Seafarer®

Pursuing Lasting Progress in Emerging Markets

Market Commentary

Emerging Markets Briefing – Third Quarter 2017

Seafarer addresses key questions about emerging markets investing and how U.S. investors can integrate the asset class into long-term portfolios.

On Value in the Emerging Markets

Paul Espinosa examines the universe of value stocks within the emerging markets. Rather than rely on basic quantitative measures to distinguish “cheap” stocks from “expensive” ones, Paul defines seven distinct sources of value that might represent viable opportunities for long-term, value-oriented investments. He applies these seven definitions to the securities universe within the emerging markets and discovers a value-oriented subset worth $1.4 trillion. Paul then examines each of the sources of value in closer detail, studying the challenges and opportunities each category presents with respect to industry, geography, and valuation. He also discusses where value “traps” might lie within each category – and how best to avoid them. Paul concludes by noting that the opportunity for value in the developing world is large, of a diverse nature, and seemingly untapped by the global investment industry.

Chinese SOEs and the Way Forward

With the introduction of the “through train” stock program, China’s A-share market is opening up to the world – and some of the state-owned enterprises that populate that market are responding by changing the way they do business.

On Mexico's Homes

The news from Mexico’s drug war continues to be grim. However, these horrific headlines obscure the fact that Mexico’s economy has enjoyed a degree of resilience despite the insurgent and criminal activities of the narcotics cartels. Perhaps surprisingly – and in contrast to recent U.S. experience – the local housing market has been a source of strength, benefitting from thoughtful government housing policies that have fostered stability and broadened demand. If Mexico manages to escape its current cycle of violence, the housing market may prove to be an important pillar of future growth.

On the Sharia and Islamic Finance

The practice of banking according to Islamic principles, or “the Sharia” - the moral code and religious law of Islam - is relatively unknown within developed nations. However, in many parts of the developing world, Islamic banking is a burgeoning industry. It deserves closer scrutiny not only because it is bringing new and otherwise un-banked customers into the fold, but also because it serves as an alternative model for finance – and it may manage certain types of risk better than conventional Western models.

On Money and Confidence

At my former firm, the founder once offered a simple but powerful lesson. He asserted that two basic dimensions sum up everything one needs to know about the prospective health of financial markets: money and confidence. What I understood from that conversation was that money was the lifeblood of markets, and confidence was the heart that pumps it.

On Mexico’s Shores

Drug-related violence has devastated the Mexican tourism industry, and the country as a whole. However, Mexico's economy may yet claim a better future if a nascent trend continues: the “re-shoring” of manufacturing capacity. This commentary explores evidence that Mexico can gain market share in manufacturing industries that shifted to China over the past two decades.

On Teflon and Emerging Market Currencies

Some major market participants have implied that emerging market bonds - including those denominated in foreign currencies - are safe havens from the malaise of the developed world economies. It’s natural to seek safe haven in a currency other than the U.S. dollar given the fiscal difficulties that exist in the U.S., combined with low expectations for domestic growth. The fundamentals of emerging market currencies are also much improved; yet they are still typically thinly traded and volatile, sometimes even fragile. Such currencies may offer desirable diversification or investment characteristics - but ultimately they remain speculative, and should not yet be accorded "safe haven" status.

On Flexibility, and Why the World Needs More of It

It has been a long and trying summer. Like everyone, I have been transfixed by the market’s wrenching descent, along with the political mayhem that has accompanied the decline. Stimulus and sovereign debt have become heated, emotional issues. However, despite prevalent rhetoric that focuses on the indebtedness of nations, I believe our primary challenge is one of growth, and not necessarily one of debt. The world needs to embrace greater flexibility in order to restore growth – and if it does not do so, I fear that equity markets will become range bound, and a sustainable recovery will prove elusive.

On Brazilian Investment

In my last commentary, I suggested that Brazil's long-term record of investment was not particularly impressive. Happily, there is a good deal of evidence that the situation is changing for the better, led by an impressive flow of foreign investment into the country. However, this change could not come too soon: Brazil must execute such investment in order to avoid the "boom-and-bust" cycles that have characterized its past.

On the Importance of Sustained Capital Investment, Part 2

As discussed last week, I hold a belief formed from experience: when investing in developing countries, it’s important to focus where there is careful but sustained investment in fixed capital. This commentary presents basic evidence from the "BRIICS" (Brazil, Russia, India, Indonesia, China, South Africa) in support of that assertion. I examine the implications of those countries' long-term investment patterns, and I conclude with a brief discussion of China's aggressive (some would say breakneck) history of investment.

On the Importance of Sustained Capital Investment, Part 1

When I reflect on my investment career, a few experiences stand apart from the rest. One occurred during a trip to India in 2003. During a meeting with a company there, I learned the importance of steady capital investment to sustain long-term growth. A company may appear well-run and profitable, but if it fails to invest in a consistent fashion, it is unlikely to offer the sort of scalable, sustained growth that characterizes a core holding.

On the Uses and Abuses of Discount Rates

When investors search the world for opportunity, do they value a dollar of profit from Indonesia six times more than a dollar from South Korea? I doubt they do. Yet large and misleading discrepancies can arise when investors rely heavily on discount rates in valuation models to determine the relative attractiveness of foreign assets. Discount rates are useful when determining the intrinsic value of a single asset, but in my opinion, they should not be a primary determinant in the allocation between multiple assets.

On China's Provincial Finances, and the Prospect of Their Reform

Recent reports from China suggest that the central government may clean up bad debts at domestic banks totaling over $450 billion. Those debts are primarily tied to provincial and local governments that borrowed heavily over the past two years. Despite the staggering losses, I am optimistic: China may be embarking on a new and important set of reforms.

On Stockpiling and the Commodity Cycle

Commodity prices have surged dramatically over the past year: one broad index produced by The Economist suggests that prices have risen over 40% in dollar terms. There are a number of well-known explanations for such gains; however, I wonder whether stockpiling by companies in developing countries has exacerbated the trend.

On Double-Invoicing and the Yuan, Part 2

Persistent discrepancies in China’s trade data suggest hidden capital flows into and out of the country. Double-invoicing reveals how little we really know about the yuan. We can take nothing about the yuan for granted—so approach it with caution.

On Double-Invoicing and the Yuan, Part 1

Among global investors, it’s widely held that the Chinese yuan is a “cheap” currency, and that it is undervalued relative to the U.S. dollar. I am inclined to agree over the long-term, but I think the near-term is far more ambiguous. Empirical analysis of a little-known practice called “double-invoicing” sheds light on what some market participants think about the yuan, and it should give investors pause.

On Corporate Hedging

Finance textbooks state company managers “are paid to take risks, but not any risks.” Managers are supposed to hedge away those risks that could jeopardize their firms’ success—like rising input prices. This seems reasonable enough in theory. I don’t buy it in practice.

On Persistent Inflation

During the fall of 2009, I argued that central banks in Asia were no longer taking their cues from the U.S. Federal Reserve, and that this would stoke inflationary pressures. I was right on that count, but did not anticipate the extent to which the Fed itself would contribute to the problem. What’s next? I believe elevated inflation is here to stay—get used to it.

On Fables, Ratings and Guarantees

When you were young, which fable did you prefer: the farce behind the emperor’s new robes, or the comeuppance of the idle grasshopper? Though only fables, the stories hold relevance for the U.S. and Chinese bond markets, respectively.

On the Brazilian Real

While in São Paulo, my main impression was that of the steep valuation of the local currency. It is understandably strong, but does it rest on a strong foundation?

On Starting Out

Judging from the headlines, it would seem an inauspicious time to start a company. I beg to differ.