4th June 2015
Tim Love, manager of the JB Emerging Equity fund believes valuations could drive returns of as much as 100% over the next four years across the world’s developing nations, below he explains why…
Over the next four years we believe that emerging market equities will deliver returns of close to 100%, based on earnings growth of around 15%, dividends of approximately 3% and a rerating of valuations from a P/E of 12 to 14-15 times. To successfully capture the region’s growth potential investors need to focus on stocks with strong free cash flow, dividend coverage and robust balance sheets. Staying on the right side of global currency moves will also be key.
Emerging market growth will be supported by inflows from captive pension funds and money moving from fixed income into equities as investor risk appetite recovers. The secular demographic growth drivers for the region remain intact, particularly the growth in the young population and increased disposable income.
Emerging markets have historically done very well post a hike in US interest rates, typically delivering an uplift three times higher than the proceeding down phase. A normalising of the US yield curve in the next three to six months will be a starting pistol to become more aggressive on deep cyclical stocks, for example shipping and rare commodity stocks. In order to make the most of the opportunity investors need to buy ahead, as soon as a bottoming out of lead indicators becomes visible.
The key – as always – will be allocating capital at the right time rather than being paralysed by fear. With some obvious exceptions, the vast majority of emerging market countries have been massive beneficiaries of a lower oil price, particularly India, China and South Korea. On a sector basis the fall can be played through downstream consumer sectors, including electronics and airlines. Discount airliners, such as AirAsia and Panama’s Copa, are examples of companies successful in gaining an edge over state owned enterprises through disintermediation.
Brazil has been a significant underweight in our portfolio, but is close to an interesting entry point as a deep value play. The country’s recent set-backs are now priced into share prices and there are opportunities in sectors including housing, retailers and oil. In frontier markets we have a strong overweight to Saudi Arabia in anticipation of the opening up of its capital markets in June. We also like Argentina where the September elections should bring a modest bias to pro-market reform and a resulting uplift in valuations.
China has had an exceptional run in recent weeks with some of our A-share holdings up by over 40%. While we have reduced our overweight position slightly, we believe share prices have further to run thanks to the gradual restructuring of China’s financial markets and reforms that will benefit state owned enterprises, and private companies alike. The healthcare, consumer, energy and banking sectors all offer opportunities, but it is the quality of earnings at a company level that really counts. We have reduced our weighting to India from around 12% to 9%, yet maintain an overweight stance as we see a second leg for the market ahead. Despite a poor earnings season, investors are supportive of the political changes underway, which prioritise infrastructure and tax incentive beneficiaries.