In today’s Thesis Focus, we’re looking at “Rise & Shine” a thesis which focuses on emerging market equities and the expectation that they will attract substantial investor money and deliver consequent outperformance in the coming years.
There are several reasons we expect this outperformance. One is that many of these countries are commodity exporters and so they will benefit from the commodity bull market we expect is underway, as laid out in a Schroders July 2021 report, another not unrelated reason is our expectation of a weaker dollar over the next few years, for which they are beneficiaries as we will discuss below, and finally they are among the economies with the highest economic growth potential, and we expect a renewed focus on that fact as the developed world slows down, at a time when developed markets, especially the US, are expensive.
“We have already covered our belief in an unfolding commodity bull-market in our write-up of the Life Support Thesis, so we won’t repeat that here, but instead let’s turn to the dollar. Most internationally traded commodities are priced in dollars, and so when the dollar falls (or rises), the price of these commodities tend to rise (or fall). It’s easy to see why when you consider that a falling dollar makes it cheaper for other countries than the US to buy those commodities in their home currencies, and so demand rises and with it price. Our expectation is that the dollar is likely to fall over time from its current level, not in a straight line, but gradually.” - Mark Borwick, Chief Advisor to the Investment Committee
In fact the dollar has been in a downward trend for many decades, as demonstrated by the Dollar Currency Index data on TradingView, punctuated by intermittent rises. The most recent drop commenced last summer and has only recently paused as dollar bond rates have risen relative to other currencies. The reasons for this long term trend are several. Having the world’s reserve currency has been both a blessing and a curse for the United States. The curse follows from the fact that as a reserve currency, the world needs dollars and the only way to get them is if the US runs perpetual trade deficits, and the result of those deficits has been an offshoring of US manufacturing over time. The blessing is the ability to live beyond your means, since the dollar reserves, which foreign countries need, end up parked in Treasuries, which means the US has been able to run large fiscal deficits along with its trade deficits. These are two sides of the same coin of course, unless you pay for your trade deficits with savings and the US has not been saving much. After many years of this, the US national debt is approaching $30tn at the time of writing, according to November 2021 Statista data, and will in future years consume an increasing proportion of GDP to service it, slowing economic growth. Similarly the accumulation of trade deficits have left foreign investors holding some $30tn of dollar investments, an overhang which they may sell at any time if the dollar falls, exaggerating the fall further. All of this leaves the US in a weakened condition and subject to increasing inflation as the only means to reduce the level of debt in relation to GDP to manageable levels, and inflation is what kills currencies. On top of that, looking out longer term, the US as a consequence of this weakening has seen a lower share of world economic activity, making it that much harder to maintain the deficits that keep the world awash in dollars. Eventually this must lead to a reduced status for the dollar as world reserve currency and along the way its exchange rate will discount that fact.
“A strong dollar has wreaked havoc on emerging markets in the past because they have dollar debts accumulated to meet their need for dollars to engage in international trade. A weak dollar by contrast reduces their debt servicing costs and is a boon to growth. Thus the weakening dollar, which we anticipate, will be a tailwind for these economies.” - Mark Borwick, Chief Advisor to the Investment Committee
Finally, the nature of investors is to look for the new shiny thing, a better place to earn returns. This behavior drives the well known rotation from asset class to asset class that takes place over time, and the US has been the shiniest thing for some years and as investors get back to basics they will look for the economic growth that drives profits, that drives stock prices, and the fastest economic growth is in emerging markets, which are always last to benefit from the latest improvements in the productivity that drives prosperity.
We’ve witnessed this in China over the past few decades, where GDP per capita was below $1,000 at a time when the west was at nearer to $50,000, as April 2021 Statista data shows, and as they caught up, their economic growth was little short of miraculous. We saw it with the Asian tigers - Taiwan, Singapore, South Korea, and Hong Kong. And we are beginning to see it in India, in Vietnam, and in many other places in Asia, Latin America, and even eastern Europe.
The Investment Committee believe that a combination of stock market growth and improving currencies will offer very attractive returns in these markets over the coming decade.
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