Trailblazer China

Which economies are likely to hit the wall in response to the pandemic?

We believe that South Africa and Turkey present the greatest risks. We fear that South Africa could be on a dangerous train ride that may derail because of unsustainable fiscal dynamics (compounded by contingent state-owned enterprise risks that the government seems to lack the courage to deal with), external vulnerabilities (structural current account deficits that cannot be repaired by currency devaluation as the country lacks competitiveness in anything outside of commodities), and thin reserve coverage.

And, of course, Turkey, which has enormous external leverage, significant corporate and bank currency mismatches, and an unrealistic political addiction to growth, which cannot be funded with domestic savings.

We believe “creative” policymaking has the potential to get Turkey into big trouble down the road.

Growth winners

Barring the possibility of financial contagion, we believe most of the larger EM economies will get through 2020 as a “gap year” of sorts.

We do worry, however, that structural growth will be seriously impaired for many of the bigger economies beyond 2020.

This view is premised on the trends we see - lower global growth, structurally weaker commodity prices, and the contingent damage of higher fiscal debts.

We see years of weaker real growth potential in many of the larger EM economies, including Brazil, Mexico, India, and Russia, unless, of course, much-needed structural reforms are implemented.

These changes include privatisation and state-owned enterprises reform (in Mexico and India), foreign liberalisation (in Brazil) and labour market reforms (in India).

In our view, the real growth winners in a global economy with growth moving at a more glacial pace may be almost exclusively in Asia.

Among the structural growth engines, we favour the Philippines, Indonesia and Vietnam, alongside, of course, what we consider to be the well-positioned, historically dependable developed economies of South Korea and Taiwan.

Strong China

We expect a massive separation over the next few years between China and the other countries in the developing world.

In fact, we believe China is likely to emerge as a dominant growth engine of the world over the next decade.

Having accounted for 30%-40% of total worldwide growth over the past 10 years¹, we believe that China will represent more than half of all global growth in this decade.

We believe the combination of high investment levels (massive savings), powerful structural reform, sustained urbanisation, and improved capital allocation could underpin a level of compound real growth over the next few years that, on a US$14 trillion economy² could create, by our estimates, economic output the size of India over three to four years.

We also believe China, from our estimates, could be in for a major equity bull market, despite the geopolitical tensions.

Investment decisions

We believe it is incorrect to follow the common assumption that all EM are growing at a faster rate than developed markets.

We cite as evidence the fact that high levels of growth among emerging countries outside of China have not been a story for nearly a decade, and we do not expect it will become one in the foreseeable future.

We also believe it is wrong to use macroeconomic growth as the basis for investing in EM equities in the pursuit of sustainable returns.

To generate long-term performance, or alpha, in EM equities, we think investors should apply the same approach that should be applied to investing anywhere.

That is, invest for the long term in attractive companies with durable growth, sustainable advantages, and embedded real options that have been underappreciated over time, while being mindful of significant currency risks in times of high volatility like we are experiencing now.

Idiosyncratic company investment cases

Despite the absence of a case of strong macroeconomic growth in other EM countries, besides China, there is an abundance of idiosyncratic company investment cases - and many of which we believe are inordinately cheap now.

In the EM universe, we believe there are two types of high-quality companies that tend to have the intriguing potential of gaining a ubiquitous market presence and, in turn, outperforming over the long term.

1. Companies that despite being in lower-growth EM economies have innovative products or unique assets that capture demand in a large overseas market. We believe an example of this type is Novatek³, a Russian-listed natural gas company. Similarly, undeterred by the limitations of its small domestic home market, Taiwan Semiconductor (TSMC)³ supplies about half of the global chip market and stands at the confluence of multiple future technologies, including 5G and cloud computing.
2. Idiosyncratic companies that have competitive advantages in terms of scale and efficiency in informality, which they leverage to gain domestic market share. Femsa³, the largest Coke bottler in Mexico, falls into this category. By introducing an innovative convenience store operation called Oxxo, Femsa has taken market share from independent stores. Today, Oxxo is by far the largest convenience store chain in Mexico.⁴

Trailblazer China

The case for China is an entirely different matter.

We believe it will be the global trailblazer for economic recovery and provide what we think may be the most compelling investment opportunity in the next decade.

Our confidence stems from the fact that we believe China will emerge stronger from this crisis, with durable macroeconomic growth and a very strong currency.

We believe high-quality companies like AIA³ and Ping An³ - which have been strengthening their insurance and financial product offerings to cater to the specific needs of mainland customers - have capitalised on greater market share and their technological and business innovations.