Templeton Emerging Markets Group has a wide investment universe to cover—tens of thousands of companies in markets on nearly every continent! While we are bottom-up investors, we also take into account big-picture context. Here, I share the Templeton Emerging Markets Group’s overview of what happened in the emerging-markets universe in the fourth quarter of 2016, including some key events, milestones and data points going back a bit further to offer some perspective.
Developed markets outperformed emerging markets in the final quarter of 20161 as expectations of reflationary measures from the incoming administration of US President-elect Donald Trump, solid US economic data and the extension of the European Central Bank’s quantitative easing program beyond March 2017, albeit at a slower pace, raised investor confidence.
Emerging markets gained slightly in December, despite the announcement of a rate hike by the US Federal Reserve (Fed). The MSCI Emerging Markets (EM) Index returned 0.3% in December, but for the quarter as a whole, the MSCI EM Index declined 4.1%, largely due to concerns over the US dollar’s surge and an increased possibility of protectionist policies from the incoming Trump administration.2
The US election appears to have had a more limited impact on frontier markets. The MSCI Frontier Markets Index was up 0.5% for the quarter, outperforming emerging markets more broadly.3 Pakistan did particularly well, ending the quarter with double-digit returns in the run-up to MSCI’s announced reclassification of Pakistan to emerging-market status in May 2017.
In 2016, emerging markets outperformed developed markets for the first time since 2010. The MSCI EM Index returned 11.6%, versus an 8.2% return for the MSCI World Index. The year witnessed a rotation in style from defensive to value, in part reflecting a turnaround in depressed materials and energy companies, which benefited from increased commodity prices.
In December, the Fed raised rates for the first time in 2016. Signaling increased confidence in the US economy, the Fed increased the key interest rate by 25 basis points (0.25 percentage points). Hawkish views from the Fed point toward the possibility of three hikes in 2017.
Crude oil prices advanced during the three-month period, as 11 non-OPEC (Organization of the Petroleum Exporting Countries) members including Russia committed to production cuts to curb oversupply in December, following proposed reductions in production from OPEC members in November. Overall, we believe upstream oil companies are best positioned to benefit from higher oil prices, and we remain positive on a number of companies in China, Russia, Thailand, Pakistan and India. However, over the longer term, a higher oil price could result in a potential increase in supply from shale producers as well as a production increase by low-cost producers (for example, OPEC countries and Russia) to support fiscal revenues. Higher oil prices could also lead to a significant increase in drilling activity around the world.
Most emerging-market currencies depreciated against the US dollar in the final quarter of 2016. The Mexican peso plunged to a record low against the US dollar in November but then recovered slightly. The worst-performing currency, however, was the Egyptian pound, which roughly halved in value following the liberalization of the currency in November. Geopolitical issues continued to weigh on the Turkish lira, which was down 17% against the US dollar.
Country Updates and Key Developments
For those who are interested in really diving into the numbers, I am including some country updates that show changes in key economic indicators and measures more recently and going back further.
Latin American markets were among the better performers in the final quarter of 2016, supported by outperformance in October. Brazil, Chile and Peru ended the three-month period with positive returns, while Mexico and Colombia lagged, in US dollar terms.
Investors in Brazil were encouraged by the approval of key reforms, with monetary easing efforts from the central bank, in order to stimulate economic growth, also proving helpful. Returns in Peru were driven by solid economic data and business confidence, while positive political progress and encouraging macroeconomic data supported the Chilean market.
Mexico was the region’s worst-performing market, as concerns of anti-immigration and protectionist policies from the incoming Trump administration weighed on equities as well as the Mexican peso. To counter inflationary pressures from a weaker peso, the central bank raised the key interest rate by 100 basis points (one percentage point).
Asian markets declined over the quarter, underperforming emerging markets as a whole. The Philippines was among the weakest performers on concerns that US protectionist measures could adversely affect trade and the country’s significant outsourcing sector.
Thailand could see some weakness in economic activity due to the one-year period of mourning following the passing of its king in 2016, but we believe this should only be a temporary effect. Thailand’s stock market saw positive performance in December, supported by the energy and financials sectors. The government’s significant economic stimulus measures, reform programs and infrastructure spending appear to be having a beneficial effect on the economy. In addition, lower commodity prices have helped to moderate inflation, boosted consumer purchasing power and enabled the implementation of reforms and accommodative monetary policies, all of which have supported economic growth. General elections are scheduled for late 2017/early 2018, which could see the return of a democratically elected government. We particularly like the consumer services, health care and tourism sectors, as Thailand remains competitive in these areas. Even though Thai banks continue to face near-term challenges from rising non-performing loans and increasing pressure on fee incomes, we continue to selectively favor better-positioned, undervalued Thai banks.
Indonesia and India underperformed amid increased uncertainty following Trump’s victory, and fund outflows. India was further pressured by demonetization measures. In an attempt to fight corruption, counterfeit currency, tax evasion, “black money” and terrorism, the Indian government scrapped usage of the highest denomination INR500 and INR1,000 currency notes from circulation. Accounting for about 85% of the currency in circulation, the liquidity shortage caused by demonetization is expected to negatively impact sectors and supply chains with high levels of cash transactions. These include areas such as real estate, jewelry, retailing, restaurants and consumer durables. As a result, economic activity in the interim will be impacted; however, in the longer term, we expect the situation to normalize and India to continue on a more sustainable growth path. These measures could also help improve transparency, increase tax compliance and accelerate a shift toward a digital economy. In the current climate, financials continue to do well, due to accelerating penetration of banking services and increased credit usage. Additionally, we believe infrastructure-related sectors like cement are well placed to benefit from continued infrastructure and housing development. Pharmaceuticals and information technology remain areas of competitive advantage for India, in our view.
Chinese shares underperformed amid a depreciation in the renminbi and increased regulatory restrictions in the insurance industry. The Shenzhen-Hong Kong Stock Connect program, which links equity trading between the two exchanges, was launched, but volumes were muted. Hong Kong also lagged its peers as gaming stocks weakened in December amid worries of capital controls from China.
In South Korea, currency depreciation and political turmoil surrounding President Park Geun-hye negatively impacted returns. South Korea’s parliament approved the impeachment motion
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