August Overview

Mark Mobius, Ph.D.
Executive Chairman,
Templeton Asset Management Ltd.

Overview

Emerging markets recorded mixed results in August and the MSCI Emerging Markets index ended the month virtually unchanged. Year-to-date, however, emerging markets were still up 51%. While Eastern European and Latin American markets continued to record positive returns, Asian markets, as represented by the MSCI AC Asia ex Japan index lost 3%. Concerns of policy tightening in China dragged regional markets down. Thailand, Pakistan and South Korea, however, bucked the trend and recorded positive performances in August. Eastern European markets benefited from lower interest rates and subsiding credit crunch worries. South Africa outperformed its emerging market counterparts with a 6% return in US$ terms. In Latin America, Argentina and Mexico were among the top performers.

Regional Update

Asia

Dispelling policy tightening fears, Chinese Premier Wen Jiabao stated that the government would maintain its current macroeconomic policy to ensure continued growth in the domestic economy. The Central Bank also announced that monetary policy would remain moderately loose to support growth. Foreign direct investment (FDI) inflows declined 36% y-o-y to US$5.4 billion in July. This brought the year-to-July total to US$48.4 billion. Fixed asset investment, however, jumped 34% y-o-y in the first half of 2009. Retail sales increased 15% y-o-y in July largely due to greater demand for automobiles resulting from government initiatives. Boosting trade and economic ties between China and Pakistan, Pakistani President Asif Ali Zardari visited China in August where the two countries signed eight Memoranda of Understanding (MoU) in sectors such as energy, agriculture and healthcare.

Bank of Korea Governor Lee Seong-tae maintained a positive view on South Korea's economic growth. While some uncertainties remained, Lee expects the economy to record positive q-o-q growth in the latter half of 2009 in part due to a recovery in the private sector. The Bank also maintained its benchmark interest rate at 2%, a record low, to support the economy. Inflationary pressures continued to ease with consumer prices rising 2% y-o-y in July, its lowest in more than nine years. During the month, the government announced plans to privatize or merge 41 state-owned enterprises. Government stakes in companies, which were supported by public funds during the financial crisis, are also expected to be sold this year.

Latin America

In Mexico, GDP contracted 10% y-o-y in the second quarter of 2009 as a result of the global economic crisis and swine flu outbreak. In comparison, GDP fell 8% in the first quarter of the year. Declines in the manufacturing, construction and retail sectors had negatively impacted GDP during the period. Mining output, however, posted a positive growth after declining for more than two years while the primary sector grew 1% y-o-y. Leaders from the U.S., Canada and Mexico gathered in Guadalajara, Mexico during the month for their annual summit. While the importance of continued dialogue was stressed to ensure economic recovery, no major agreements were reached.

The International Monetary Fund (IMF) commended Brazil's strong macroeconomic foundation which allowed the country to "increase its resilience to the global economic crisis" and maintain financial stability. The organization also remained confident of Brazil's banking sector. Credit growth has been improving with bank lending recording positive monthly growth in the last four consecutive months. This brought the year-to-June growth in Bank lending growth to 20% y-o-y. Elsewhere in the economy, industrial production continued to record positive m-o-m growth for the sixth consecutive month in June. Automobile manufacturing output, however, declined 1% m-o-m in July.

Africa

The South African economy contracted 3% q-o-q in the second quarter, its third consecutive quarterly decline. It was, however, a significant improvement from the 6% q-o-q contraction in the first quarter of 2009. The manufacturing, wholesale and retail trade and hospitality sectors were the major culprits. Conversely, growth in construction and mining activity, ahead of the upcoming 2010 World Cup and a recovery in Chinese demand for commodities, had a positive impact on GDP. Signaling the likelihood of improved relations between the U.S. and South Africa, U.S. Secretary of State Hillary Clinton visited South Africa in August where she also met with President Jacob Zuma.

Europe

Russia's GDP declined 11% y-o-y in the second quarter of 2009. This compared to a contraction of 9.8% y-o-y in the first three months of the year. Major reasons for the economy’s performance included weak external demand, investment and consumption. More recent data, however, showed continued improvement in industrial production with output increasing 5% y-o-y in July, higher than the 5% y-o-y growth in June. In an effort to cut public expenditure, the Russian government announced plans to freeze public sector wages and subsidies in 2010. A budget deficit of 8% of GDP is expected for 2010. Russia and Turkey signed energy agreements as well as a customs accord to improve trade relations while Russia has also approved a nuclear energy deal with Turkey.

The Turkish Central Bank maintained an expansionary monetary policy in August to support the domestic economy. The Bank cut its benchmark borrowing interest rate by 50 basis points (0.5%) to 7.75%. Inflation continued to ease with consumer prices increasing 5% y-o-y in July, lower than the 6% y-o-y in June and below the Bank’s 8% target for the end of the year. Turkey and Russia signed energy agreements as well as a customs accord to improve trade relations while Russia has also approved a nuclear energy deal with Turkey.

FEATURE OF THE MONTH: THE ATTRACTION TO EMERGING MARKETS

More than 20 years ago, investors were introduced to an alternative equity investment opportunity to the prevalent developed markets such as the U.S., U.K. and Japan. In 1987, the concept of an "emerging market" was new with limited investment opportunities. The situation has since changed dramatically.

Emerging market equities have increasingly become significant alternatives for the international investor. Investors are being drawn to an arena, which on one hand, appears to be attractive for investment because it offers potentially higher returns, but on the other, proves challenging by exposing them to different risks and opportunities. However, as the search for above average returns continues, there has been a significant increase in the amount of funds being channeled into this emerging market asset class.

Since 1995, portfolio inflows into emerging markets have totaled more than US$123 billion. A significant amount, considering it includes the US$49 billion in net outflows in 2008 as a result of the global financial crisis. The recovery in emerging markets and hunt for attractive investment opportunities, however, saw these funds return just as quickly with inflows totaling more than US$44 billion in the first seven months of 2009, nearly 90% of the outflows registered all of last year.

Emerging markets offer a number of important advantages and there are very good reasons why investors should adopt a positive long-term view of emerging markets. Most important, while global growth has slowed, emerging markets are still expected to grow at a much faster rate than developed markets. In 2010, emerging markets are forecast to grow at an average of 4%, compared to no growth in developed markets.

Although the slowdown in the global economy has had an impact on emerging markets, emerging economies are becoming more domestically driven. Government expenditure in areas such as infrastructure as well as private domestic consumption will, at least partially, offset the decline in growth resulting from slowing exports. The services sector has also been gaining in importance, especially in China and India.

Another important factor contributing to the growth in emerging markets is the emerging market consumer. We have been stressing the importance of emerging market consumers since there are more of them: over one billion each in China and India, for example. Emerging markets account for more than 80% of the world’s population. With economic growth accelerating and population growth decelerating, per capita income is one the rise. In our view, markets such as China, India and Brazil stand at the front of the class.

Looking at the stability and safety of emerging markets it is important to note the accumulation of foreign exchange reserves which puts emerging economies in a much stronger position to weather external shocks than say about ten years. Foreign reserves, for example, in China are the largest in the world, totaling more than US$2 trillion. As of end-April 2009, total foreign reserves in all emerging markets totaled US$4 trillion, while developed markets reserves stood at only US$2.5 trillion. This is in marked contrast to ten years ago when developed markets had US$1,100 billion, almost double the reserves of emerging markets, which were US$668 billion.

Most important for value investors, the current valuations of emerging markets remain more attractive than developed markets. As of end-August 2009, the benchmark MSCI Emerging Markets index had a P/E of 16 times, cheaper than the MSCI World index which was trading at a P/E of 21 times. Selective markets such as Russia and Hungary are down to single-digit P/Es, making them especially appealing.

In addition to emerging markets, we think frontier markets are looking interesting and could become tomorrow's emerging markets. We opened offices in Vietnam and Dubai in the last few years to allow us to capture the exciting opportunities in the Middle East and Mekong River regions. Additionally, the frontier markets of Slovenia, Romania, Croatia, Kazakhstan and Ukraine are also beginning to look interesting.

While the global economic crisis did interrupt some of the emerging markets growth momentum, we expect the long-term growth of emerging markets to continue. Although we are optimistic about the markets' upside potential, it is important to realize that volatility is still with us and will be with us for a while. From an historical point of view, current valuations remain below their peak and are not excessive. As such, we not only continue to find particularly good value in markets like China, Thailand, Brazil, Turkey and South Africa but also find opportunities in emerging markets globally.

Please click for more information on the following funds:
FTIF - Templeton Asian Growth Fund
FTIF - Templeton Asian Smaller Companies Fund
FTIF - Templeton BRIC Fund
FTIF - Templeton China Fund
FTIF - Templeton Eastern Europe Fund
FTIF - Templeton Emerging Markets Fund
FTIF - Templeton Emerging Markets Smaller Companies Fund
FTIF - Templeton Frontier Markets Fund
FTIF - Templeton Korea Fund
FTIF - Templeton Latin America Fund
FTIF - Templeton Thailand Fund

Posted: 11 September 2009