U.S. markets have provided plenty of excitement this year to keep investors on their toes. But as badly as U.S. and European stocks have performed since the start of the 2022, emerging-market equities have done worse.
But as the U.S. dollar as retreated from its multi-decade highs over the past month, investors, including Allianz’s Mohammad El-Erian have pointed out that valuations in emerging markets have reached “historically cheap” levels.
Asked about his outlook for emerging- markets, Mark Mobius, a pioneering investor who helped to build Franklin Templeton’s emerging markets business before launching Mobius Capital Partners, argued that while the overall tone has been “generally negative” this year, there are still plenty of opportunities to be found in the emerging-markets space.
‘We are finding good companies in all regions’
To be sure, the underperformance of EM stocks is nothing new.
The MSCI Emerging-Market Index 891800, +0.15%, a gauge that includes shares of companies from more than 20 of the world’s biggest markets in Asia, Latin America and Africa, is down 18.4% compared with the S&P 500’s 13.4% SPX, +1.56% year-to-date. Over the last 10 years, MSCI’s EM index has returned just 36.9% in U.S. dollar terms, while the S&P 500 has returned 264.5%, according to FactSet data.
Within the index, performance has varied widely, and past performance doesn’t dictate future returns. When asked about his outlook for each region, Mobius said it would be “impossible to generalize” but that he sees “opportunities” for investment around the world.
“We are finding good companies in all regions,” Mobius said during an email exchange with MarketWatch.
When it comes to individual countries, Mobius said he favors India among the biggest EM players, and sees opportunities in Kenya and South Africa among smaller emerging and frontier markets.
Any investor looking to invest in the EM space should keep a few important prerequisites in mind.
“The key is the foreign exchange situation and the country’s ability to pay it debts and our ability to get [U.S. dollars] out of the country when we want to liquidate holdings,” Mobius said.
At the company level, Mobius looks for firms with strong pricing power and “little to no debt”.
Since the start of the year, the financial crisis in Sri Lanka has stoked fears that other frontier markets might experience something similar as the strong dollar and high commodity prices weigh on the finances of countries that largely import commodities like oil.
While there are a few exceptions — the currencies of energy producers Mexico USDMXN, +0.11% and Brazil USDBRL, +0.02% have held up remarkably well — the dollar has risen more than 6% against both the Indian rupee USDINR, +0.02% and Chinese yuan USDCNY, +0.00%.
Investing in emerging-market equities likely means investing in Asia, which is home to by far the largest share of publicly-traded companies represented in the MSCI index.
Taiwan Semiconductor Manufacturing Co. 2330, +1.83%, the semiconductor giant that’s a critical link in the global tech supply chain, has the largest weighting of any company in that index.
Outside Asia, Brazil has the biggest weighting, with Brazilian companies comprising more than 5% of the index’s market capitalization. One reason for this lopsided representation is that Latin American economies have more of a “fixed income culture”, which makes them more heavily represented in emerging-market bond indexes, and less so in the equity gauges, according to Dirk Willer, managing director of emerging market strategy at Citigroup.
Chinese stocks have performed particularly poorly over the past year, as investors dumped the country’s highflying tech stocks amid a Communist Party crackdown on the industry.
The KraneShares CSI China Internet ETF KWEB, +2.06% is down more than 23% so far this year as investors fear ructions in China’s property market could metastasize into a broader financial contagion.
While he expects Chinese tech stocks will rebound soon, Mobius said foreign investors should approach Chinese stocks with caution.
“There will be some recovery in those tech names but the general tone of the market is not good in view of the disastrous property market,” Mobius said.
With House Speaker Nancy Pelosi’s recently completed trip to Taiwan dominating headlines this week, is Mobius concerned about the additional strain it could put on the bilateral relationship?
“The impact [of Pelosi’s visit to Taiwan] will be steadily increasing tension between the U.S. and China on all fronts: Trade, Investment, Education, etc. There is increasing competition in all areas with technology and weaponry the most salient,” Mobius said.
U.S. stocks haven’t seen the bottom yet
Shifting to a discussion of U.S. stocks, Mobius said he still thinks there will be more pain ahead for investors, even as stocks rebounded in July.
“We probably have another leg down as the Fed continues to raise rates,” he wrote. “I expect rates to go much higher and that means a number of companies will be in trouble and the glamorous tech stocks with no earnings and dependent on more and more cash inputs will be in trouble.”
Mobius added that he won’t feel comfortable calling a bottom until he sees “complete surrender”.
“Of course we must realize that we are already in a bear market but the endgame requires complete surrender on the part of investors. Currently, there is a lot of hope.”
U.S. stocks rebounded on Wednesday following back-to-back losses. The Dow Jones Industrial Average DJIA, +1.29% was on track to recoup its 400 point loss from the prior day, while the S&P 500 and Nasdaq Composite COMP, +2.59% were both on track for strong gains.