Emerging Markets currently offering significant value, says Old Mutual Investment Group

Feroz Basa, Portfolio manager of the Old Mutual Global Emerging Markets Fund at Old Mutual Investment Group.

As the US/Chinese trade war standoff intensifies, Emerging Markets continue to be caught in the crossfire with no clear indication of when the volatility will end. Despite this pressure, Emerging Markets are currently offering some of the highest upside ever seen, according to Feroz Basa, Portfolio manager of the Old Mutual Global Emerging Markets Fund at Old Mutual Investment Group, who believes that the current environment is creating significant value opportunities.

The relentless Emerging Markets sell off somewhat stabilised in September even though the US has followed through on their tariffs against China. However, investors are still nervous as evidenced by Emerging Market funds reporting record outflows in the last few months.
 
Basa points to the global trade war as the Emerging Markets black swan event of the year. “We didn’t know how aggressively the US would go after China in terms of trade tariffs, but this has certainly exacerbated the situation,” he explains. “We knew about the Fed hikes, that Quantitative Easing would unwind and that China is a managed economy that tends to pull back when it is overheating and stimulate when it underperforms. So none of these issues were a surprise. However, the extent of the global trade war situation was the one that no one really saw coming.”
 
He adds that global investors were also aware that the US economy is currently going at full tilt. “Conventional economics tells you that stimulating the economy when it is doing so well increases the risk of overheating. These latest US tax cuts are like pouring paraffin on a fire,” says Basa. “So now you have a strong dollar – a historical headwind for Emerging Markets – rising interest rates and uncertainty caused by the global trade war; all factors that are putting Emerging Markets under pressure.”
 
However, these are short to medium-term concerns, says Basa. “When you look at the markets, what we are currently seeing is not only Emerging Markets selling off, but also currencies. Looking at any measure, Emerging Markets are actually 30 percent cheaper than Developed Markets on an aggregate basis, and that provides a buffer,” he explains. “On a longer term basis, the best determinant of potential returns is the price you pay today for the future opportunity offered by an asset.”
 
Basa points out that Emerging Markets currencies have become cheaper, and looking at any measure, the US dollar and equity markets are expensive. “The S&P 500 currently trades on a 32X Shiller Price Earnings (which adjusts for economic cycles), with Emerging Markets at 11X. Not only is the US expensive on this basis, but companies are earning record profit margins, so earnings levels are also relatively high. This is being backed by record stimulus measures and cheaper finance and on a five year basis we expect this to unwind,” he says.
 
Emerging markets on the other hand are on a relatively cheap price earnings multiple or arguably depressed earnings, says Basa. “Post the Global financial crisis, emerging economies have had to adjust their businesses to lower global growth and overall utilisation which has placed pressure on company earnings. Therefore the biggest current investment opportunities are in Emerging Markets.”
 
He adds that there are concerns that, with the US heading for tougher times over the medium-term, Emerging Markets cannot completely escape the contagion effect of this. “We don’t have the answer to that conundrum right now, but what we can say for certain is that, based on our fund analysis, this is the highest upside we’ve ever seen in our Emerging Market fund,” he states.
 
“We don’t know exactly when, but at some point in the not too distant future this upside should materialise. We’re currently seeing high quality Emerging Markets companies offering significant value for long term investors.”
 
So while investors might have to endure volatility, there are significant investment opportunities that should pay off over the longer term. “If you go back to the 2008 global financial crisis, from 12 September 2008 to 12 September 2018, the S&P500 increased by 185 percent. So on average you nearly tripled your money over 10 years, but if you had tried to time the market, between 12 September 2008 and 9 March 2009 the S&P500 lost 45 percent of its value. Now imagine you had panicked there,” he says.
 
Basa believes that China, as a managed economy, will continue to manage the long-term performance of its economy and this is where we’re likely to see some of the stimulus to Emerging Markets coming from. “Global growth is certainly not falling off a cliff and Emerging Markets in particular are still outperforming in terms of growth, but the US has just been extraordinarily strong and the tax cuts have amplified this situation. “Besides a few exceptions like Argentina, Turkey, Brazil and SA, most Emerging Markets are actually growing just fine and on aggregate Emerging Markets growth is still outpacing its Developed Markets counterparts.
 
Basa firmly believes that the price you pay for an asset today will determine your future returns. Emerging Markets have sold off more than 20 percent since January and have become cheap relative to Developed Markets. Short-term volatility could persist, but investors with a longer term horizon should benefit handsomely.”