Manraj Sekhon, CFA, Chief Investment Officer
While the United States and Europe are just starting to feel the economic impacts of the coronavirus, China is starting to recover. In our latest “Talking Markets” podcast, Manraj Sekhon, Chief Investment Officer, Franklin Templeton Emerging Markets Equity, offers some perspective from Asia and where potential investment opportunities may be found in emerging markets.
Hear how the recovery from the coronavirus shock is underway in China and possible opportunities resulting in select emerging markets in a conversion featuring Manraj Sehkon and our Renee Anderson.
TRANSCRIPT
Renee Anderson: Manraj, let’s start with you and your views on China and emerging markets.
Manraj Sekhon: I would describe the situation in China right now as being two things:
First of all, I would say it’s first in, first out. So, the issues that we saw developing at the end of last year and the beginning of this year in terms of the spread [of the virus] are now contained. The situation has become significantly deescalated and we are seeing recovery. And secondly, I would say that the situation in a strange way has now come full circle and that the real concern and the real focus is on the spread from people coming into China, rather than from within China, I think that can be managed. But in addition to that, I think the bigger medium- to longer-term question is the impact on growth and demand and activity outside of China and what that means for the external sector. And I think we are yet to see that.
So just coming back to the number of new infections in China, they’re relatively negligible in the context of what’s happening around the world. When you look at what’s been happening on the ground over the last few weeks, we have seen February being focused on getting people back to work. And now in March, the objective from the government and the companies is to get production back online. We think about 60% of production capacity is back online. And we will see more of that normalization through April. Fairly, this has implications for supply chains and growth, but we think China is recovering. And as I said, it’s more about the external sector.
The first two months of the year has seen some of the worst data we ever recorded in China. Retail sales down 20%, fixed asset investment down 25%. We have never seen numbers like that. I don’t think people are going to be focusing on those numbers, but that gives you some idea of a slowdown over the first few months.
I’m sitting here in Singapore and we were early into this like China, and significant aggressive measures were taken. I think that if you dropped in here from somewhere else without knowledge of what’s going on and you went down the central town, you really wouldn’t be guessing we were going through the COVID-19 situation. Clearly there are measures being taken, people are being very careful, there are measures at work, travel, etc. So, there is some activity going on, some reasonable activity going on with the usual areas being affected. Similarly, when I speak to our team on the ground in China, in Shanghai, it’s been very difficult. But on the streets in Shanghai now, things are slowly getting back to normal and with the usual aggressive protection measures being taken.
So, I think we need to be able to look through this, have a sense of what it could be like if everyone is sensible, and when we get back to normal, things will look very different.
Renee Anderson: So, let’s talk about policy tools in the toolkit to help on the recovery side.
Manraj Sekhon: We have seen significant policy action from the central bank in China in terms of low interest rate, refinancing support for small- and medium-sized companies, for companies that are really exposed to what’s happened with the COVID-19 situation. We have started to see interest-rate cuts. We have started to see reserve requirement ratios for the banks being cut by between 50 to 100 [basis] points. And this is just the beginning, I think. Contrasting it with what we have seen in the West from say the Fed [Federal Reserve], I would say Chinese authorities are using their bullets very carefully and in a very measured way. And I think we will see more to come.
Fiscal stimulus is yet to come. Over the last 12-18 months, we have seen a lot of reform in China because of the long-term plan, but also because it’s a response to the trade-war situation. And so, I don’t believe the long-term reform agenda is at risk, but certainly it’s going to be paused whilst we get through this. And coming back to the fiscal health, I think one very interesting statement from the Chinese leadership last week, which we need to pay attention very closely to, is that the focus will shift from GDP [gross domestic product] growth to jobs. This is a big statement from the leadership, and everyone will know that data and targets have been a major focal point for the Chinese leadership over the long term. The fact that they are refocusing to jobs shows you a few things.
First of all, the development and the maturing of the economy, but be in the short term. More importantly, them understanding and realizing that this is a very different crisis. And in a way that’s different from previous crises, one that they can’t on their own necessarily get their arms around and solve immediately. And so, they will be focusing on jobs. And I think over the coming weeks and months, we’ll see more announcements, possibly supporting corporates and ensuring that payrolls are kept intact so that companies can retain workers and not be forced to retrench them. So, I think those are a few things to look out for.
Renee Anderson: Manraj, you’ve got feet on the street in Asia across different emerging markets. What are you hearing locally about the near-term impacts and what are you thinking about current valuations in your parts of the world?
Manraj Sekhon: I think that’s the key question, Renee. And, I think first of all, I would say it’s too soon to say. We are talking all the time to companies on the ground, not just in China or North Asia, but around the emerging world, and what we are seeing and I think just putting this against what the markets are telling us, it’s about liquidity, it’s about balance-sheet strength and it’s about how close you are to the consumer. And clearly, companies that are on the consumer interface directly are suffering.
Having said that, obviously there are clear beneficiaries as well. You know, when we talk to companies on the ground, so far, the focus has been on getting the supply chain back intact in technology and manufacturing, and in industry. Given what’s happening to demand, we are seeing some companies very slowly pick up capacity utilization again and building up inventories. So, they’re being very careful about it. And I think because the demand side is at question now, we have to treat the near-term numbers, production numbers, operational numbers with a lot of caution. In many ways, this has gone from being a supply side issue to a demand-driven issue. So, in short, I would say it’s too soon.
What we are seeing though is the impact on different kinds of the economies across the emerging world differently. China is clearly coming out of it sooner. I think if you go further down South in East Asia, it really depends on how externally driven the economies are. So, the more flow driven economies are clearly having a tough time and certainly at least in the short-term recession right now. As you know from the data, we are beginning to see the impact of this in some of the bigger emerging economies that are further away from China, India and Brazil. And we are starting to see some market reaction to the potential financial distress this may bring but again, it’s too soon.
Just coming back to the questions, in China, I would say what we expect to play out over the next six to nine months is a domestic-driven recovery. So I think companies, corporates that are really focused on what’s happening locally in China will come out of this first and there is a lot of pent up demand in China and as China normalizes, you’ll start to see that impact consumer spending, leisure-related activities probably sooner rather than later. And I think we should start expecting to see this within the first half of this year. I think the bigger question is, even though China is now much more domestically driven economy, about two thirds of the economy and the market are really about what’s happening domestically, is again about the external sectors. So, there will be some feed through of the slowdown and what’s happening in the West and that could have secondary effects on what’s happening domestically.
And, you know, I think whilst the number of cases are going up in the West and whilst activity has come to a halt, I think the policy action is not what the markets are focusing on and understandably so. So, I see the policy action, whether it’s monetary or fiscal, we have seen very aggressive fiscal in parts of Europe, the UK, in particular. I see that as some sort of a backstop. For now, the markets are really focusing on liquidity and having some estimation of what the impact of shuddering halt through activity will bring.
But once we start seeing stabilization in the spread, and again that’s a very dangerous thing to predict, but once we start seeing that, then I think reasonably the markets will start recognizing correctly what the impact of fiscal and monetary will bring and that will be the backstop to start giving people a reason to look further out. And in the meantime, there is a dash for liquidity, which is what we are seeing in Equity markets, what we have seen in credit markets, which have effectively stopped functioning, but we need to see that stabilization.
Coming back to your question about valuations, I think it’s quite interesting that in some parts of the emerging world, in fact, some of the largest companies, we have actually seen very little impact at a stock price level relative to what’s happening in the rest of the world. And as investors, I think, we believe that’s reflecting some look through of the current episodes, some market efficiency, but also a recognition of what people want to be exposed to in these markets. We are seeing technology companies relatively defensive in this episode. But having said that, we think they will still be the winners through this period. We are starting to see a lot of value in financials, in some of the consumer areas. But it’s probably too soon to start focusing on those areas. So I would say, we were seeing a lot of valuation support. We need to look through this episode and see what the world looks like at the end of this year, which is what we are trying to do right now and staying very close to the companies in the meantime.
Renee Anderson: That’s really interesting views, Manraj, We have some other geopolitical events obviously occurring around the world, so what are some of the longer-term implications for investors? Where are you seeing really some risks and opportunities more broadly and thinking with a long-term perspective in mind?
Manraj Sekhon: I think as active investors, as active managers, whilst this is a terrible time for everyone, I think it does give us the opportunity to really engage with companies and figure out how we think companies are going to come out of this and position ourselves well. So, I think, this is a time to be very active and very selective, which we are doing.
Low energy prices, low oil, is generally good for Asia. It’s certainly good for the major economies in Asia, like China and South Korea, certainly Japan as well, India.
Coming back to your question about where we are seeing the most interesting opportunities? I would say North Asia is one, and as the supply chains come back into effect, we are going to start seeing consumer selectively. And I would say probably at the mid end of the consumer space, mid-end and low-end consumers are going to start spending more quickly. We are also looking at Brazil again, Brazil has been a very strong performer over the last year or two. We have seen a severe correction in that market. And I think this is an option as you relook at that because the policy agenda in Brazil has not changed. The growth profile is still intact through this episode. That’s another area which we’re looking closely at. So, I would highlight those two areas, in particular.
Renee Anderson: Great points, thank you Manraj, for sharing your insights and perspectives with us today.
What Are the Risks?
All investments involve risks, including the possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Investments in fast-growing industries like the technology sector (which historically has been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasizing scientific or technological advancement.
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