Emerging markets are finally showing more than just promise. They are delivering profits. But for how much longer?
Emerging market funds have been in nonstop rally mode since 2001, even in the face of commodity-bubble, interest rate and terrorist fears. And while these concerns have grown more acute, Mark Madden, portfolio manager of the $4 billion
Oppenheimer Developing Markets fund, doesn't see them bringing down these shares anytime soon.
Madden's fund is up 10.79% year to date and has returned a staggering 14.46% annually over the past five years. (In case you were wondering, the
has lost 2.5% per year over the same period.)
checked in with Madden to learn why he believes the rally in developing countries will continue -- and for how long.
OK. How much longer can this bull market run?
Emerging markets began outperforming most developed markets in 2001. Nevertheless, 2001 and 2002 were dramatic down years in the global equity markets, so the emerging markets were also down modestly in those years. Even so, the outperformance relative to the developed markets began in 2001 and has continued since then. We expect overall outperformance to continue for several more years.
Today, EM stocks are still less expensive than developed market stocks and they also offer greater growth prospects in the coming years. Based on that, we believe that there are two to three more years left in this EM bull market.
Which developing markets show the greatest promise?
In our view, some of the more attractive markets are Brazil, Turkey and India. The first two countries still have rather high interest rates, both nominal and real, and significant potential for interest rate cuts over the next several years. As interest rates decline, we think that GDP growth will be strong as domestic consumption growth accelerates and, equally important for equity prices, is the asset price appreciation that will come from lower rates.
U.S. tensions with China, the world's largest emerging market, are increasing. What does this mean for future business with other developing countries like India?
The China juggernaut will not be adversely impacted by the recent U.S. tensions. These sorts of tensions have come and gone over the years with little impact to the long-term growth in China and the continued integration of their economy with ours. The ending of the Multi-Fiber Agreement, which limited certain types of textile imports from China and included preferential quotas for selected small countries like Cambodia and Bangladesh, has resulted in a doubling and tripling of some textile exports from China. Those tensions will benefit India in that buyers will want to diversify sourcing so as not to become too dependent on Chinese producers. There are other product areas where India will benefit to some degree from the desire of buyers to diversify their supplier risk.
That will only be a marginal benefit to India. The longer-term opportunity for India lies in growth in exports in a variety of industries, and that will depend on the Indian government's ability to improve the country's infrastructure and further streamline the economy from the standpoint of taxation and regulation.
What Indian companies do you like?
We are substantially overweight India and have seen good returns from many of our holdings. Some of our biggest positions of names we like include
Housing Development Finance
, which does residential mortgage lending and lease financing for companies. Another is
, which is in energy, petrochemicals and telecommunications, all rather high growth industries in India.
Which countries are most susceptible to a drop in commodity prices? What about higher interest rates?
We have a diversified portfolio of stocks, some of which would be impacted by a decline in commodity prices. However, we are underweight materials relative to the benchmark and hence our portfolio would be less affected by a commodity price decline than many others. We are substantially overweight financials, and we will see some headwinds from higher interest rates, but not to the same degree as many other of the more developed markets globally.
Your portfolio seems heavy with Brazilian and South Korean shares. What is the political environment in those two countries? Is it safe for investment?
Since Lula was elected, the political risk in Brazil has declined dramatically. Ironically, there has been a rise in the risk in owning Brazilian shares simply because there is less risk discounted into stock prices. That risk is more than offset by the asset price appreciation that we believe will come as interest rates decline in Brazil over the next several years, even in the face of continued
South Korea has a low probability of a major crisis, but if a major crisis with the North did occur it would be very bad. South Korea has some of the rising multinational companies in autos, consumer electronics and other industries -- some of the stocks are
, which we own, and
, which we do not own. The key from an investment standpoint is to find those companies that offer good value and also have management who seek to achieve good return on capital as opposed to taking market share but earning no return on capital deployed to do so.
What are your favorite stocks in Brazil and South Korea right now?
in Brazil. One is a leading bank, trading at a PE of 9 times and has a dividend yield of 4%, and the other is one of the larger retailers, trading at a PE of 15 times (but with expected high growth) and a dividend yield of 3%.
In Korea, we like the refiners since demand for refined products, mostly transportation fuels, far outstrips refining capacity in the region. We own
. Both stocks are reasonably valued, trading at PEs of 4.5 times and 7.5 times and offer 3.5% and 6.0% dividend yields, respectively.
How will the recent resurgence in terrorism with the London bombing affect trade with developing markets?
Global markets have shown by the recent London bombings that investors have now accepted terrorism as a fact of life and that there will be more incidences but that they will have little impact on our long-term growth and prosperity. The one exception to that is if the Mideast OPEC producers play the oil card and are able to sustain or increase further the prevailing price of oil from the recent $60 levels. That would most definitely reduce GDP growth globally for several years until our economies responded with new ways to mitigate the growth in consumption and to stimulate production in other parts of the world.
Some emerging markets are more at risk than others from such events as we have seen by the terrorist actions in Morocco, southern Thailand, Turkey and Indonesia in recent years. Even in those cases, the market sold off initially and then recovered as investors realized that there was minimal long-term adverse impact to overall growth and corporate profits.
What are your prospects on the dollar?
I believe the direction of the dollar from here will depend on the U.S. consumer. If consumption continues to be strong, then I would expect the dollar to remain stable at these levels; however, if the consumer slows down and the economy hits a rough patch as a result of it, I would expect the Fed to back off on rate hikes and perhaps even reduce rates again while simultaneously allowing the dollar to weaken further.