Wednesday, 1 May 2013

Go, Jonny, go

After a ‘man-of-the-match’ display at the weekend in what has become club rugby’s pre-eminent competition, The Heineken Cup, the case mounted for Jonny Wilkinson’s inclusion in the British & Irish Lions squad, set to tour Australia this summer. The heightened debate centred on the concern that Jonny’s inclusion would displace another emerging star (Owen Farrell) from the opportunity to tour and, therefrom, gain valuable international experience. Having already retired from international rugby in 2011, Jonny’s selection would be as a match winner, not as a means to help develop his talents for future tours.

Having played a crucial role in our inaugural rugby fixture (and victory) against Rathbones in 2012, I feel my opinion carries some weight. I am of the belief, therefore, that Jonny should have been selected. Though unlikely to merit a starting berth, his ability to come off the bench and slot crucial points may have proved vital in what are likely to be the tightest of test match fixtures.

Within an investment portfolio I am of the same view; that emerging strategies should be making way for the more developed options – in particular the US.

As has been discussed on the blog on many occasions, the US remains our favourite equity market. However, would we not expect the strength of the US economy to prove a catalyst for emerging market performance? Our conclusion, based on some of the following points, leads us to believe that US growth will not be sufficient to lift emerging markets out of their current malaise.

Source: Bloomberg
• Strong US economy - strong dollar
Recent weakness in economic data suggests the Fed closure of its ‘QEternity’ programme of $85bn monthly asset repurchases, has likely been put back. However, longer-term trends in the housing and jobs markets suggest the US remains on a sound footing toward a self-sustaining recovery. If we combine this with the recent US shale energy boon, and the improvements it will make to the trade deficit, the US dollar is primed to put in a stronger decade than the last.

As the chart above highlights, a weaker dollar has historically had a reasonably tight relationship with stronger commodity prices. Emerging markets, of which so many are commodity producers, have been the beneficiaries of such a relationship, boosting their national incomes and their propensity to spend. This is further highlighted in the performance of the MSCI Emerging Markets Equity Index.

On this basis, anything other than a weak dollar would mean flat or falling commodity prices. This is not necessarily, however, of detriment to all emerging market economies. Countries such as Turkey and India possess very little in the way of commodities and, as such, run large current account deficits to help maintain growth rates. On balance, however, falling commodity prices would be a negative multiplier for emerging market performance.

• Slowing Chinese Demand
Whilst China’s economic performance still remains remarkably strong, it is clear the pace of growth has begun to slow. The dominant components of these growth numbers are also likely to be less resource-intensive on a longer-term horizon, as the economy re-orientates to a more sustainable balance of services and consumption. Admittedly, fixed asset investment still has a huge role to play in the development of the Chinese economy. This is particularly the case in building sustainable economies in the hinterland, however, the incremental demand this places on commodity markets may continue to ease.

• Relative Wage Costs
Another point so widely discussed on this blog is that, given the level of US unemployment, there remains very little upward pressure on wages. This should prove a strong tailwind for corporate profits. In emerging markets the situation is quite the reverse, with increasingly large wage settlements used as a tool to maintain political popularity, or to suppress potential insurgents. This is a clear headwind for profits, and is particularly painful for the state-influenced companies that dominate emerging stock markets.

All this being said, the more widely-known emerging market fund managers continue to deliver impressive levels of outperformance. This is largely because they recognise the above issues and select companies with profitability in mind. Those companies and regions offering better fundamentals are, however, starting to trade at rather challenging valuations. Regardless of the manager, therefore, an improving US economy is best exploited by US equity investing.

Time to let the Old Guard do its job in these more uncertain times. Let’s just hope Warren Gatland (British & Irish Lions manager) never faces such a dilemma.

Ben Gutteridge
Divisional Director - Research

No comments:

Post a Comment