In 2011, perceptions regarding the composition of the global economy underwent a shift—instead of the U.S. being considered as the world’s key growth engine, investors began to realize that large emerging economies such as China and India were increasing their contribution to global GDP. While the U.S. saw its long-term credit rating downgraded in August and the eurozone was the center of heightened worries about sovereign debt for much of the year, some emerging economies witnessed positive growth in 2011.
That is not to say there were not challenges. As most developed nations continued to implement very loose monetary policy measures, washing much of the global financial system with liquidity, many emerging countries had to reckon with higher prices for goods and services, appreciating currencies and, in some cases, “imported” inflation. In their fight against high inflation, several emerging-market central banks embarked on tightening monetary policies for much of the year, which led to investors worrying about the prospects for economic growth. Indeed, the high-growth economies of China and other emerging Asian and Latin American countries lost some momentum as the year wore on, but to us they now appear poised for softer landings than their developed-market counterparts.
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The death of North Korean leader Kim Jong-il on December 17, 2011, escalated the uncertainty surrounding the regime change in Korea, which was preparing for a leadership transition in 2012. Very little is known about Kim Jong-un, the young man who is taking on the role of dynastic head. Some analysts feel that the death of Kim Jong-il sharply increases the risks and uncertainties from the secretive Pyongyang regime, which has significant consequences for security on the Korean peninsula and beyond. South Korea and Japan are most immediately threatened, but China and the U.S. are also deeply involved with vital stakes in North Korea’s future.
We believe Kim Jong-un, being untried and young, may not be entrusted with the power his father had, at least initially, and there is a chance that he will be affected by the rest of the Kim family. We think there is a potential risk that the regime may undertake some type of military activity or nuclear tests in an effort by the new leadership to demonstrate to the outside world that there has been no regime policy change, internal strife or reunification with the south.
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This week I’ve joined forces with Dr. Michael Hasenstab, co-director of Franklin Templeton Fixed Income Group’s international bond department, to bring you our joint perspectives on emerging markets: where they have been, where they are now, and where we believe they are headed.
I invite you to read “Emerging Markets: Yesterday, Today and Tomorrow” at Beyond Bulls & Bears, which hosts perspectives from many of my fellow portfolio managers.
If you are a resident of the United States, you can find that blog here and follow the tweets @FTI_Perspective.
If you reside outside the United States, please find our new post here and follow the tweets @FTIPerspective.
I’ll be back on this blog in the next week or so with my 2011 year in review and outlook for 2012.
Hello readers, thank you for your patience while I was away from this space for a few weeks. We continue to see quite a lot of market volatility, but of course we consider these to be times of opportunity in our ongoing hunt for attractive investments, and we have been pounding the pavement to look for bargains. Here’s a note from a recent visit.
At an oil rig on the Caspian Sea
What country is the world’s largest producer of petroleum? No, it’s not Saudi Arabia but Russia.[1] Oil and gas are important to Russia’s economy, as are a whole host of natural resources such as nickel, palladium, diamonds, etc. Because of what have been higher commodity prices, Russia’s economy is growing at a fast pace (it is projected by IMF to grow 4.3% this year),[2] interest rates have come down from their peak in 2008, unemployment is lower, foreign reserves have risen to over US$500 billion as at July 2011, and Russian equity markets have generally done well since 2008, even considering recent declines. That is why we have been to date interested in Russian oil companies. For this reason, I launched a trip to the Caspian Sea to see first-hand how oil drilling and production operations worked on an offshore oil rig. Read more…
In the search for good investment opportunities around the world, I have made many interesting company visits. This time, I particularly wanted to share some of my noteworthy observations from Argentina, where we had our semi-annual analyst conference earlier this year.
Argentina has been experiencing steady growth throughout the years despite the country’s economic problems, from double-digit inflation to a shrinking trade surplus. We saw one good example of the improvements in the country when we arrived at the Ministro Pistarini International Airport, which, since its privatization, is in much better shape than it was in the past. Besides the bright and airy new wing, the customs and immigration process was quick and efficient. We then checked into a modern hotel in the Puerto Madero area in Buenos Aires, which is another good example ofArgentina’s transformation. Puerto Madero was a rundown port with derelict red-brick warehouses, but thanks to creative entrepreneurs, the warehouses lining the port canal have been transformed into offices, restaurants and apartments. The hip and wealthy have migrated to the area; across the canal are a slew of new high-rise, high-end apartments, and a half hour’s walk from the hotel along the canal is a floating casino that is seeing brisk business.
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I recently visited Muscat, the capital of Oman. Oman has a very strategic position in the Middle East, controlling the tip of the Musandam peninsula even though the peninsula is separated from the rest of Omanby land belonging to the United Arab Emirates (UAE). That tip points right into the Straits of Hormuz, which is the choke point for oil leaving Saudi Arabia, Qatar, Iran, Kuwait, Iraq and the UAE from the Persian Gulf to the Arabian Sea, leading to theIndian Ocean. On a clear day, you can see Iran from the tip of the peninsula. Oman’s military, therefore, has a big responsibility to protect that waterway.
Like its neighbors, Saudi Arabia and the UAE, Oman has a reasonable amount of oil, though of course, not as much as Saudi Arabia. With advanced recovery techniques, Omanhas been able to increase production to about 800,000 barrels per day, compared to Saudi Arabia’s current production of about 9 million barrels per day. So the Sultan of Oman has wisely been promoting other industries such as manufacturing and tourism in this country of three million people (of which one million are expats from places like India, the Philippines, Bangladesh and Pakistan). For example, Sohar, a city north of Muscat, is being developed as a manufacturing zone and a port. We traveled there to see how it was growing and to view a plant that was utilizing gas from the country’s natural resources.
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Mexico has a wonderful combination of a dynamic economy with an active cultural scene. Just like other markets around the world, Mexico’s stock market suffered a crash at the end of 2008 and the beginning of 2009, moving from the 2007 high of almost 32,473 points to an October 2008 low of 16,979 points, an enormous decline. Since then it has climbed steadily, more than doubling to reach 38,600 points again at the beginning of this year.[1]
The Mexican economy has mirrored the stock market. After a disastrous 6% contraction of the economy in 2009, Mexico grew by more than 5% last year and is expected to grow by 4% in 2011.[2] Mexico took its medicine early in the crisis with fiscal reform in 2009 which included a value-added tax and cuts in government spending. The public deficit is now only 2.5% of the GDP and is expected to decrease to 2% in 2011.[3] Public debt as a percent of GDP is 40%, which is considered reasonable when compared to other nations around the world.[4] More importantly, foreign reserves are building up and have risen from the mid-2009 level of US$80 billion to over US$120 billion today.[5]
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I’m saddened by the devastation and the lives lost in Japan as a result of the massive earthquake, tsunami and multiple aftershocks. I worked in Japan during the 1960s and have been visiting the country at least on an annual basis to meet with clients, even though our emerging markets-focused portfolios do not invest directly in Japan. Living on a fault line, many Japanese people have experience with disaster drills to prepare for such natural disasters. If there’s one thing that I’m confident of, it is the ability of the Japanese people to bounce back from this disaster, as evidenced by their quick recovery after the 1995 Kobe earthquake, which occurred in a more economically vibrant area.
The fiscal stimulus package to get the Japanese economy back on track is expected to be much bigger than that for the Kobe earthquake. Although Japan has a large fiscal deficit, unlike the U.S. or European countries, it also has one of the largest foreign reserves in the world, second only to China at almost US$1 trillion.[1] Most of the Japanese debt is also domestically funded.
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Over the past few months, the world’s attention has focused on events in the Middle East and North Africa (MENA), as the uprising that began in Tunisia spread to Egypt and onward to a number of countries in the region. The widening conflicts were quickly reflected in CDS (credit default swaps) spreads widening in those countries and the decline or closure of regional stock markets. Although we do not have investments in Libya, when I see what is happening there, I worry about the safety of innocent citizens. I’m encouraged by the determination of many Libyans who are fighting for more freedom and an opportunity to more fully share in their country’s economic future.
The upheavals in Tunisia, Egypt and other countries can be attributed to a complex of variables, most important of which are rising food prices, unemployment, corruption and political stagnation. Unemployment has stayed high and, more crucially, waves of new young job seekers entering the labor market have not been absorbed. As in many emerging markets, the populations in MENA countries are young—approximately one-fifth are between the ages of 15 and 24.[1]
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There will always be unforeseen factors and circumstances that might become catalysts for greater changes in the global landscape, as we have seen from the current unrests in the Middle East. No one knows what will happen in the future, but below is some of what I envision for the emerging markets landscape in the next decade.
Greater Dominance in Global Economy: I believe that emerging stock markets could be much larger than they are today and in the next decade their combined value could exceed the combined value of the U.S., Japanese and European equity markets. Emerging markets have come a long way since 1986, when the International Finance Corporation (IFC), a World Bank subsidiary, started to make efforts to promote capital market development in less developed countries. Since then, emerging countries have progressed from being simply low-cost manufacturing economies to growth-driven economies with a very strong consumer base. The importance of domestic demand in emerging countries will play an even more important role in the future as growth in developed markets is expected to be much lower, fraught with fiscal challenges. With emerging markets, growth in domestic consumption should be driven by, and hopefully sustained, in two ways: rising per capita income and, more importantly, the maturing of the young, working population who will be reaching the most productive years of their lives. However, if governments fail to keep up with this new and rising middle-consumer class, e.g. through a lack of employment and high unproductive government spending that could in turn lead to inflation, this could lead to political instability, a persistent poverty trap and a widening gap between the rich and the poor.
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