a big change in the industry, so people are beginning to look more and more to ETFs. But I think it will reach a limit because there is a realisation that there is a place for active management. Active management does not always underperform. There are times when active managers can do very well. Active managers are now trying to differentiate themselves as well because their clients are saying, look we do not want to pay your fees if you are farming an index or if you lack at ETF. So, there is an interesting development taking place in the industry.
Q: You think that there is a risk of destabilisation of the market because of the importance of ETFs today, the amount of money which is coming in, which comes in and goes out together?
A: Definitely yes. They definitely have an impact. The large giant ETF funds are buying the same stocks and they basically end up controlling the market.
Q: You alluded to Trump at the start of the interview, do you think that risk which people were talking about, about trade wars and what impact it might have on emerging markets, was that overblown? Are you breathing a little easier now or is he still too unpredictable and that risk is not off the table completely?
A: I have always felt that what Trump was saying and what he would be able to do once in office were two diametrically opposite things. At the end of the day, I always felt that he would not be do the kind of trade war and other restrictions that he was talking about. Once we see the negotiations with the Chinese, the outcome of those negotiations, we will probably see that there are things that the Chinese can do assuage Trumps concerns. At the end of the day that is the big picture - USD 340 billion trade deficit is giant. So, they have to attack that.
I think the Chinese will come to the table with something to give to Trump, to make this situation not as severe as what it appears now.
Q: You don't see that as one of the main risks for the market in 2017 though?
A: It is, it is definitely a risk. If we have a situation where they impose import tax and a trade war begins, it is not going to be good for anyone including the US. So, hopefully that can be averted.
Q: After such a rally from the start of the year, if I were to ask you what worries you the most or what could trigger a correction which we haven't seen for 3 or 4 months now, what could be the central risk you see now?
A: I would say that a risk of a trade war where the US imposes taxes that are not tolerated by other countries and they retaliate, I would say that is one risk we see. The other risk is of course aligned with that, would be withdrawal of investments. Very often trade is tied with direct investments. So, countries who say no we are not going to allow you to invest in our country and so on so forth, that would be a big risk.
The other risk is the rise of populism in some countries.
Q: Does the socio-political context today in many countries bother you - what is going on in Europe, what happened in America. Right now markets have shrugged it off but do you think there might be a time when it begins to concern people, what is going on today?
A: I think it is already a big concern in Europe. I think the imposition of rules and regulations from Brussels and move towards a more socialistic mind bend, with government restrictions has been a real problem for Europe which is why Brexit occurred. Many British subjects felt that this was not very good and they wanted to get out of it. So, hopefully Brussels and the European leaders, they have got to loosen up and allow for more free enterprise, particularly amongst small and medium enterprises.
So, in that sense I think I am relatively optimistic because I think as a result of Brexit they begin to wake up to the reality that they got to change. However still there are number of nations that are moving towards a more authoritarian bend. In Poland you have a gentlemen behind the scenes trying to control things and then in Hungary, you have a situation where they are moving in that direction which cannot be good.
Q: You spoke about the US Fed as well, it seems like markets have sort of discounted it. It is not talked about that often as major destabilising risk. Do you see it that way or does it still have the potential to inject some volatility this year?
A: It can have a great potential to volatility because the Fed now wants to reduce its balance sheet, which means lot of securities will flow into the market and will suck up liquidity. So, the speed at which they move balanced by government spending is really what we have to look at. Hopefully if Trump can get its defence spending package going, get its infrastructure package going, that government spending will balance what the Fed is doing in drawing money out of the market. So, this is something we have to watch carefully.
Q: So, far what have you made of the signalling from the Fed because it seems to be moving in a direction or pace which is meant to not ruffle stock markets too much?
A: They realise the risk, they realise that they cannot move too quickly but history shows central banks sometimes particularly the US Fed, sometimes their timing is off and they are not sensitive enough to what is happening. To talk about timing, I think they went too far in building their balance sheet. Now they are in a position where they have got this incredible problem in getting rid of these assets.
Q: Do you see a situation where inflation actually runs away in the US, leading the Fed to move faster now and to get off the tiger sooner than they had wanted to or they would have liked to?
A: Hopefully inflation moves fast and outpaces the interest rate raises because if that happens then we are in pretty good shape in terms of the equity markets. Then the Fed will have room to get rid of their assets because there will be enough of a market to absorb those assets.
So, I am praying and hoping that inflation picks up at a faster pace. Of course ideally we should not have inflation but the reality is that markets move on that gap between inflation and interest rates.
Q: In emerging markets, what is your preference right now because sometimes, we see that there are fundamentally strong economies like India, but market performance tends to be better in spells for some of the commodity strong emerging markets like Brazil and Russia? Where is your preference, given the current momentum?
A: Preference in terms of sectors I would say we have to look more carefully at the resources sector, oil and minerals.
Q: You are bullish on that?
A: Yes, because they are beaten down so much. The demand for these products is not diminishing. If you look at the global demand for oil, it keeps on going like this, the price of oil goes like that. But the demand continues to rise. The same thing for iron ore, for example, the prices are all over the place, but demand continues to rise. So, there will be good opportunities in some of these sectors. Already oil prices from the absolute bottom have gone up by 100 percent which is when you were at these low points, the upside is quite impressive.
Q: But is it conceivable that crude oil goes back to something like USD 80-90 per barrel again in the foreseeable future?
A: It is conceivable because if you see a weak dollar then the prices of these commodities in dollar terms can go up because the demand is still there. So, I am not discounting that. Of course, if you talk to any oil man, he will say it will be maybe between USD 40 per barrel and USD 60 per barrel. But, you know and I know that these predictions are often not worth very much in the longer term.
Q: So, there is more upside to oil, you think? You would not be surprised if it surprises?
A: I would not be surprised. A number of reasons. Saudi Arabia cannot tolerate these prices for very long. That is one thing. The other thing is that we are beginning to realise that the oil sands are not as easy to mine at a low cost. Some of them are doing very well. And by the way, the rise in interest rates also puts a squeeze on the financing of these most tenuous sources of oil.
Q: What about metals because in India, we have seen some tremendous rallies, stocks have tripled and quadrupled in aluminium and steel kind of names. Are you optimistic on that space?
A: Depending on which one. Let us take palladium. I am very bullish on palladium because it is needed for catalytic converters and gasoline engines and China is producing gasoline engine cars at a very rapid rate. So, for some of these commodities, you are going to see an increasing demand. And again, if you even take copper, there are all kinds of problems now, facing copper producers, government restrictions, we know what is happening in Indonesia - they are insisting that the copper producers do their smelting there which may not be economic. So, there are a lot of these problems that are coming up. And also, a lot of the big projects in places like Africa have been abandoned because of these prices. So, you have the cycle again.
Q: What about things like steel and aluminium where we have a lot of big Indian stocks listed?
A: With steel, you are going to see a rising and stabilising trend. And the reason why I say that is that that Chinese realise that they cannot continue these polluted, inefficient steel mills. So, they will close down a lot of those. Aluminium, the same thing. You just heard the largest smelter in China is in financial difficulty. So, there has to be some kind of convergence of these companies and perhaps, mergers and a cut down in production going forward. So, aluminium is probably a reasonable bet, same with steel.
Q: We were talking about Trump earlier and what that has resulted in is stark underperformance in some of the export sectors in India like IT, even pharmaceuticals. Do you find value there or would you stay clear of those sectors now?
A: We still find value in the IT sector. We still hold IT stocks, but we are also increasing in some of the internet stocks as well because we are seeing stocks now that actually earn money which we did not see before in many of these internet stocks. So, if you look at weightings, you will that there has been a transformation partly because the oil and minerals prices came down so the weightings came down. It did not mean that we sold, but those weightings came down. But IT has definitely has gone up.
Q: What are your top overweight sectors in India right now? What are you most optimistic on?
A: It will be IT, we would be probably a little overweight and it would be in consumer oriented stocks that we would be overweight. Those would be the two.
Q: What about telecom where you did have some interest a few years back but that sector underperformed, but started picking up recently once again. How do you read it?
A: We do not have much in telecoms because we are always afraid of the government using telecom companies as a cash machine. So, we have to see more stability in terms of the licencing.
Q: In terms of shocks to the market, do you think China can come back on to the table as a risk because I remember, last year it was a big talking point and now, people seem to have quietened down a little bit on China. How do you see things there?
A: China has always been a big question mark for so many people because they look at it through the eyes of Wall Street which is really not the way to do it. It is a planned economy. They decide what they want to do and they go ahead and implement it. They have bumps along the way and they correct them. But at the end of the day, when they say 6 percent growth, that means 6 percent because they are going to give money to the major banks which they control to create the credit that will result in 6 percent growth. So, I am pretty sanguine about China.
Now I realise there will be individual problems. There will be companies that will go under, groups that will go bankrupt, no question about that. So we are going to have to be very cautious particularly since the government wants to move more and more towards a market oriented system which means that the benefits and the ills of the market economy will be imposed on these companies. But, when you look at the state owned enterprises, it is difficult to imagine any of them going bankrupt in the true sense of the word.
Q: I want to ask you about earnings because that is another concern which a lot of global investors have about emerging markets. They say, okay, we might have been underweight on the asset class, but last three years we have not seen great earnings growth in most emerging markets. When do you think that will turn around decisively?
A: If you compare at a growth level, earnings per share (EPS) growth, emerging markets are doing better than developed markets. Not outstandingly better, but you are talking about 3-4 percentage points better. Going forward, we are going to have to be very selective because some companies just will not be able to hack it because of the competition and the over-capacity, a lot of capacity in the market as a result of the cheap finance that we have seen.
So, we are going to have to focus on those companies that are not heavily leveraged and companies that do not have a situation where the industry is over-capacity. And that is the reason why some of these consumer stocks and some of the IT stocks are doing pretty well because they are in growing industries. The growth is there to absorb their capacity. So, as interest rates go up, the necessity for higher growth is going to come to the fore and those companies that are not able to meet those growth requirements will fall by the wayside.
Q: What is your gut feeling? Do you see this as a start of a structural bull run for 3-4 years or are we still very cyclical and you will have one good year, one bad year like we have been seeing for the last few years?
A: In terms of emerging markets, we are probably in a bull market that will last for a few years. If you look at the history of these bull and bear periods for emerging markets at least, the bull markets have lasted quite long. It lasted 3-4 years like that and that is probably the case now because there is a momentum that begins to feed into these markets.
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