Michael Hasenstab of Franklin Templeton delivered the opening keynote address on Wednesday at the Morningstar Investment Conference, and his message was simple: emerging markets are not monolithic.
“To talk of emerging markets as uniform makes no sense,” said the chief investment officer of global bonds for Franklin Templeton’s fixed income group. As an example, he displayed a slide showing the wide range of 2013 returns for individual countries, with Hungary as the top performer and Indonesia as the worst performer: “Look at the variance,” he suggested, in terms of both performance and fundamentals.
Taking a longer view, he used Mexico as an example. “Is it the 1990s? Not in Mexico,” where today the country has a credit line that enables it to navigate volatile asset flows. “It’s one of our largest investments,” he said, with an economy tied to the reviving U.S. economy, and said Mexico’s improvement has been “impressive.” Many EM countries have delevered, he pointed out; even Ukraine only has a 40% debt-to-GDP ratio.
Hasenstab had another message for investors worried about countries’ debt-to-GDP ratios. “If you’re concerned about debt in the U.S. and Eurozone, you should be petrified about Japan’s debt.”
While many market observers have been focused on the Fed, they should be looking at central bank actions worldwide. “What’s driving the emerging markets? Central banks,” he said, especially the Bank of Japan, which is set to print $1 trillion as part of the Abenomics’ “tripod” policy, which includes QE, structural reform and fiscal consolidation. “But only QE is working,” he said.
Japan is now running both a trade deficit and a current account deficit, and the BOJ’s QE “could be looked at simply as debt monetization, where one arm of the Japanese government” is helping out another arm. That $1 trillion, he worries, will be sending a “wall of liquidity” into Asia.
Speaking of which, Hasenstab then focused on China, where the investment-consumption mix is changing. Mao’s “one-child” policy is now beginning to show itself in labor shortages in China, which has led to real monthly wage increases since the early 2000s. Higher wages, he said, leads to higher consumer spending, even though Chinese workers are big savers. That consumption will become a “larger, more stable share” of China’s GDP, serving as a “growth anchor for China.”
He counseled that China economy watchers should look at labor and wage dynamics, not other measurements of the economy, as indications of where the country is headed. President Xi of China is moving to liberalize interest rates, which will allow more capital to flow to the private sector, which in turn will yield “less quantity, but higher quality of growth.”
China also still needs massive investment in its infrastructure to support its rapid urbanization process, including railways. He displayed a slide showing the nascent subway system in the city of Chengdu and compared its relatively paltry system with the sprawling Tokyo subway system. The point: to build a large city, the mass transit system must be large and broad enough to support the residents and businesses of that city.
Concluding his presentation, Hasenstab spoke of what Franklin Templeton’s bond portfolio managers are attempting to achieve: how to deliver positive returns in a negative period for bonds. There are three sources of potential alpha over time in a global bond portfolio: the yield curve, currencies and sovereign credit. The strategies his team is taking including holding very short duration bonds, and on sovereigns, “going more global,” such as increasing its exposure to Korea.
On currency, FT’s Global Bond Fund now has negative correlation to U.S. interest rates, which he said is “exactly what we wanted.” Hasenstab said we can expect “extreme bouts of volatility” over the next few years in emerging markets, with variance continuing, and even more variance in frontier markets,” and urged the Morningstar attendees to see those bouts of volatility as opportunities.
In answer to an attendee’s question about bankruptcy laws in emerging markets, Hasenstab admitted that the “ability to recover assets in emerging market countires is very low.” and that his team focuses on the issuer’s “ability and willingness to pay.” However, he cautioned that “investing in emerging market benchmarks is a good way to lose money.”
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