David Semple

China, Brazil, and Hungary are strong performers

Emerging markets continued to gather momentum and flows following the June Brexit vote and, in the third quarter, outperformed most global indices including the S&P 500® Index.

Large-caps outpaced small-caps, again extending the performance gap for the year. Growth stocks staged a modest comeback over value stocks.

After a couple of quarters of weakness, China was among the best performing countries in the third quarter, accompanied by Brazil (a familiar outperformer this year) and Hungary. India also advanced. Turkey, on the other hand, declined substantially in 3Q as a result of the power grab attempt by Turkish president Recep Tayyip Erdogan following the unsuccessful coup. Technology stocks pushed higher during the quarter to become the third best performing sector for the year following energy and materials. Emerging markets utilities stocks were the worst performers.

Emerging markets challenged by Brexit and “populist politics”

Global markets have seen some significant challenges, including record low and negative bond yields and concern about the limits of quantitative easing. Markets have been challenged by Brexit, and concerns about the rise of “populist politics” – to name a few issues. Emerging markets specifically have seen some challenges, including political change in Brazil and an attempted coup in Turkey. Notwithstanding these risks, the summer was actually a period of restrained market volatility, which surprised many market participants.

We believe that China should remain stable

Many factors combined to create the stronger relative performance from emerging markets during the quarter, and so far this year, compared to global indices. First, the rapid appreciation of the U.S. dollar appears to have faded as market expectation of a U.S. Federal Reserve (“Fed”) rate hike has been pushed back until the end of the year and possibly next year. Second, despite the febrile headline grabbing comments of market pundits, China has not had any kind of “Minsky moment” (a collapse in asset prices following the exhaustion of credit expansion), whether related to capital outflows or leverage. Although we certainly concede that there are some significant imbalances in China’s economy, we believe that the extra “stabilizers” available to authorities will be used to attempt to achieve a reasonably stable outcome over the medium term. Third, the supply and demand equation for commodities looks more balanced. Fourth, earnings are likely to be much less disappointing this year, partly because expectations have been reset to lower levels, and partly because corporates are gradually acclimatizing to a slower growth world and generating more efficiencies, rather than focusing predominantly on top-line growth.

Reform efforts have been uneven in emerging markets, but we are encouraged by the long-term impact of the passage of the GST (goods and services tax) in India. In China, some reform efforts are often opaque and sometimes appear to represent “two steps forward then one back”. The outcome of tax amnesties in India and Indonesia appears to have been better than expected, and, finally, infrastructure projects seem to be developing greater impetus in a number of countries, for example, the Philippines.

Emerging markets have shown considerable relative strength in 2016

We remain constructive on the continuing outperformance of emerging markets in a global context. After an extended period in the wilderness, emerging markets assets have shown considerable relative strength so far this year. We feel that there is reasonable evidence for that outperformance to continue for the asset class as a whole. Broadly speaking, a stable U.S. dollar, better commodities’ prices, a more resilient earnings profile, and light positioning in the asset class ought to combine to increase the relative attractiveness of emerging markets.

Given the economic history of many emerging markets economies, there are many very large scale state-owned companies in the emerging markets universe. The prominence of these companies we feel comes less from superior competence than from historically state-sponsored systemic advantage which is unlikely to be sustained in the long run. In addition, we believe many of these large companies are essentially driven by global cyclical factors such as energy and materials. We will continue to implement our philosophy of structural growth at a reasonable price. We are not style agnostic, drifting into whatever appears to be working at any given time. We are style specific and we continue to find that there are many areas of superior, sustained growth that are essentially non-cyclical in nature and will likely provide reliable opportunities for well-managed companies to exploit.

Valuations for emerging markets equities and currencies are generally constructive, but not compellingly cheap. Expectations for earnings are much more realistic, and positioning in the asset class is cautious. Delayed expectations of further Fed tightening have also been positive for the asset class. Finally, it is perhaps hard to construct a case for alternative geographies and asset classes; arguably, the U.S. equity market looks overvalued, Japan is struggling with a strong currency, and Europe faces significant questions and uncertainties surrounding its political and economic future.

By David Semple, Portfolio Manager, Emerging Market Equity Strategy

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David Semple

Emerging market equities outperformed global indices in the third quarter of 2016 and continue to gather momentum according to VanEck’s visiting emerging markets expert.

David Semple, Portfolio Manager for VanEck’s Emerging Markets Equity strategy, said, “Emerging market equities have generally underperformed over the past four or five years, however the tide is turning. Emerging markets growth relative to developed markets is at its highest since 2014 and we believe it will continue to outperform developed markets over the next five years.”

According to Semple, there are several factors driving the strong performance of emerging market equities including dollar and commodity stablisation, low global bond yields, improving earnings and relief in China.

“Emerging market performance has been supported by a stable US dollar. Given that many potential global headwinds are still yet to play out we expect market uncertainty to continue into the next year. Because of this, we don’t expect to see the dollar appreciate aggressively in the near-term which supports investment in emerging markets. Stability in commodity markets is also a positive for emerging market companies.

“China offers pockets of opportunities. After two quarters of weakness, MSCI China was one of the top country performers in the third quarter. The question really shouldn’t be if to invest in China but rather where to invest. The local population no longer want to see ‘black stinky water’ and instead want better air quality, cleaner water and good healthcare. We see opportunities in companies focused on providing middle-income services and companies focused on the environment.”

According to Semple, emerging market small and mid-cap companies offer plenty of opportunities but are poorly captured by widely used benchmark indices and instead investors should be considering an emerging markets equity strategy that has the flexibility to go anywhere across the market-cap spectrum to find the best growth opportunities.

“While most emerging market large-caps have shown strong performance, we believe that much of their performance is cyclical. Small to mid-cap companies offer strong performance opportunities because they are less developed, domestic demand driven but not necessarily more risky,” he said.

“We believe emerging market companies are better positioned than previous years given the majority have adapted to a low growth environment and are meeting changing domestic demands. They also have better management structures and cost saving mechanisms in place, resulting in better earnings and profit margins.

“Most investors are under-allocated to emerging market equities because they are skeptical about performance. We expect this sentiment will shift as investors continue to see strong performance into 2017 and as a result, we expect they will significantly increase their exposures,” he said.

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David Semple

With all the gloom and doubt surrounding China and other emerging market economies, Portfolio Manager of the Van Eck Emerging Markets Equity Strategy, David Semple, remains optimistic that 2016 will end well.

“We anticipate better economic numbers out of China and at least we have started down the journey of Fed tightening. A combination of Fed tightening and cheap emerging markets valuations historically sets up good emerging markets performance and we certainly hope that this will be the case in 2016,” Mr Semple said.

“China gets the blame for just about everything bad that happens in global markets, but the reality is different. As emerging markets become bigger, the key is to be very specific about where to invest. There are companies in the technology, health care, tourism, education and insurance sectors that will generate higher profitability this year,” he says.

“We are not investing in the state-owned banks, the heavy industry, the smokestacks. We invest in the ‘New China’, focused on things like clean air, clean water, clean governance. For example, a company like electricity distributor Boer Power Holdings, which benefits from China’s energy-efficiency push. It trades at 10 times next year’s earnings, which are growing at 20% to 30%.”

“Overall, we expect lower, but better, growth from China, with continued monetary and fiscal easing in 2016. We expect the currency, the RMB, to depreciate versus the US dollar in a modest and fairly controlled fashion, assuming that the US dollar continues to be strong versus other major currencies. It’s also worth noting that offshore Chinese shares are historically relatively cheap compared to other emerging market and developed market countries.”

Mr Semple notes, “One of the buzz phrases being bandied around is that there is a ‘quality growth bubble’ in emerging markets. This implies the valuations of companies that have quality characteristics are trading at a significant premium to other companies in the emerging markets. As far as we can see this seems to be a problem that is associated with large caps in emerging markets. Therefore considering all-caps is important as we do not see overvaluation in mid- and small-cap “quality growth” stocks. Further we think that in a world that is starved of opportunities the better certainty of growth that tends to come from companies with quality characteristics, deserves a premium.”

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Emerging markets look good for the rest of 2014: Van Eck Global

Emerging markets economies are poised to offer higher economic growth for the remainder of 2014 than recent previous corresponding periods, according to Van Eck Global, the US parent company of its exchange traded fund business, Market Vectors ETFs. Van Eck Global currently manages over US$35 billion in assets.

David Semple, Portfolio Manager and Head of Van Eck Global’s Emerging Markets Equity Investment Team said, “The tide is turning for emerging markets, which outperformed the broad US market in the second quarter of 2014—an event we’ve not seen for some time. The asset class attracted particularly strong inflows in April and May this year, the highest inflows since March 2013.

“In the second half of 2014 we believe emerging markets will continue to perform solidly, providing better earning outcomes than we’ve seen in the past three years.”

According to Mr Semple, investors are beginning to warm up to emerging markets again as better earnings typically indicate a recovery. He believes the main risks for emerging markets in the second half of 2014 are geopolitical and interest rate sensitivity.

“Ongoing tensions in Ukraine have impacted the Russian economy and the escalation of sanctions will have a broader impact on a fragile European economy. The earnings impact from the sanctions as they exist today is fairly mild, but we think the cost of equity will rise as investors shy away from the possibility of further and more serious geopolitical tension, combined with the possible implementation of full sanctions on listed companies.

“China continues to provide a mixed picture. There is a wide range of opinions, and a great deal of scepticism about the China story,” Mr Semple said. “There is a continuing tug of war between significant positive and negative economic variables. We believe the ongoing modest and targeted stimulus is expected to continue and keep growth above the 7% to 7.5% level. Despite all that, it’s important not to forget the positives, such as the fact that China has the largest e-commerce economy in the world,” he said.

Despite geopolitical risk, Mr Semple believes most emerging markets countries have absorbed a significant amount of bad news. According to Semple, there are good opportunities in Taiwan, India and Latin America.

“The decisive win for the Bharatiya Janata Party (BJP) in India appeared to be beneficial for the stock market, although there are major hopes for better governance and acceleration of capital expenditure in the near-term. In Brazil, the outcome of the election in early October will be important. We expect a change of government will have a positive impact and will help reinvigorate the stagnant economy,” he said.

“Indonesia has some very significant long-run advantages in terms of demographics and resources, but has significant work to do to increase the return on those assets. This will mean increasing the ease of doing business, whether by investing in infrastructure, streamlining bureaucracy, reducing subsidies, and providing a level playing field for investments.

“We believe emerging market economies will continue to offer higher economic growth in the medium term, particularly as investors increasingly diversify away from their domestic economies and identify better value in stronger performing emerging market economies this year and into 2015,” Mr Semple said.

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