Franklin Templeton Investments' Emerging Markets Conference

The world economy has been turned on its head over the last couple of years, but investors’ portfolios have not necessarily been adjusted to recognize this. Michael Hasenstab, senior vice president, global fixed income, at Franklin Templeton Investments, said: “I would argue that the safe assets have been flipped around. We are seeing more safe havens in many emerging markets now.”

“We currently have no holdings in US Treasuries,” Dr Hasenstab told delegates at the Franklin Templeton Emerging Markets conference, held in London on Wednesday. “Conventional investment theory says that is a risky position to take – I would argue it may be the safest position.” The huge structural headwinds in the US and Europe, namely the leverage which has migrated from the financial sector to public balance sheets, could hold back growth for years to come. “In China, India and Brazil, growth is so strong they are actually raising interest rates,” said Dr Hasenstab. “Meanwhile, rates are still at historic lows in Europe and the US. Everyone is so focused on problems in Europe that they are missing the boat on all the positive things happening in Asia"
There is particular concern over the outlook for European growth, he said. “This is not just about Greece – there is a bigger problem, which is the reliance on the bank sector. About 70-80 per cent of capital in Europe goes through banks and that channel is still clogged.” This is likely to lead to a muted recovery and a continuation of the rising unemployment rate in Europe even as it falls in emerging markets.

Some emerging European countries had been more serious and more successful in tackling their debt problems than their Western neighbours, he said. “Hungary, Latvia and Lithuania are seen as higher risk countries, but I believe they are years ahead of the game in terms of tackling their fiscal problems. In the US, we can only dream about
what they have done, particularly in terms of social security reform where they have applied some really tough measures.”

By contrast, Asia began the crisis in much better shape, with little leverage, and the result was a stronger rebound with the potential of more rapid growth to come. “This year we expect the average growth in emerging markets to be 5.4%[1] against 3% in the US[2] and 2% in Japan[2],” said Mark Mobius, executive chairman of Templeton Asset Management. “There have been no headwinds in Asia, so there has been a much faster cyclical recovery,” added Dr Hasenstab. “Even we were surprised. We thought emerging markets would be back to their potential growth rates by 2011 or 2012, but actually it is more likely to be the case by the end of this year.”
Given this positive outlook for emerging markets, should investors allocate more to equities or bonds? Dr Mobius says: “It comes down to where the assets are in the cycle, but I wouldn’t recommend timing the market.” Diversification is important, even when the long-term fundamentals are positive, says Dr Hasenstab. “Emerging market equities and global bonds are not highly correlated, so investing in both may lower overall volatility.”

1 Source: EIU; April 2010

2 Source Consensus Economics; 7 January 2010

Is the perception in some quarters that risks are growing in many emerging markets justified? Delegates at the Franklin Templeton Emerging Markets conference in London on Wednesday expressed concerns over growing industrial unrest in China, political violence in Thailand, the inability of Greece to service its debts and the recent aggression between the Koreas.

Dr Mark Mobius, executive chairman of Templeton Emerging Markets Group, noted that many foreign companies in China were currently complaining of a shortage of labour. “How can it be there are a billion people and that there is still a shortage of labour?” asked Dr Mobius. “The answer is, that they are not prepared to work for the level of wages they used to earn. They are not coming to the coastal cities any longer because the hinterland is opening up and providing jobs. There is a rise in wages all over China.”

However, there is an upside to this, and one which may please investors who have called for Chinese consumption to increase to offset decreased consumption in developed markets. Dr Mobius says:

“The wage increases are from a very low level. But, in any case, higher wages mean wealthier consumers.”

As regards Thailand, the political difficulties have not negatively impacted the economy. “The headlines are focused on the violence,” says Dr Mobius. “Meanwhile, the market remains unchanged over the last six months. The economy is doing well, exports are up and tourist arrivals are good.”

Greece has attracted much negative attention but we are unlikely to see the same deficit problems come up in other countries, according to Michael Hasenstab, senior vice president, global fixed income, at Franklin Templeton Investments.

“Greece is very different from Spain or Italy; I can’t see a domino effect. I think the rest of Europe will be more like Japan than Greece, with a long period of slow growth rather than a widespread sovereign crisis.”

Meanwhile, the crisis in Korea is widely misunderstood by those outside the region, Dr Hasenstab said. “The market panics every time Korea makes a noise. But China is an important stabilising factor that always prevents the rhetoric from becoming real events. Every time the market panics, we see that as a good buying opportunity.”

Are emerging market equities in bubble territory? Renowned emerging markets investor, Dr Mark Mobius, is not convinced that this consensus view is correct. The executive chairman of Templeton Emerging Markets Group says the fact that emerging market IPOs are anticipated to have their strongest year in 2010 since record listings in 2007 is a powerful signal of continuing market strength. According to Dr. Mobius, emerging market IPOs this year are expected to reach $144bn, compared to the $180 billion raised in 2007[1].  In addition, there are an estimated 10 additional IPOs awaiting listing, valued at about $94bn[1]. “We have seen a high correlation between stock prices and the amount of IPOs,” Dr Mobius told delegates at a Franklin Templeton Emerging Markets conference in London on Wednesday. He noted that since 2000, emerging market IPOs had risen from 20% of the world total to over 70% today[2].

A further reason to believe that prices could climb further lies in potential demand for emerging market equities. Although emerging markets represent about 32% of the total world stock market capitalisation, institutional investors on average allocate just 3-8 percent to emerging market stocks[3]. “It is clear that many people are overlooking the importance of emerging markets in their portfolios,” said Dr Mobius.

The perception by many investors that the emerging markets have hit their peak is not backed by the available data, Dr Mobius believes. Bearish investors may be overly focused on the fact that emerging markets suffered three major corrections in the last 12 years: in 1998, 2001 and, 2008. “The interesting point is that each of these was short in duration while the bull markets have been very long,” said Dr Mobius. “The average emerging markets bull market has produced an increase in prices of 423% and lasted 69 months, whereas emerging markets bear markets last 14 months and move prices down by only 57% on average[4]. The result has been that over one, five and ten years, emerging markets indices have significantly outperformed developed markets indices[4].”

Dr Mobius said emerging markets should also outperform over the longer term. He pointed to a number of factors that he expects can contribute to emerging markets outperformance, not least the increased spending power of domestic consumers. There are, he said, 5.7bn people living in emerging markets compared with just 1.2bn in developed countries[5]. “If you look at China, for instance, there is a predominance of middle-aged consumers who are typically high consumption, high productivity people,” said Dr Mobius. In addition, the growth rate of GDP/capita in emerging markets was 126% between 2003 and 2008 compared to 32% in developed markets[6].

This had led to sharply increased consumption: in 1990, 1% of Chinese households in rural areas had fridges, but this had risen to 26% by 2007[7]. And while 5% of the population had televisions in 1990, by 2007 the proportion was 94%[7].

1 Source:  Dealogic, Templeton, as at March 2010

2 Source:  Dealogic, as at April 2010

3 Source: MSCI, Pensions & Investments, as of 6 Jan 2010.

4 Source: FactSet; MSCI. MSCI EM Index vs. MSCI USA Index  as at 4 May 2010

5 Source: EIU as at December 2008

6 Source: EIU as at December 2008

7 Source: Wall Street Journal; China National Statistics Bureau; as at March 2009

Central banks in emerging markets face an almost impossible balancing act in the years to come, according to Michael Hasenstab, senior vice president, global fixed income, at Franklin Templeton Investments.

Dr Hasenstab told a Franklin Templeton Emerging Markets conference at London’s Commonwealth Club that the next year or two would test policymakers’ skills to the limit. "The question will be how to manage the impossible trinity of open capital accounts, flexible exchange rate regimes and monetary independence," he said.

Ironically, emerging markets central bankers face these challenges because of the success of their economies rather than any problems, as is the case in many Western countries. "Differing rates of economic recoveries between developed and developing countries should favour currency appreciation and tighter monetary policy in emerging markets," Dr Hasenstab said. "In our view, this combination will likely attract additional capital and trigger a virtuous cycle of stronger growth in emerging markets."

Dr Hasenstab also added that investors’ concerns over Greece were a "red herring" and had caused several emerging market currencies to fall through association in recent months, despite no obvious deterioration in their fundamentals. The fundamentals were likely to reassert themselves in the medium term.

"The inflow of capital will likely present challenges," said Dr Hasenstab. "While capital is being productively absorbed at the moment, there is a risk over the medium term that asset bubbles could form if policy remains accommodative for too long and structural transformations are resisted."

Dr. Mark Mobius and Dr. Michael Hasenstab of Franklin Templeton Investments outlined where they are finding equity and fixed income opportunities in emerging markets in London on 9th June at a conference for professional investors. 

Phil Davis, freelance writer, blogged the event from London.

Dr. Mark Mobius

Executive Chairman of Templeton Emerging Markets Group

Dr. Mark Mobius joined Franklin Templeton Investments in 1987 and currently directs analysts based in Templeton's 17 emerging markets offices. Dr. Mobius has spent more than 30 years working in emerging markets all over the world. In 1999, he was appointed joint chairman of the Global Corporate Governance Forum Investor Responsibility Taskforce of the World Bank and Organization for Economic Cooperation and Development.

Dr. Mobius earned bachelor's and master's degrees from Boston University, and a Doctor of Philosophy (PhD) in economics and political science from the Massachusetts Institute of Technology. He is the author of the books Trading with China, The Investor's Guide to Emerging Markets, Mobius on Emerging Market, Passport to Profits, Equities - An Introduction to the Core Concepts, Mutual Funds - An Introduction to the Core Concept, Foreign Exchange - An Introduction to the Core Concepts and Mark Mobius - An Illustrated Biography.

Dr. Michael Hasenstab

Senior Vice President, Franklin Templeton Global Fixed Income Group

Dr. Hasenstab, is senior vice president of Franklin Templeton Fixed Income Group and co-director of the group's international bond department, overseeing the global fixed income portfolio management team and investment strategies. He is also a member of the group’s Fixed Income Policy Committee. He has won numerous awards globally, including being named Top U.S. and Global Bond Fund Manager by Bloomberg Markets in 2009, Global Bond Manager of the Year by Investment Week in 2008 and Best Global Manager by Standard & Poor's/BusinessWeek in 2006.

Dr. Hasenstab holds a Ph.D. in economics from the Asia Pacific School of Economics and Management at Australian National University, a master’s degree in economics of development from the Australian National University and a B.A. in international relations/political economy from Carleton College in the United States.