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Which emerging markets will perform strongest in 2017?

23 December 2016

Fund managers outline the investment case for several developing countries that could outperform in 2017.

By Jonathan Jones,

Reporter, FE Trustnet

Developing markets have undergone a major turnaround in performance following a challenging 2015, emerging as one of the strongest equity plays this year.

Conditions for emerging markets have improved as Federal Reserve has kept rates lower than anticipated and commodity prices have stabilised.

Big emerging economies such as Brazil and China have seen better-than-expected growth, while other countries have benefited from concerns over potentially destabilising geopolitical events in developed markets.

Performance of indices in 2016

 

Source: FE Analytics

As the above graph shows, emerging market equities have risen 30.64 per cent this year, compared outperforming the 28.96 per cent return for the broad MSCI World index.

Below, FE Trustnet asks industry experts which country has the potential for a quick turnaround similar to the one seen in Brazil next year.

Don’t sleep on Brazil continuing its march forward

One of the biggest improvements among emerging markets has been Brazil, which has seen a number of developments during 2016.

Brazilian equities have been one of the stand-out performers in 2016, having risen by 83.34 per cent and at their peak in October were 124 per cent ahead.

Under president Dilma Rousseff, the country had failed to live up to its potential and lagged other developing markets. However, her impeachment earlier this year and replacement by Michel Termer has signalled a positive change for the economy.

Temer, who had already released his manifesto called ‘Bridge to the Future’ in October 2015, has begun to tackle issues including government debt, pension reforms and government spending.

Tom Smith, manager of the Neptune Latin America fund, says Brazil could again surprise investors in 2017, with Temer already launching policies to fix a number of issues.

“The real worry with Brazil at the start of this year was the sustainability of government debts and over two years the debt rose from 50 per cent of GDP to 70 per cent of GDP.”

“It was clearly on a very unsustainable trajectory and people were forecasting a rise to 100 per cent as early as 2020.”


“At the same time the government had been running a primary surplus for all of the past decade and this had collapsed and was now running a primary deficit for the first time in a long time,” said Smith.

“It is key for him to stabilise the government finances and to continue to attract capital and stimulate investment in the Brazilian economy.”

Brazilian equities vs MSCI EM index in 2016

 

Source: FE Analytics

Smith says that the new president has “done an excellent job” in enacting some of the policies announce in his aforementioned ‘Bridge to the Future’ manifesto.

“The current account has now largely closed. The IMF believe that an emerging market can run a sustainable current account deficit of around 2 per cent, we’re already less than that so Brazil’s vulnerability to external shocks has massively diminished.”

“This means that if he can get fiscal accounts under control then we can move to much more orthodox economic policies and Brazil can really emerge from this deep recession.”

Next year, Smith says Temer will also have to address the pension deficit, which is expected to reach new highs in the near-term.

Yet, while Brazil has certainly outperformed this year, it remains a long way off the highs seen earlier this decade.

“Despite all of these positive developments, despite the Brazilian market being up 80 per cent year-to-date, it’s still well down from 2011 levels – so we’ve had a nice turnaround but we are still a long way from the levels we were at as recently as five years ago,” said Smith.

Indeed, the market remains more than 30 per cent lower than it was in 2011, despite the rise seen so far this year, meaning investors with a long-term view potentially still have a good entry point to the market.

 

South Africa could outperform if it follows in Brazil’s footsteps

Away from Brazil, Nicolas Field, fund manager of emerging market equities at Schroders, says South Africa could be the surprise package of 2017 – though stresses that much would need to change for this to happen.

“I think the most likely one is South Africa in the sense that the interest rate cycle could turn,” the manager of the Schroder ISF Global Emerging Market Opportunities said.

“It could be a political change that could drive it because the key thing in Brazil was that the whole expectations for the country changed when the politics changed and a new government with different economic policies came in.”

“That changed the outlook and also gave the central bank the opportunity to cut rates and strengthen the currency rather than weaken it.”

“Although the politics are always local to the country you can see some parallels in South Africa – the currency has been extremely weak the policies adopted have not been particularly effective, fiscal has been quite loose.”

Field added: “If Zuma was removed somehow or other that would restore a lot of credibility around South African institutions and probably induce some capital flow.”


He says that a very weak currency and previous equity sell-off would also give the country’s market some tailwind.

However, while it is a possible turnaround story Field reiterates that it will rely on political change that is “not necessarily on the cards”.


Don’t forget the frontier markets either

Sam Vecht, portfolio manager of the BlackRock Frontiers and BlackRock Emerging Europe investment trusts, says there a number of frontier markets expected to do well in 2017 as well as the emerging markets.

He notes that when looking at investments, he makes sure to look at the dollar returns rather than the local currency returns.

“One has to think about it in dollar terms not in local currency terms which is important because markets can do a lot in local currency terms like Egypt this year but it may be that the currency depreciates against the dollar and it’s not worth that much,” he said.

“The countries where we have the largest absolute weightings are Argentina, Romania, Pakistan and Bangladesh and I think all of those markets look okay going into 2017 but they’ve all had fairly good runs already.”

“I would not expect any of them to be the stellar outperformer – but if I had to pick a couple of surprises I would go for Vietnam to have a good 2017.”

“I think investors have to be a little bit selective over which stocks they like in Vietnam but I think the country could have a surprisingly good 2017.”

He added: “Vietnam is a more diversified market but I do think that following a long period where the market hasn’t done that well because they had financial challenges several years back and they have been coming out of that slowly, I think perhaps they could emerge finally.”

Much like Brazil and South Africa, Vietnam also underwent political changes in 2016, installing a new government earlier on in 2016 and may benefit from some political reforms next year, according to Vecht.

He also highlights Kazakhstan as a potential for strong growth in 2017, though it is exposed to the oil price so investors need to make a decision on whether they are happy to be exposed to the commodity.

The fund manager said: “Always one has to think about two things – earnings and the price that we are going to be paying for those earnings.”

“I think Kazakhstan is one of the cheapest markets in the world today. I do think given how low valuations are there is room for those to expand quite substantially.”

However, not everyone agrees that any country will outperform in 2017, with Patrick Cadell, manager of the Liontrust GF Global Strategic Equity fund, noting that he is shorting the MSCI Emerging Markets index.

He said: “We see the combination of a strong US dollar, higher rates and protectionism as negative for emerging market assets and likely to end the inflows which have been so supportive this year.

Despite this, he does expect single-stock opportunities “to be plentiful and some stocks to benefit from the new landscape which is emerging”.

BlackRock’s Vecht emphasises that a diverse portfolio which incorporates some of these best ideas, rather than individual country plays are the best bet for investors.

“It’s important to stress that when it comes to investing in emerging or frontier markets one has to take a portfolio approach,” he said.

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