MBMG International Ltd.
Nominated for the Lorenzo Natali Prize
Three Wise Men
Three highly respected investment gurus were recently asked their
opinions of what will happen to Emerging Markets in the near future.
Christian Menegatti, MD and Head of Global Economic Research at Roubini
Global Economics, says that, “China is one of the largest contributors
to global growth, although subsidized by its government. We cannot
predict if the Chinese slowdown will have a soft or hard landing, but
the effects will be global.”
However, Menegatti is also concerned with the US as its performance will
have a worldwide impact. He believes, “We cannot look at the US in a
vacuum as there is still plenty of external risk. Oil prices are rising
dangerously and the Eurozone is a significant external risk… In terms of
internal risk, the US is undergoing a deleveraging process mostly in the
private sector, but it will eventually have to deal with an
unsustainable fiscal outlook… payroll tax cuts, unemployment benefits
and the recovery package are all expiring by the end of the year. This
could tilt the US economy into a recession.” Obviously, this would not
be good for the rest of the world.
He continued, “CIOs (Chief Investment Officers) have the opportunity to
broaden their investment spectrum towards economies that were not
necessarily part of the investment mix before. The opportunity here is
to learn to be more selective and not to lump emerging markets into one
category, as they have very different characteristics, potential growth
rates and political risk.”
However, caution on Emerging Markets (EM) is given by two of the most
renowned EM fund managers Angus Tulloch and Jonathan Asante, both of
First State Stewart. Tulloch, who is joint Managing Partner and
concentrates on the Asia Pacific regions, starts, “For all the optimism,
we remain concerned that markets are still held up by accommodative
monetary policy (printing money in the west) and that the eventual
removal of this stimulus will bring a reality-check in Asia and
To start with, he is worried about the two big players in Asia - India
and China. He has concerns that the ruling political party in India has
not fared well in recent local elections and is not in a strong enough
fiscal position to ‘persuade’ the electorate to persevere with them
which is what they usually do when this happens.
In the same vein, the abrupt sacking of Bo Xilai in China is further
proof that Chinese political stability is not as stable as some would
imagine and thus the ensuing negative impact on the local market was to
be expected. Tulloch is not convinced the Chinese government has total
control and can automatically guarantee a comfortable and easy slowdown.
However, in the long term he accepts that Emerging Markets will pull
through either due to or in spite of the West. This will be mainly due
to domestic consumption and the fact that Asia is, increasingly,
exporting within itself.
Tulloch also agrees with Menegatti in that he is the first to confess
the future of the emerging market economies relies heavily on how the
western world will fare. "With the slowdown resulting from debt levels
in the West countered by inflationary government policies, the outlook
for the region still depends largely on outside influences. With such
opposing forces, preservation of capital should remain the focus and
hence our portfolio remains very defensively positioned focusing on
companies with pricing power, strong sustainable cash flows and growing
Jonathan Asante is head of Global Emerging Market equities at First
State Stewart. He foresees there could be many potential potholes for
people to trip over. He said that a recent “visit to Asia has made us
concerned that private banking in the region could be the next banana
skin for global banks looking for new sources of revenue. The drive to
increase income from fees could potentially lead to a mis-selling of
He agrees with Tulloch about the problems in China. However, he goes
even further and does not necessarily believe the supposed success of
the consumer story. "A continuation of the Chinese investment and
capital expenditure growth is questionable even if Chinese consumers
continue to be better off in the medium-term.”
Another thing for investors to consider is the inter-connectivity of
global markets. Asante is a worried man. For example, there are
countries which rely heavily on commodities. The governments of these
countries may well plan their spending projections on high commodity
prices. This is especially true of countries in Latin America and
Africa. This could be a real problem for China which has invested
heavily in these types of places as the implications are obvious.
As an aside, Asante reckons the best country to invest in South America
is Chile, “Indeed, the Chilean government has perhaps the best record of
any [Latin America countries] in honoring long-term agreements with the
These guys remind me of MBMG’s long term investment advisers,
MitonOptimal, in that they are realistic and pragmatic when it comes to
investing other people’s money. Both funds have fallen short of their
respective benchmarks over recent months but, given their conservative
outlook, this is hardly surprising. In the first quarter of 2012,
Tulloch posted gains of only 7.8% as opposed to 9.4% with the benchmark.
However, in the last year he has made 2.4% as opposed to a benchmark
loss of 6.6%.
The same goes for Asante. In Q1 2012 he made 7.0% against the benchmark
of 11.0%. For a present day ‘bear’ this is not bad at all.
Also, if the three Magi are right and uncertainty lies ahead, it would
seem more than likely that the gains over the first three months of this
year will be lost for most fund managers. I would not mind betting that
First State will be leading the way again soon as their managers are
amongst the most honest out there.
Why on earth would anyone buy equities now?
Source: Gavekal, June 2012
As things stand now, it might seem that there is no light at the end of the
tunnel - in investment terms at any rate. American government debt has been
downgraded, the euro zone is about to go into its second recession in five
years, the US’s fragile recovery is in serious danger of stalling and
China’s transition to a more balanced, consumption-led economy is more than
challenging its double-digit growth history. Given this environment, why
would anybody want to buy equities? After all, globally equities lost 40% in
2008, and whilst this has been recovered to a large degree, it has taken
five years to do so! Japan has never even come close to revisiting the heady
heights of the Nikkei in 1989. This option does not really seem like a great
source of stable, inflation beating returns does it?
However, there are actually some very compelling arguments for holding
equities right now (or rather, more accurately, holding US equities) - at
least for the short to medium term. One of MitonOptimal’s research providers
- Gavekal - recently put out a piece that makes a persuasive case for this
particular asset class. Their conclusions are based on the old-school
approach of valuing a company by discounting its future earnings at an
appropriately risk adjusted rate. They argued that companies are actually in
a very strong space right now. Their profit margins, and consequently their
returns on equity (ROE), are extremely high and the low interest rate
environment means the fair value of the S&P 500 is more than double its
current level (3200 vs 1331).
Not everyone is convinced, “That’s na´ve!” scoff those that disagree. They
believe that, “Profit margins must revert to trend and current rates are in
a bubble - they must also increase to offer real returns at some point in
The Gavekal authors agree about both points but identify firstly that the
internationalization, to emerging markets, of earnings of the S&P firms has
put it onto a positive trend and so the downwards revision is in the order
of 10%, not 40%. Secondly, whilst a reversion of government bond yields to
long run averages of GDP growth (the Wicksell rule) will lead to a reduction
in the fair value estimate to 2064 that is still about 55% above the current
levels. If both happen, the fair value estimate is 1660 - still 24% higher
than current levels.
Has this theory worked in the past? Back testing of the eight buy-signals
since 1960 based on the Wicksell rule shows that equities have generated
annualized average returns of between 17% and 19% over the one, three and
five year periods following the buy decision. It does seem to work.
Does this want us to run out and buy more equities? Not really. We get the
point that equities are cheap right now, but also believe that they will not
revert to the mean immediately. There is a lot of bad news depressing their
price and whilst it will go away eventually, it won’t do so immediately.
We continue to hold equities, although these holdings have been cut
recently. When we deem the time is right for our risk level to go back to 5
(the neutral position), or even higher, we will boost these exposures and
ride the wave that should be coming.
The above data and
research was compiled from sources believed to be reliable.
However, neither MBMG International Ltd nor its officers can
accept any liability for any errors or omissions in the above
article nor bear any responsibility for any losses achieved as a
result of any actions taken or not taken as a consequence of
reading the above article. For more information please contact
Graham Macdonald on [email protected]
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