WorldWatch
Having invested in EM equities at TT since 2011, many of the opportunities that we currently see in the asset class are among the best we have ever known. In this piece we focus on some of the most compelling.
Argentina: economic shock therapy
A pre-requisite to successful investing in Emerging Markets is to get the politics right, and this is where any constructive investment argument for Argentina must begin. Milei’s shock therapy is treating Argentina’s Achilles heel, its fiscal deficit. Historically the country has run deficits, initially funded through debt, and eventually through money printing, causing an inflationary spiral. The new administration aims to run a balanced budget, covering all expenditures and interest costs. So far the adjustment has been rapid, with the country moving from a primary deficit of around 3% to a primary surplus of 2-2.5% in a matter of months. At the same time, the central bank is no longer creating money, and relative prices in the economy have been left to adjust freely. As a result, both CPI and PPI have been falling very rapidly. On the external side, the trade balance already exceeds $20bn, and this surplus looks set to increase further. The “omnibus bill” that was recently passed by the Senate is looking to create tax incentives that should see Argentina become a major producer of copper and LNG, in addition to oil, lithium and agricultural goods. As an aside, the current administration has fewer than 15% of the seats in Congress, so passing any law is a major accomplishment, with positive implications on governability. While we expect exports to be the initial engine of growth, as the economy starts to rebound towards the end of the year, the government has stressed that it will give back any topline gains through tax cuts. This should sustain growth by allowing the private sector to become more competitive, and stands in stark contrast to previous Argentine cycles, when populists squandered windfalls by increasing spending.
With the country having endured the most difficult part of this extreme adjustment, Milei’s popularity still remains above 50%. We attribute this to his effective communication about what was required at the outset, and the fact that people had been suffering under the previous regime, affording a degree of tolerance to the necessary hardship. Whilst market volatility is to be expected amid such an extreme adjustment, and Milei’s popularity will need to be monitored closely, we maintain substantial exposure, particularly in the Energy sector. Having recently met with Vista Energy and YPF, we have even greater conviction in these investments as activity is increasing and pipeline capacity – the main production bottleneck – is improving, with the new Vaca Muerta Sur pipeline now under construction. Amid growing confidence in the domestic economy, we have also bought Banco Galicia. Argentina’s financial system is almost purely transactional, with credit-to-GDP of just 8%, compared to an average of 40% in LatAm. This means that credit can expand many multiples from here, within a wider economy that itself has scope to grow substantially. There has been large-scale crowding out of the private sector by the government, but as the latter retires from being a new borrower, it should have exactly the opposite impact. Banks that are currently parking money with the central bank will put it to work in the domestic economy, which will be expansionary. On this point it is encouraging to see a number of banks starting to offer mortgages. Argentine banks such as Galicia are currently trading at 1-1.5x book value, compared to 2.5-3x when Macri was President. If Argentina has truly crossed the Rubicon, these valuations look extremely attractive for the growth on offer.
Turkey: Sick Man of Emerging Europe out of intensive care
Turkey has long been considered an investment pariah and, to rehash the 19th-century cliché, the Sick Man of Emerging Europe. Shunned by international funds, its relative importance has declined to the extent that it now constitutes less than 0.5% of the MSCI EM Index. For many asset allocators, this made it too small to make a difference, too easy to disregard, but now perhaps, at last, it may be too tempting to overlook. After years of deterioration, Turkey may finally be on the road to recovery, with policy normalisation and rock-bottom valuations possibly allowing it to recapture the attention of value investors and contrarians.
As recently as 2013, before the outlook began to darken following the Gezi Park protests, Turkey was promoted as the poster child for Emerging Markets, with its burgeoning middle-class and enviable demographics. Its rapid recovery from the Global Financial Crisis, its growth and reform story, its dynamic free-market practices, the sense that the inflation genie had been rebottled, and a general perception that Turkey was integrating ever more closely to the European political economy all combined to form a seductive investment case. Unfortunately, Erdogan’s time in power has emblematised the proverbial game of two halves. If his rule had ended after ten years, chances are he would have been viewed as one of the most successful economic reformers of recent times, but of course, history is the narrative of everything that needn’t have been that way. The hallmark of a genuine democracy is a peaceful transition of government, yet Erdogan has clung on and wreaked years of economic damage. Succumbing to populism and the demands of the electoral cycle, he ran the economy too hot with huge external financing, and successive credit-fuelled booms were not tackled with monetary policy orthodoxy from an independent central bank committed to taming inflation. Instead, the Prime-Minister-then-President fired successive central bank governors that didn’t keep policy loose enough for his liking. One of the consequences of Erdogan’s misgovernance has been a financial ostracism, with the market completely disappearing off the radar screens of many investors. This is where the opportunity may lie. Currently trading on less than 5x 2024 earnings, Turkey is among the cheapest equity markets in the world. Of course, cheap on its own is never enough; cheap with a catalyst is what’s required. Thankfully, the country now has one in the form of policy normalisation. After many years of erratic monetary policy, the central bank has been granted more autonomy to pursue economic orthodoxy, raising rates significantly to tackle inflation. We believe that inflation will fall rapidly from here, providing scope for some monetary easing towards the end of the year. This would be beneficial to the banks, which are extremely sensitive to rate cuts.
AI: driving multiple supercycles
We continue to be constructive on AI, with Nvidia’s blockbuster results clearly demonstrating a broadening of demand and expansion of addressable market. The leading manufacturers of chips and other technologies that will power the AI revolution are based in Asia. They trade at significant valuation discounts to their chip design peers in the US, despite being exposed to the same exciting opportunities. We retain substantial exposure to chip makers, particularly memory producers including SK Hynix, SK Square (essentially discounted exposure to SK Hynix with the additional catalyst of Korean ‘Value Up’ corporate reforms) and Samsung Electronics as the current memory upcycle looks set to be the strongest in over a decade. During the recent downcycle, capex in the memory industry was well below the level needed to service and sustain existing capacity. This lack of investment came at a time when the memory supply chain rapidly shifted to High Bandwidth Memory (HBM), which is used in AI servers. HBM requires twice the wafer capacity per bit than regular DRAM and its production yield is much lower than commodity DRAM as only premium dies can be used. Consequently, the ongoing transition to HBM means that conventional DRAM production capacity is predicted to fall by almost 40% from 2022 levels. We see an unprecedented supply-demand imbalance in 2025 and believe we are entering a memory supercycle, with pricing power among the best in the Tech sector.
We also expect a supercycle for advanced packaging, driven by AI’s insatiable demand for computing power. Advanced packaging is a critical means of increasing processing power. Achieving performance improvements the old way, via advances in semiconductor processes, is simply too expensive as chips approach the practical limitations of physics. Thankfully, ‘chiplet’ architecture now enables packages of smaller, cost- and performance-optimised chips, extending Moore’s Law significantly. We believe the global advanced packaging market will reach well over $100bn by 2027, and have exposure through the likes of TSMC and SK Hynix.
Base metals: more than meets the eye
Although copper and gold are consensus longs, we believe there are aspects of both investment cases that are still underappreciated by many investors. The structural story on copper is well understood, given its centrality to decarbonisation efforts globally, as well as the relatively limited supply. Where the market appears to be far less efficient is in translating this bullish top-down view into bottom-up ideas that will generate the strongest shareholder returns. For example, at the end of last year we identified several Chinese copper producers that were being materially undervalued relative to their Western peers. Zijin Mining and China Molybdenum have subsequently featured amongst our best performers this year. We also looked to find a copper producer that combined our top-down thesis with stock-specific catalysts around a free cash flow inflection point. Capstone Copper was the ideal candidate as it is coming to the end of a period of substantial capex, with its Mantoverde Development Project now in the commissioning phase. Again, it has been a strong performer this year, but we still see significant upside.
The consensus view on gold is that it has been driven primarily by expectations of rate cuts. However, this is difficult to reconcile with that fact that gold has continued to rally despite rate cut expectations being pushed out. We believe that actions in China are a bigger driver of the gold price at present. In line with our view that China is actively seeking to remain export competitive by debasing its currency, the People's Bank of China has been buying gold very aggressively. Crucially, it is doing so from a low starting point. Average gold positions in global central banks are around 15% of total reserves, compared to just 4% in China, giving scope for extensive further buying. This could be supplemented by retail demand, given potential forthcoming regulations to enable and facilitate Chinese individuals to buy gold. We have been adding to our gold positions, including AngloGold in the Global Emerging Markets strategy and OceanaGold in our more unconstrained products. The latter is a Filipino miner with a mid-teens dividend yield.
India: treading a tightrope between growth and value
India offers almost unparalleled long-term structural growth, but accessing this opportunity at a reasonable price can be a delicate balancing act. Our solution has been to scour some of the more overlooked but extremely compelling areas of the market, allowing us to build exposure whilst maintaining our valuation discipline. One example of a holding in our Unconstrained strategy is Cera, a leading producer of sanitary- and faucet-ware products such as sinks, taps and toilets. It is a play on the Indian property market, which has shown remarkable strength in recent years and offers a powerful opportunity over the coming decade in our view. As India's wealth levels increase, the demand for higher-quality housing stock should surge, creating tens of millions of new homes. Since COVID, property pre-sale numbers have been very strong – a clear indication of future demand for building materials. However, given the length of development projects, completions are yet to show the same acceleration, leaving Cera to be overlooked by many investors. Materials used earlier in the project cycle, such as cables and wires, have exhibited rapid growth in recent quarters. Looking ahead, products used closer to completion should enjoy similar growth. Sanitary-ware producers such as Cera should therefore be major beneficiaries at this point in the cycle. The investment thesis is one of sustained mid-teens (or better) revenue growth, compounded by margin improvement, partly as a result of premiumisation. When comparing Cera's valuation to its peer group, we believe it stands out as an attractive long-term opportunity to capitalise on India's housing boom. We also continue to maintain our long-term overweight position in banks, which we believe offer a combination of strong structural growth and value in an Indian context.
LatAm ecommerce: a classic EM story
Ecommerce infrastructure is far less developed in LatAm than in Asia, and we see a compelling opportunity to capture the rising middle-class and its increasing purchasing power. Mercadolibre is the largest ecommerce player in Brazil, Mexico and Argentina. It is also one of the largest positions in our portfolios. Mercadolibre has grown Gross Merchandise Value at 20-40% depending on the market, and we believe that such expansion is sustainable, given the underpenetrated nature of ecommerce across LatAm. The company also has further scope for growth in its FinTech division, mostly notably opportunities in consumer credit and unsecured lending to SMEs. We see it as a strong compounder that trades at a very large discount to its own history and peers.
As can be seen, we are currently finding many compelling investment ideas that are diverse in terms of geography, sector and factor. However, they share one thing in common: all represent opportunities where strong top-down and bottom-up catalysts coalesce. Integrating top-down and bottom-up analysis is a cornerstone of our investment process, and we therefore remain extremely optimistic for the rest of the year and beyond.
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