Our belief is that there are three key events or trends that will affect emerging markets during the second half of 2015.
Firstly, the likelihood of a “U Shaped” growth recovery. In a disinflationary world, growth recovery would be a gradual “U shaped” rather than a historical “V shaped” recovery.
Secondly, demand scarcity with capital abundance, we believe that world today faces a demand problem while capital remains in plenty thanks to quantitative easing (QE) by big central banks. In such a scenario, relatively unleveraged economies with favourable demographics and stable political structures like India, Philippines and Indonesia are likely to attract significant investment interest from businesses, creating a virtuous loop.
Thirdly, will the US Fed raise interest rates? As we head into the second half of 2015, expectations of the US Fed raising interest rates will become more of a market focus. Rate hike cycles predicated on strong growth and normalization of monetary policy offer an opportunity in emerging markets. Markets that can take advantage of an increase in trade from strong global growth should benefit in our view; especially those trading at below average valuations.
In terms of regional plays, we remain constructive on Asian equities in 2015, although post a strong run up, pullbacks are possible as growth response to monetary easing would be fairly uneven across economies. The benign commodity cycle is a key positive for the Asian region overall, yet the widening premium in China A-shares over H-shares and extended valuations suggest that the Chinese market may have become overheated. Within this backdrop, we adhere to the view of getting “China right” as a central element within our Asia portfolio, moderating polarizing utopian and doomsday scenarios by investing in high quality companies at reasonable valuations through bottom-up stock picking.
China requires a balanced view, as overcapacity and capital misallocation hang over a slower economic recovery on the back of a raft of monetary measures taken by the People’s Bank of China (PBOC) in the form of four interest rate cuts, local government debt relief, and capital account opening as Beijing eschews the export, investment-led model of the past. We see nimble small and medium-sized enterprises that can capitalize on fast-changing consumer trends as index agnostic investment opportunities.
The world today faces a demand problem while capital remains in plenty thanks to QE by big central banks. In such a scenario, relatively unleveraged economies with favourable demographics and stable political structures like India, Philippines and Indonesia are likely to attract significant investment interest from businesses, creating a virtuous loop.
Latin America has suffered through negative sentiment and earnings revisions, with painful fiscal adjustments undertaken by various governments. With many of these reforms now in place, we believe that the region is poised for a turnaround in sentiment, backed by leading indicators pointing to macroeconomic improvement.
In Brazil, we are unlikely to see a rebound in growth in the second half of the year, but we believe that the market should look past short term indicators and toward a longer term correction that will allow the country to begin cutting interest rates and stimulating growth in the next two years.
In EEMEA we foresee a pick-up in sentiment and earnings growth, when global growth produces an improved trade environment. We see relatively attractive valuations in the region, although we acknowledge a high risk of political headlines causing volatility in the region for the remainder of the year. Certain valuations in EEMEA are particularly attractive with financial and cyclical sectors, specifically, well positioned. On the political front we will see elections in Egypt, Argentina, Colombia, Poland and Venezuela, although none of these should be disruptive to markets.
The biggest surprise of the first half of 2015 was Russia’s resilient growth post US and European sanctions. We believe that the sharp depreciation in the ruble and the required emergency rate hike to protect the currency will show its effects only in the second half year. Both oil and politics remain uncertain and we expect the market to remain volatile. With that said, the market remains under owned and attractive opportunities should be monitored during periods of risk aversion.
Overall, a key focus in the second half of 2015 will be the US Federal Reserve and an assessment of policy credibility; rate hikes predicated on growth and policy normalization offer opportunities in emerging markets. Policy action that suggests the Fed may be behind the curve, however, would instead lead to volatility and in particular for the more vulnerable emerging market countries. Geopolitics will remain in the headlines over the second half of the year in places such as Greece, Russia and Turkey. In Latin America there is significant scope for improvement in sentiment and we like what we are seeing on the fiscal reform front in Brazil. Although there is still more short term pain given the required steps, the outlook beyond is gradually improving.
Rahul Chadha (above) and Jose Morales are CIOs at Mirae Asset Global Investments