John Mauldin – World Money Analyst Update on Emerging Markets
You know that I roam the world (mostly by letting my fingers do the walking) in search of great pieces for Outside the Box. But for the next few weeks, on Thursdays, I’ll be sending you special editions of Outside the Box that highlight the excellent research that is produced by our own Mauldin Economics writers and analysts.
World Money Analyst is a perfect example. Led by Managing Editor Kevin Brekke, WMA features research from analysts and money managers from around the globe. Today, Kevin interviews Ankur Shah, one of our key WMA contributors, who is based in Dubai.
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Their conversation focuses on the very hot topic of the prospects for emerging markets, now that the Federal Reserve is tapering. They examine the currency issues and inflation implications, which are certainly drastic; but Ankur makes a very interesting case for taking a patient, longer-term view of the growth potential of emerging markets.
I spent most of a day with Ankur last month in Dubai, where he was kind enough to show me the city and a few favorite spots. Dubai is a great base for him to travel all over Asia and the Middle East searching out ideas and companies. He has roots in both the trading and research aspects of the business and specializes in Southeast Asia. He is the right mix of skeptical and enthusiastic, and I am pleased that we have him on the team.
And without further comment, let’s jump into the interview.
John Mauldin, Editor
Outside the Box
World Money Analyst Update on Emerging Markets
Ankur Shah interviewed by Kevin Brekke
Hello. This is Kevin Brekke in Frieburg, Switzerland. I’m the managing editor of World Money Analyst from Mauldin Economics. Today, I’m speaking with Ankur Shah. He’s a contributing editor for World Money Analyst, covering Southeast Asia from his office in Dubai.
Let’s start with what’s probably on most investors’ minds, especially international investors’ minds, after the latest handoff of leadership at the US Fed from Bernanke to Yellen; and that’s monetary policy and the monetary experiment that continues in the US, EU, and Japan. What are the implications for the European or the emerging economies?
We are seeing a lot of pressure on weaker emerging countries, and when I say “weaker” that usually means the countries with large budget deficits. What’s happening is that you’ve had a reduction in liquidity coming from this reduction in quantitative easing, and a lot of the hot money that flew into these markets is now flowing out and heading back to the developed countries’ own domestic markets. So I do think you are going to see more pressure on some of the weaker currencies, especially the Argentine peso and the Turkish lira, for example.
What are the inflation implications for emerging economies?
One of the results of quantitative easing is that you have this competitive devaluation, so a lot of the Asian and export-led economies had to keep their currencies competitive with the declining dollar and the euro or yen, for example.
That meant they were basically buying foreign currencies and selling the domestic currency, putting pressure on their own currency. What happens as a result is that it imports inflation into these markets. And so you had a combination of weakening currencies plus rising domestic inflation, which was a very sad scenario for domestic investors. Now you have the reverse of that as the Fed pulls out liquidity, and you will see weakness in some of these emerging-market countries. Now you see the Brazilian and Indian central banks raising rates to protect the value of their currencies.
Indeed. There is a lot of chatter in the media about crisis in these countries, and the theme seems to be that the emerging markets have slowed, some of the currencies have sold off, as you’ve just mentioned, and so the question is, “Is the growth story over for the emerging markets?”
I think the financial media often tries to sell with headlines, so I think it is important to take a much longer view of emerging markets and the growth story. Standard Chartered Bank put out a report in November last year called “The Super-Cycle Lives,” and their main point is that if you take the current share of emerging markets in terms of total global GDP, it’s about 38 percent; and by 2030 that’s going to increase to about 63 percent. I think a lot of investors are unprepared for that change. It’s really a story that plays out over the next ten to twenty years. And it’s more about industrialization leading to a growing middle class in these emerging economies. These countries will claim a much larger share of global GDP than they do now.
Agreed. Also, the emerging markets tend to consistently be portrayed as a single unit, moving in lockstep, but common sense would tell you that it’s a set of very individual countries. What investment implications can be found there?
It’s very important to look at the countries individually, because even for countries that are considered weak—for example Indonesia, India, and South Africa, which have been in the news lately because of their weakening currencies—the actual scenario on the ground is quite different from what you are reading. In India, the new RBI governor has actually raised interest rates. The rupee bottomed at 68 back in September, but it’s now trading at 62, so it’s strengthened from its weakest point last year.
And similarly in Indonesia, you have a slowdown in growth, but there are quite a few banks and other companies that are still benefiting from the domestic and resource-led growth there. It’s important to identify the countries that are truly under stress. For example, Turkey, where it is more of a political crisis than anything else, as opposed to Turkey just being an emerging market.
That’s a good point, and you’ve made that point quite often in your analysis in the letter. And as you mentioned, long-term is very important. Speaking of long-term, the emerging markets lagged the S&P 500 in 2013, but what picture emerges if we take a longer-term view of emerging markets?
It’s quite interesting, actually, because if you go back to January of 2000 and you compare the performance from then until January of 2014, you see a much different picture. The Indian market is up about 280 percent over that period, Brazil is up about 200 percent, and even China, which has been a significant underperformer for the past three years, is up about 50 percent. In comparison, the S&P 500 is up only about 22 percent over that period.
The point is that it’s not just about one-year performance. You should look at a much broader time frame.
Yes, I think that’s a very good point. I think that a lot of the commentary lately gets stuck on what’s happened in the last day, month, or six months; and it’s important to step back and take a broader view. You are a value investor, Ankur. What metrics do you consider when you place valuations on company shares? Can you give us some idea as to what you use?
The process I use is sort of a triangulation. I use measures like price to earnings and price to book. I also look at how shares trade. The final piece of the puzzle is really just a discounted cash-flow evaluation. So, if you use those three metrics, you can come to a pretty reasonable evaluation of a company.
What other indicators do you look for when analyzing a company?
I like to find businesses that are franchises, so companies that are high-quality based on return on equity, primarily, and with low debt or low leverage. I look for companies that trade with ROEs above 50 percent consistently and also with return on invested capital that is also quite high, and with very low leverage. I think if you find companies that have those high-quality characteristics, it is a good equation for strong performance and growth going forward.
Well, your approach has worked out well for World Money Analyst subscribers. In particular, one of your calls that put into play both your evaluation and your fundamentals was Infosys. Our readers had a nice 20 percent gain there, and it took maybe two months.
Ankur, let’s briefly touch on India. I know that as the founder of the Value Investing India Report you are very in tune with the Indian markets. As you mentioned earlier, India’s currency has been down a bit, 20 percent or so against the US dollar; and like many emerging markets, India has had its own set of political and economic hurdles. What is your outlook for India, both short- and longer-term?
In the short term, I definitely think you are seeing a bottoming of growth here. In the current fiscal year, which ends March 2014, India has probably had the lowest growth in terms of GDP that we’ve seen over the past decade, but I do think the RBI is putting in the right policies. Basically, they have raised interest rates to eight percent to combat inflation, which was running at nine percent. If you see inflation coming down, I think that’s really a bullish case for equity.
The other big catalyst will be the upcoming elections—the national elections in May. Essentially, you have had the Congress Party in power over the last 60 years, and I think people are looking for a change. If you have the Bharatiya Janata Party (BJP) come in—that’s the main challenging party—you could see more market-oriented reforms. It could definitely drive growth going forward. I think the combination of a pickup of cyclical growth from a GDP perspective along with a political change could make India a very interesting story for 2014 and looking forward.
I tend to agree. Once the [Indian] markets eventually open up fully, it will be a very exciting market, but one of the hurdles is that foreigners had been barred from trading on the Indian markets until 2012 when SEBI (the Securities and Exchange Board of India) started an opening-up process. There are still some hurdles, but it’s getting easier. Have you seen a rise in interest in the Indian markets from US investors?
I definitely think that a lot of institutional investors are very active in the Indian market. We just saw some transactions go through. For example, Fairfax Financial Holdings, which is a Canadian company run by Prem Watsa, just bought a company called Thomas Cook, so you are seeing foreign direct investment coming in on an institutional level. Unfortunately, on the individual investor level, it is still very difficult for an American to trade India through his brokerage account. They’re mostly just stuck with buying EDRs. There is a QFI process you can go through, but I think a lot of individual investors just think it’s too much of a hassle to actually go through that process to start trading in India.
I agree. I’ve been doing some research on that, and I’m hoping that sometime later this year it will become easier and we can help our readers to go through the process, get set up, and begin trading on those markets. I look forward to that.
Thank you for being with me today, Ankur. The emerging markets are definitely influential for the global economy. I really appreciate your contributions to World Money Analyst.
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