[TOP STORY] Emerging markets yesterday, today and tomorrow

SIMON BROWN: I’m chatting now with Feroz Basa, head of emerging markets at Sanlam Investments. Feroz, I appreciate your time today.

Emerging markets – a lot has been dominated by the Russia/Ukraine war. Of course, we’ve got the issues around Turkey and their insane inflation numbers and the lack of independence of the central bank. But you and your team are looking at this, and you’re saying sure, in the immediate [future] there are some challenges and that those are very real, but there are areas of the emerging market where…there’s some good opportunity, particularly over the longer term.

FEROZ BASA: Yes, hi Simon. It might seem like there are, but there’s just bad news all around. You mentioned the Russia/Ukraine war, which is very sad. You mentioned Turkey and the hyper-inflation environment. We are now looking at – if you looked this morning and the day before – China and the zero-Covid policy, where Shanghai is in lockdown; they have 26 000 cases a day and they locked down an entire city of 25 million people.

And, if you look at the Shanghai Shenzhen port close by, the ships are piling up, 90% of the truck drivers aren’t operating, the whole country is in lockdown. Just cast your eye back to when we went into lockdown, how bad that was. Yes, so it’s bad news all around, Simon. It’s hard to see any good news around,

…but think, if you look at it over the longer term, the big opportunity set is really in emerging markets.

SIMON BROWN: Emerging markets. We are obviously one of them, but looking even broader than that to…other emerging markets out there, are there some that you and your team are favouring over others?

FEROZ BASA: Yes. I think if you look at the current market, sure. There is all this turmoil in China at this particular point in time. That is the biggest in the emerging market index.

But I think from an opportunity set, China has never been as cheap as it is now.

So China’s probably our top-picking emerging market at this point in time.

They are trading on decade lows relative to the All World Index. On an absolute price-to-earnings ratio they’re trading below 12 times. That hasn’t been there in the last 20 years.

We must always remember that China has the firepower to stimulate the economy once they come out of these lockdowns. They’ve got a balance sheet as a country to do that, and there are some fantastic companies growing earnings phenomenally globally, and that’s where the big opportunities are.

Also we have been in the doldrums for a number of years now, [and] we’re starting to see some very good opportunities emerging in Brazil.

Brazil is benefiting from the high commodity prices. So that region is doing well, and then our old favourite has been Mexico for a long time.

Mexico links quite strongly to the US growth, but also [has] a commodities angle. So they also are doing [well].

Quite a number of the emerging-market countries actually are doing reasonably well, not to mention India, although India from a valuation perspective is now expensive. India’s been doing reasonably well for the last two years, post a massive Covid upsurge they had in the country.

SIMON BROWN: In all the cases here you mentioned China and the ability of the state to juice the economy. Brazil, of course, [has] commodities; Mexico has that proximity to the US and is benefiting from that. I think when a lot of people think emerging markets, they think – to use a really horrid phrase – third world. This is not the case. These are modern economies. They’re just ‘emerging’ in that they’re fractions of the size of those developed economies, such as Western Europe and North America.

FEROZ BASA: Excellent point, Simon. If you look at some of the companies that we own in our portfolio, these are world-class companies that stack up against the best in the US and Europe. Take Samsung in electronics, it stacks up against some of the big US companies. Look at Taiwan, semiconductors, the biggest manufacturer of semiconductors globally. Look at Lenovo, the PC maker, it’s the biggest PC maker globally above Dell and above HP. So yes, I think you raise a very good point in that we talk about emerging markets, but these markets have some really high-quality, globally dominant businesses in those regions.

SIMON BROWN: What we are going to see, as you mentioned, these are attractive – not only in the companies, but the valuations. You mentioned India. That valuation has run away from investors. But there’s going to be volatility. Markets are not plain sailing, markets are volatile. As an investor, we are going to need to expect that going forward. It might ease a bit, maybe, if we see some development in Russia/Ukraine, but we are still going to see a fair bunch.

FEROZ BASA: Another excellent point, Simon. I think volatility now, with all the uncertainty, there is geopolitical risk. Because of the geopolitical risk and the war … there’s cost-push inflation coming through on agriculture, on gas, on oil – on all of these things. And we haven’t mentioned that inflation is out of control in the developed word and the [US] Fed is fighting itself and saying, ‘What do we do, do we tame inflation? What happens, do we squeeze the economy too much? Do we pull stimulus out, what happens?’

The US is heading for a recession, a potential recession. What does that mean with high inflation? It means stagflation, and that is very bad for markets.

So again, you look at all of these issues and you say, look, where is the opportunity? Where are the opportunities?

It’s hard to see right now because Russia is an emerging market and [we don’t know] what will happen with the war. What’s happening in China now with the zero-Covid policy and the impact? It’s hard to see emerging markets as the big opportunity. But if you look at the starting point, the valuation of emerging markets versus developed markets, you look at all the macro dynamics on a three-to-five-year view, the real big opportunities are in emerging markets. You must remember, Simon, markets move through cycles.

Since 1973, we had DM and EM [developed market and emerging market] cycles. They have now lost on average five to six years. This has been one of the longest for DMs over EMs, and we do have markets moving in cycles. So we will have another emerging-market cycle. The starting point of valuation is better. The inflation macro-dynamics on a three-year view is better.

So at some point we should see EMs outperform DMs significantly.

SIMON BROWN: To the point you make there, the risk right now is those developed markets, and inflation running amok.

We’ll leave it there. Feroz Basa is of emerging markets at Sanlam Investments. Feroz, I really appreciate at the time today.