Latest Emerging Market Viewpoints
From Matt Linsey and the North of South Capital team
As 2018 draws to a close it is easy to forget that Emerging Markets were outperforming their developed counterparts only last year. This has now largely been reversed and brings us back to where we were in 2016 in relative terms. The MSCI Emerging market index remains at least 30% cheaper than the S&P on most measures.
We mainly focus on valuations relative to the cost of capital which leads us to closely monitor interest rates. We have always warned that countries like Turkey would suffer most during a period of rising US interest rates. This year the effect played out in spectacular fashion as Turkish 10yr bond yields shot up from 12% to 22%. This was accompanied by a dramatic 40% collapse in the currency and a 20% decline in the stock market. Politics did not help of course, but this was fundamental economics at play.
Other markets such as Taiwan have held up far better. Taiwanese 10 year bond yields remained below 1% this year, similar levels to the past fifteen years. The country runs significant current account surpluses and is an exporter of savings. Yields are low not because of QE intervention but because of low debt and high savings. The Taiwanese market was showing a positive US$ return this year up until the end of September – until even Taiwan was caught up in the global sell-off. We see this correction as a value opportunity. The prospective dividend yield on the market is at a record high of 4.5% despite continued low interest rates.
Even more noteworthy is the fact that the Brazilian market is delivering a positive US$ return this year. The catalyst for this is the election of a controversial but market friendly President, but we view this event through the prism of cost of capital.
Brazil has a history of consistently having the highest real interest rates in the world – an unhelpful record when it comes to growth and equity valuations. The reasons boil down to a relatively low domestic savings rate and a government that consistently crowds out the private sector. The cathartic election of President Bolsonaro brings about an opportunity to deal with some of these problems. This has resulted in Brazilian long bond yields declining this year and leaving them a full 6% lower than at the end of 2015. The Brazilian central bank has been able to cut its base rate and maintain it at the lowest levels in modern history. If the President’s advisors manage to push through reforms, this could permanently transform Brazil’s outlook.
We see various opportunities in the Emerging space. Structural reform in Brazil, attractive valuations in Taiwan and even possibly Turkey where authorities have been chastened by the market and yields have stabilized. All have risks attached – ranging from unpredictable politicians to slowing technology demand. These are not dissimilar from the risks faced by developed market investors today, but we have the benefit of lower valuations and, broadly speaking a narrowing gap in interest rates.
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