Emerging Markets Diary - March 2018
Read Leigh’s regular blog and keep up to date with the current thinking of the London-based portion of our Emerging Markets team, as they analyse the latest developments and draw on first-hand observations from their travels across the globe.
Headlines this month:
- Rollercoaster Q1 ended with the MSCI Emerging Markets index up 1.47%1
- The Latin American team visited key regional markets Brazil and Argentina in February, coming back with a relatively positive view on both countries.
- The Frontier team also visited Vietnam and whilst valuations are at the upper end, they believe there may still be upside potential.
It’s been a rollercoaster Q1 in emerging markets (EM) – plain sailing in January, followed by a significant volatility-driven sell off in February, and then somewhat choppy through the rest of the quarter. The MSCI EM Equity index ended up +1.47%. Brazil was the strongest of the major EM countries (+12.5% in March), while several frontier countries were up around 20% (Kenya, Romania, Vietnam). India and the Philippines were the notable laggards for the month (-7% and -11%).1
The Latin American team visited Brazil in February, coming back with a relatively positive view. The private banks are seeing higher consumer activity flow through into their results, credit growth is inflecting and loan mixes are improving. People had just stopped paying for services such as insurance after the crisis, and we are now seeing a major catch-up. Credit card transactions are overtaking debit volumes for the first time in 5 years.
The Brazilian consumer companies we met with were also sounding upbeat on the demand recovery, but in some cases the team felt that estimates had got a bit ahead of the actual recovery and cautioned that companies might underwhelm relative to high expectations, but that growth should still be solid going through this year.
We have seen this play through with some weakness in key holding Raia Drogasil in Q1. The standout meeting of the trip was with Mercadolibre (pan-Latin e-commerce leader, listed in Argentina but with a large exposure to Brazil). After an in-depth session with the senior management team our conviction increased on the strong outlook for the platform and optionality from the payments business. We believe that the addressable market still offers opportunity for market share gain and growth runway if they get it right and many lessons can be learned from Alibaba’s success in China. Amazon has recently gained some traction in Mexico, and we are watching their strategy closely, but overall competition is stable.
For now Brazil remains an overweight position in our EM portfolios, with the caveat that political-noise will remain high over the next few months. It’s not yet clear who will be the frontrunners in the upcoming presidential election, but for whoever wins, the economic and market reality should force them to follow a sensible path and proceed with pension reform. We did eliminate our remaining Brasil Foods position on corporate governance grounds in the first quarter, but otherwise our positions remain.
The Frontier team joined the Latino’s for the Argentina leg of the trip. Argentina accounts for almost a quarter of our Frontier Markets Equity portfolio and its stock market was the top performer in the MSCI Frontier Markets Index in 2017. We approached the trip thinking about whether we should be taking profits on our Argentine positions, however, post visit the general conclusion was that things still have further to go. Fiscal progress has been tangible, many institutions and companies have undergone welcome management changes, and growth is continuing to accelerate. The banking system is undergeared and this is allowing fast growth off a low base.
One key risk for Argentina is that inflation expectations are proving to be a bit sticky on the upside, and the peso was quite volatile during February’s global risk-spike, with the country still relatively dependent on US dollar debt.
The conclusion from our Vietnam trip was very similar – another Frontier market that has been a large position and a top performer over the last year. Valuations, along with Argentina, are at the upper end of Frontier markets, but with GDP growth remaining very strong, low inflation, banks growing out of their bad debt problem and strong consumer growth continuing, we think it is too early to take profits. However, we need to keep monitoring things closely, and making sure there are no signs of over-heating. Over 260 buy-side investors were at the conference we attended, up 30% year-on-year, so Vietnam is becoming a well picked-over story.
The team also spent some time digging further into Mobileworld which is one of our key Frontier Markets holdings. The firm has grown successfully in electronics and mobile phone retail, but the newest part of the story is food retail. The formalised food retail market is still very small in Vietnam, and others are struggling to make the economics work. These businesses (when you can find the winners) can be extremely successful over time in emerging markets and we believe Mobileword has a good chance to do well here.
As we start Q2, minds have been sharply focused in Russia with the escalation of sanctions against several oligarchs and companies. They are more severe than before as bans do not just apply to new equity or debt, but effectively to all ownership or business dealings with sanctioned entities. Comments from President Trump linking the sanctions to further developments in Syria also keep things unpredictable.
We do not have any direct exposure to sanctioned entities in our portfolios, but the equity risk premium has risen and we have seen some sharp corrections in stocks across the board, particularly large holding Sberbank. Sberbank does have a loan exposure to Rusal (approximately 1.4% of its net loans) and the Russian central bank is currently looking at the possibility of transferring these loans off the balance sheets of the commercial banks in order to avoid sanctions reaching them.
At this stage Gonzalo is holding on to his positions in Russia. The silver lining is that the Russian economy is in much healthier shape than that last time sanctions were applied. The oil price in ruble terms is at all time highs, and Russian reserves have been rebuilt to very healthy levels. We will be keeping a close eye as always.
1 Source: MSCI as at 31 March 2018
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Transactions in securities denominated in foreign currencies are subject to fluctuations in exchange rates which may affect the value of an investment. Returns can be more volatile than other, more developed, markets due to changes in market, political and economic conditions. Investments are less liquid than those which trade on more established markets.