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Written by: Rob Brewis | Aubrey Capital Management
A year ago, we dared to suggest that a lot of the bad news in China was in the price and some of the business regulation headwinds were alleviating. We did not however, foresee the draconian zero covid policy which sucked the life out of the Chinese economy, reaching a climax expressed in civil disorder not seen since 1989. So far, the result of these protests has, thankfully, been very different this time.
China has had other issues to worry about too: the demise of over-leveraged property developers and the collapse of housing starts; problematic relations with the U.S. culminating in the highly restrictive semiconductor rules; even exports which have been the bright spot in recent years, but now face a slowing world economy.
But we invest in the Chinese consumer: will he/she be released to spend the massive savings hoarded up in the past few years? We believe so, and this will be a much more favourable backdrop for our consumer companies who are now very cheaply valued.
About India, our predictions proved more accurate. Despite its strength in 2021, it proved very resilient this year too. The spike in oil came and went and India survived as we thought it would. Like much of the emerging world, inflation picked up a little, but much less dramatically than the developed world, and now looks to have peaked.
We cautioned on valuations last year, but earnings for our consumer leaders have grown even faster than we had predicted, as the sector leaders we favour gained share from weaker players and the informal sector. Meanwhile, the market has had a year of consolidation while earnings have caught up, leaving valuations in our stocks, at least, now looking reasonable.
Further on inflation, it is worth clarifying the emerging market experience this year. Most emerging markets did not have near zero inflation, nor zero rates going into this period. So, while inflation and subsequently interest rates have risen, the magnitude of these rises has been much less dramatic than in the U.S. and Europe. For many, India, Mexico and Vietnam are perhaps the best examples, inflation has been on a long and downward trend, which may have been temporarily interrupted, but the downtrend remains largely intact. Long term structural downtrends in inflation are usually good for equities.
Exceptions to this would be Turkey and Brazil, but even in Brazil it looks like we are getting back on track. At the other end of the scale is China which remains a comprehensively deflationary economy, and one that continues to exert this deflationary impact on the world, as we see with solar panels, batteries, and increasingly, electric vehicles.
This brings us onto globalization which, contrary to popular opinion, is very much alive and well. Exports for all the major emerging markets have accelerated in recent years, with China leading the pack, albeit the recent global slowdown is having some impact now. While there is a consensus that China is losing business, the latest American Chamber of Commerce survey from early 2022 revealed that 83% of companies have no intention to relocate, the exact same number as in 2019.
There is inevitably some de-risking underway in global supply chains as manufacturers seek to diversify their production away from China, but this is all turning up in India (viz Apple’s vast new phone making cluster outside Chennai), Vietnam, Mexico, and Indonesia to name a few. In other words, it is very positive for most emerging markets.
With one or two notable exceptions, the latter part of 2022 has been a period of weakening commodity prices. For most emerging market consumers, this is very good news. The changing energy landscape is also a long- term positive for most emerging markets. India is again the standout winner in this, being short oil and long solar, at least in terms of potential. Russia, to which we have had no exposure in recent years, is the standout loser.
Perhaps the final positive for emerging markets is US monetary policy. As China has witnessed in the past year or so, it is very hard to ease policy when you run a managed exchange rate, and your benchmark currency is very strong. Whether US rates are near a peak is open to debate, but there are signs that the Dollar strength might at least be abating, which makes it much more comfortable for emerging market central banks.
We have broadened our portfolio during 2022 such that about a third is spread across Indonesia, Mexico, Vietnam, Thailand, Poland and Brazil. For most consumers in these markets, as well as in India, their job markets are robust, driven by strong investment and a continuing post covid recovery, while living costs look to be peaking. A good combination for real incomes and therefore consumption. Although it is hard to forecast exactly how China’s change of direction on health plays out, zero covid is being unwound and the potential rebound in consumer spending is huge. Our stocks there are well placed to benefit from it.
Altogether, this looks like an encouraging combination for 2023.