Transcript
Hello and welcome to The Download. I'm your host, Dave Richardson, and I am joined by the one and only Phil “The Thrill” Langham from London. Phil is responsible for emerging market investment with RBC Global Asset Management (UK) Limited. Phil, welcome back.
Thank you very much for having me, Dave. Happy New Year to you.
Happy New Year to you, too. You're looking fine. This is just an audio broadcast, but I can tell everyone that Phil is looking sharp over there in the UK today. But what everyone really wants to know is how sharp are emerging markets going to look this year. We've got lots of stuff going on in China, from government policy to issues in different parts of the economy. We've got U.S. dollar bouncing all over the place. We've got lots of things happening in different emerging markets. I'm sure you always educate around the wide range of emerging markets, but pull it all together. What are you thinking about? What are you looking at and what kind of year do you think we're going to have in this area of the market?
Well, Dave, you're right, China is extremely important, and emerging markets were really dragged down by China last year. China was the weakest of all the markets last year; really hit by two key factors. First of all, regulatory uncertainty, and secondly by tight policy, which really caused a slowdown in growth. In terms of regulation, that really impacted the Internet sector— and the Internet sector is very significant in China; it represents almost 50% of the index. The rules that we saw, we feel, very much made sense. They were geared at areas such as competition, supporting customers, supporting employees; the sorts of regulations that we think ultimately will occur in the developed world. We very much feel that we've come towards the end of that regulatory hit that we're going to see. From here, returns are likely to be lower for Internet companies, but we don't think we're likely to see any more significant negative regulations. And then in terms of growth, in contrast to what we see in the developed world, monetary policy has been very tight in China. We are now starting to see signs of loosening. We've seen interest rate cuts; we've seen targeted aims at growth in areas such as infrastructure. We feel that that's likely to continue. So, whereas, in the developed world, the case for seeing much tighter policy, for seeing interest rate rises from here is very strong, we're almost likely to see the opposite in China now. We don't expect to see aggressive loosening. We think that China is wary of having too much debt, but we do feel that in targeted areas— areas such as renewable energy, electric vehicles, independent technology—, we are likely to see government support, and we are likely to see an improvement in growth. Outside of China, what we saw last year was that the U.S. dollar strength— that you touched on, Dave— was a real overhang; the U.S. dollar has been strong for most of the last decade and generally within emerging markets. Emerging markets don't tend to perform well when you see U.S. dollar strength, but we do feel that from here the case for the dollar to start to weaken is very strong. We saw extremely aggressive balance sheet expansion by the Fed. We've seen very loose monetary policy, very strong growth in money supply. We also have a rally in the US dollar that looks quite extended, both in terms of duration and degree. If you look at the valuation, particularly of emerging market currencies, they do look particularly attractive now. Outside of currency, we see a good case for emerging markets really driven by an improvement in earnings and relative GDP growth from cyclically low levels, driven by productivity improvements, structural reforms and growth-friendly policies. And the valuation case for emerging markets, particularly compared to developed markets, after several years of underperformance, is also very strong in terms of where we are at the moment.
Phil, are we going to see a split— or have we already seen a split— between the emerging markets that are much more reliant on stronger commodity prices versus those emerging markets that don't have those big resource bases? So Brazil and Russia versus some of the other emerging markets?
We have seen some of the commodity markets do much better. We've certainly seen commodity sectors do much better. Areas such as energy and materials. What we would say is that in general, we think the case for more cyclical areas, more value-orientated areas to do better is very strong given the recovery that we are seeing. But I say that in particular, we feel that the case for extremely expensive stocks— so the most expensive sort of 10% or 20% of stocks— to underperform is very strong. The valuation of these stocks is extremely high. Given the movement we're seeing in bond yields, these are the sorts of stocks that tend to underperform. We've actually started to see that, particularly in developed markets actually at the start of this year. We've seen these very expensive stocks start to underperform. We feel that there's a strong case for more the middle sort of stocks. Stocks with decent return on equity, good quality stocks, but stocks trading at reasonable valuation levels. We tend to be more cautious on extremely cheap stocks; stocks that often don't meet their cost of capital. But we feel this sort of middle ground— decent quality, sensible valuations—, that is really the best area to be at the moment.
So, Phil, just one last question. Here in North America, the big economic headline in Canada and US is around inflation. How do you think about inflation? Is that a big issue in emerging markets, and how does it impact the way you think about investing in emerging markets in the coming year?
Well, as we've seen in the developed world, inflation has been coming down in most emerging markets but has been starting to tick up. One country where inflation isn't an issue is China, because policy has been pretty tight. There are always one or two countries that tend to be more impacted than others, from an inflation point of view. Traditionally, it's been the fragile five: Brazil, South Africa, Indonesia, India and Turkey. We do feel that many of them have seen substantial improvements; improvements in their current account, improvements in their reserves. Probably the most vulnerable country at the moment is Turkey, but Turkey really represents very small parts of emerging markets. We would say that perhaps the area to be most concerned about is what I've talked about just before, the very expensive stocks; that if we start to see inflation and therefore a rise in bond yields will be more vulnerable from a valuation point of view. So our feeling is that the main impact of inflation will be on these extremely expensive stocks.
That's great. Phil, I hate to tell you, I lied to you: I have one more question. Because I know whenever we get a chance to connect— and we haven't for a couple of years now, so I miss seeing you— but we come through the conversation and you share a particular country or area that you think is really exciting given economic conditions and what's going on in that country. What country or area you're looking at right now that really excites you, that maybe is again off the beaten track for a lot of investors?
Well, our favorite country at the moment is India. We see much faster growth in India than in all other markets. Penetration is still relatively low in a lot of different areas. We also see very strong reform agenda in India; areas such as demonetization, goods and services, tax, deregulation of labor and foreign direct investment. But one thing that we see in India that is really significant at the moment is a new Capex cycle. So really, we've seen a multi-year hiatus in Capex in India, but that's changing. Lots of signs that Capex is picking up, and we think that's going to be extremely important for future growth.
Well, that is really interesting. That's a big country to have as your favorite. So that can do a lot of heavy lifting for economic growth all around the world if that plays out.
Absolutely.
So, Phil, as always, thank you. Great to see you, at least virtually. And hopefully we'll see you in the not-too-distant future, face to face. Thanks for your time today; I know how busy you are.
Thanks. Great catching up. Thank you very much, Dave.