“So consumer financing companies, and that means banks and shadow banks that provide credit, those will continue to do well. … Banks generally do well when the yield curve steepens.” Indeed, the 10-year Treasury yield has tripled from 50 basis last summer to 174 at the beginning of April. “What that means is that banks generally borrow at the low end of the curve, keep money, and lend it out at a little bit higher rates, and obviously when rates were really low, that was a flatter yield curve, banks were less profitable. As the rates have gone up on the long end, the yield curve has gotten steeper.”
It’s also gotten steeper because of the semblance of global growth in the U.S. and elsewhere. So he thinks that financial services will do well both in the U.S. and abroad.
Roddy Snell, an investment manager on the Baillie Gifford emerging markets equities team, says he’s very bullish on the emerging markets and there’s a dramatic period of change afoot where a lot of Western money is going to come to these countries, where he thinks the balance sheets and cost of capital are more sensible. He says 10 years of technology business growth was compressed into six months’ time because of the Covid crisis, putting a number of companies in strong competitive positions.
Silly Videos, New Players
Who might have thought that silly videos on TikTok might help the economy?
The acceleration of tech use amid the Covid crisis have opened up huge opportunities for e-commerce companies, Snell says. “Just like SARS back in 2002, 2003 really gave birth to the Chinese internet giants that we see today [like Alibaba], I think Covid will do the same for internet companies and usage across emerging markets. And you can see that in a place like Indonesia, where there is one company called Sea, which seems to be now the dominant e-commerce company definitely across Indonesia, and really looking like it’s going to dominate most parts of [the Association of Southeast Asian Nations] over the next five to 10 years. It’s originally a gaming company backed by Tencent. They started an e-commerce business called Shopee.” Other success stories are China’s online grocery delivery and retailers such as JD.com and Meituan. The latter’s stock price soared during the pandemic after a reported 400% surge in online grocery delivery, he says.
“If you go to China, you see a new rung of technology companies really coming to the fore during the crisis,” Snell says. “So your Tencents and Alibaba, which have sort of been dominant for a decade, have really seen a pickup in competition in the likes of Kuaishou, which is a short-form video company, and ByteDance,” the No. 1 short form video platform (and TikTok’s owner). These companies have seen explosive growth, he says, and ratcheted up a 50% market share of social media advertising, “which I don’t think anyone would have expected three or four years ago.”
Still A Middle Class Play
The key driver of the emerging markets is still the growth in the middle-class consumption in the Asian countries, especially China, but that’s largely been overlooked because of the success of the American equities market. Again, Snell thinks that story is set to change if these countries are better set to come out of the crisis in the next 10 years. China will be less dependent on exports. Also, if the U.S. and Europe launch big infrastructure projects, the emerging market economies should benefit.
“We think materials look incredible interesting at the moment,” Snell says, where he says the firm has an overweight. “We have big positions in copper and nickel. This is really a play on the green revolution, which appears to have been accelerated by Covid. … Copper is great in that because it really is the new oil. The green revolution cannot happen without the best conductor in the world. And nickel, which we’ve had holdings in for several years, is a crucial element in electric vehicle batteries.” If China ramps up its electric car fleet to its ambitious goals of 30% or more, he says, “there will simply not be enough nickel in the world today.”
Brian Nick, chief investment strategist at Nuveen, says that his firm likes EM for the rest of the year, since the firm doesn’t see a lot of central bank tightening and emerging market currencies have improved this year (as of early May), and when there are expansions in global manufacturing in the developed world, it’s going to spill over to emerging markets. The firm has been overweight in Latin America and the consumer sectors, adding to discretionary consumer. “We’ve been adding to countries like Brazil, which obviously didn’t work in the first quarter, didn’t work well at the end of last year. Some of that is a valuation story. We’re willing to be patient on the overweights. Some of it was taking some profits in Korea and Indonesia where we were market weight [or] overweight.” But he says that EM might not outperform other sectors that are bouncing back, such as U.S. small-cap stocks.
Tom Wilson, head of the emerging markets equities team at Schroders, agrees that countries making up two-thirds of the benchmark, China, Korea and Taiwan, managed the Covid crisis very well, and contributed to its strong performance. These countries also benefited from the heavy presence of tech stocks in their benchmark composition, he says. Tech benefited from the trend everywhere for people to work from home, which helped hardware companies, the semiconductor space, memory names and e-commerce, gaming, etc., he says.
Other countries were more vulnerable and Covid made them more so. “Brazil, for example, where you saw quite a marked escalation in government debt to GDP as a function of their quite a generous support program for households.” The countries more exposed to cyclical and vulnerable stocks like travel, tourism, restaurants, suffered until the vaccine news hit the front pages. At that point, companies that could rebound in earnings started to ramp up—Wilson points to banks and energy stocks.
“You began to see a marked rotation and cyclical recovery from the beginning of November onwards driven by vaccine news flow and expectation of normalization,” he says. With the cyclical stocks rebounding, the vaccine news hitting the papers and commodities rebounding, money started to turn around and flow back into the EM space last fall.
That river has begun to slow to a stream since the beginning of the year, however, according to the Institute of International Finance. The view at the beginning of the year was that the dollar was going to depreciate, said Wilson, which helps emerging markets. But the dollar has stabilized as of mid-May. And, banks aside, the 10-year Treasury bond rising is not necessarily good for the emerging markets, It’s “a headwind for long-duration cash flow,” Wilson says. “So for structural growth names where a lot of the value sits further out, if the long end of your yield curve is going up, your discount rate is lifting and so you’re discounting those long-dated cash flows at a high level. Ergo, your fair value is going to be impeded by that, so then you began to see the steam come out of some of the structural growth names,” Wilson says.
Jin Zhang, a portfolio manager at Vontobel Asset Management, says his firm likes companies with pricing power that can deal with rising commodity costs and thus protect their margins. “That’s what you want as the shareholder. You want the company to be able to protect their margin in a rising rate environment. Many of these consumer companies can do that.”
Besides Meituan, he also mentions Chinese alcoholic beverage company Wuliangye and a snack food company there called Chacha, companies that boast brand recognition among a hungry and homebound customer base. Both these names saw their stock prices double over 2020.
“I would say from a structural perspective, I’m still more interested in the newer industries, i.e., consumer and technology as versus the old industries [such as commodities and energy] that used to dominate the EM index like the Petrobras of the world. That change is still there. I’m not sure of the durability of the commodities rally. We’re definitely still very much emphasizing the consumer companies, the middle-class story.”