Quarterly Outlook: Global EM Equities

Date: 11. Oct. 2019 Time 15:40

The trade conflict continued to draw attention in the third quarter but more dovish central banks across the globe as well as a number of positive measures in India also made an impact.

Return developments in Q3
The fund generated a return of 1.22% in Q3 2019 whereas its benchmark, MSCI Emerging Markets, posted a return of 0.08%. The fund’s return for the quarter was 1.14 percentage points above the return of its benchmark. As a result developed markets (+4.91%) outperformed emerging markets (-0.11%).

The trade conflict continued to draw attention in the third quarter but more dovish central banks across the globe as well as a number of positive measures in India also made an impact. Mexico (+2.46%) was the largest driver of performance in Latin America, which was characterised by global uncertainty and problems following the primary election in Argentina.

Country review
The absolutely most important event of the quarter was India cutting its corporate tax rates from 30% to 22%. And the tax rate for new businesses is only 15%. Consequently the corporate tax rate for new businesses is lower than in for instance Vietnam and as a result it is suddenly very interesting for foreign companies to set up production in India. We increased our position in India during the quarter. In addition the government presented the first of three stimulus packages to help boost growth in the country. The government wishes to lower taxes, raise liquidity in the banking sector and increase public spending by means of infrastructure investments.

As anticipated there was no decisive breakthrough in the trade conflict in the third quarter. Trump accused China on Twitter of not buying the agricultural products that the country said it would. This prompted China to hit back with a tariff on USD 75bn worth of US goods and to suspend all imports of US agricultural products. The Chinese currency subsequently slipped past the much talked about level of 7 renminbi per US dollar, which prompted Trump to accuse China of currency manipulation. The two parties are scheduled to meet again on 10 and 11 October.

The Fed has lowered interest rates by 0.25 percentage points – the first time in over a decade. This sets the stage for looser monetary policy and a number of central banks in emerging markets have since followed suit and also the general rhetoric has become considerably more dovish.

In July Brazil’s lower house of Congress approved by a large majority the base text of the country’s long-awaited pension reform. The reform must be approved by the Senate before becoming a reality. There is great confidence that the bill will be passed by the Senate in the fourth quarter. So things are looking up for the Brazilian economy, which may put the lid on the currently extremely favourable pension terms and thereby save the state around USD 200bn over the next decade. As expected Brazil’s central bank cut its policy rate by 50bp in July. In September it lowered the rate by a further 50bp.

Mexico’s finance minister, Carlos Urzúa, resigned unexpectedly in July. The new finance minister presented the national budget for the coming years. The budget was criticised for being overly optimistic compared to the country’s revenues. In the first seven months of the year Mexico took the lead as the United States’ largest trade partner. In August, for the first time in five years, Mexico’s central bank lowered interest rates by 0.25 percentage points in an attempt to boost the country’s growth.

Unexpectedly Alberto Fernandez won Argentina’s primary polls by a wide margin. This caused the country’s share index to plummet by more than 50%. The Argentine peso fell by around 26% against USD. The risk of state bankruptcy rose considerably, which spilled over in general into the entire region.

Market outlook
The meeting between the United States and China will attract huge attention and the statements after the meeting will as usual be weighed and measured by investors. It seems unlikely that Chinese companies will be delisted in the US. In India the positive effects of the tax cut will be visible in companies’ adjustments of earnings estimates in the long term. This will result in more positive focus on India, which has longed for good news that could give the country’s growth a boost.

Equity markets are likely to remain volatile in the fourth quarter. In recent years equity markets in Latin America have to a great extent been driven by the political picture. However we believe that we are moving towards a time when person-focused policies and two birds in the bush in the form of reform hopes will influence share price developments to a lesser degree and markets will start to focus on actual results achieved by the large reform packages and the derived effects on companies’ earnings.

Brazil’s pension reform is expected to be approved in the fourth quarter without any major issues. The reform will ensure substantial budget savings and could pave the way for a new period of growth after a long period of sluggish economic indicators. The stage is set for further reforms to help boost Brazil’s economy, including a tax reform that aims to simplify the tax system and the privatisation of state-owned enterprises.  The content of the tax reform is still under discussion and so far there is no time schedule as to when a specific draft of the reform bill can be expected.

In Mexico the political picture seems to have stabilised slightly again. Focus will be on whether the government is able to maintain the relatively high level of budgeted earnings as well as the USMCA trade agreement between the United States, Mexico and Canada.

In Asia several of the region’s shares are still attractive based on valuations measured by estimated P/E for 2019. Far Eastern shares measured by MSCI Asia ex Japan’s P/E are trading at 14.03 compared to MSCI World’s (developed) P/E of 18.08. As a result a discount of around 24% can be achieved at the end of the quarter.