October Overview

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

Overview

Emerging markets recorded mixed results in October. This led the MSCI Emerging Markets index to end the month virtually unchanged. Year-to-date, however, emerging markets were still up 65% in US$ terms. Most Eastern European markets continued to record positive returns while stronger regional currencies supported performances in Latin America. In Asia, however, with the exception of China, Malaysia and the Philippines, most markets ended the month lower. China was among the strongest emerging market performers as concerns of policy tightening subsided and the economy continued to record robust growth. In Eastern Europe, Poland and Russia were the top performers. The South African market, on the other hand, ended the month with a 1% decline in US$ terms.

Regional Update

Asia

GDP growth in China accelerated in the third quarter of 2009 as the government's stimulus measures and robust bank lending continued to boost economic recovery. GDP grew 9% y-o-y during the third quarter, compared to 8% y-o-y in the second quarter. Consumer prices declined 1% y-o-y in September, less than the decline in August, partly due to higher food and beverage prices. Russian Prime Minister Vladimir Putin visited China where he met President Hu Jintao to discuss plans to improve co-operation, especially in areas such as energy, technology and culture. As a result, Russia and China signed deals worth US$3.5 billion. Moreover, Vietnamese Prime Minister Nguyen Tan Dung met his counterpart in China during the month where both leaders agreed to initiate measures to increase bilateral trade, economic and investment relations.

Exceeding market expectations, the South Korean economy grew 3% q-o-q in the third quarter of 2009, the fastest in more than seven years. Growth in the manufacturing and capital sectors coupled with stimulus spending and record low interest rates supported the domestic economy. Aimed at improving bilateral relations, Minister of Foreign Affairs and Trade, Yu Myung-hwan visited Vietnam in October. Both sides agreed to increase dialogue to develop mutual understanding and further expand political, economic and cultural relations.

Latin America

In Brazil, the victory of Rio de Janeiro as the host of the 2016 Summer Olympics will make it the first South American city to host the games. Preparation for the games is expected to further boost the country's economy recovery. Significant investment in areas such as infrastructure, construction, transportation as well as tourism and hospitality is expected. Retail sales remained resilient with sales increasing 5% y-o-y in August. This followed a 6% y-o-y growth in July. The food and beverage, pharmaceuticals, cosmetics and office equipment sectors continued to record strong sales. Inflationary pressures continued to ease with prices reaching its lowest in nearly two years and within the Central Bank's target. Consumer prices rose 4% y-o-y in September. The government announced the implementation of a 2% tax on capital inflows into portfolio investment. The tax is primarily aimed restraining the strength of the Real and curbing speculation in the country's stock and bond markets.

Mexico's Lower House of Congress approved the government's fiscal package, however, not before making several tax modifications. These included the rejection of a 2% consumption tax and a reduction in the 4% tax on telecommunications services to 3%. Plans included a 1% increase in the current sales tax to 16%, increase in income tax for high earning individuals and businesses to 30% in 2010-12 and higher levies on beer and tobacco. The new fiscal package is expected to result in a deficit totaling 1% of GDP for 2010. Inflationary pressures continued to ease with consumer prices increasing 5% y-o-y in September, its lowest in more than a year. This was mainly due to lower transportation and housing costs.

Africa

The South African government intends to implement plans to increase spending in infrastructure and social security despite the global economic crisis as the extra expenditure could support domestic demand and stimulate economic recovery. The economy is expected to return to growth in the fourth quarter of 2009 or 2010 due to greater global demand for commodities, a recovery in domestic demand and the 2010 World Cup. GDP is forecasted to grow 3% y-o-y in 2010. Inflationary pressures continued to ease, with consumer prices reaching a two-year low of 6% y-o-y in September.

Europe

The Russian economy grew 1% q-o-q in the third quarter of 2009, returning to growth for the first time since the second quarter of 2008. Government stimulus measures, favorable external conditions and lower interest rates supported the country's economic recovery. The government expects GDP to grow about 2% in 2010. The Central Bank maintained an expansionary monetary policy in October as efforts to stimulate the domestic economy continued. The benchmark interest rate was cut by 50 basis points (0.5%) to 9.5%. The Bank has cut the rate by a total of 350 basis points (3.5%) since April 2009. Inflationary pressures continued to ease, reaching a two-year low of 11% y-o-y. Prime Minister Vladimir Putin visited China where he met Chinese President Hu Jintao to discuss plans to improve co-operation between the two countries, especially in areas such as energy, technology and culture. Russia and China signed deals worth US$3.5 billion.

The Turkey Central Bank maintained an expansionary monetary policy in October to support the domestic economy. The Bank cut its benchmark borrowing interest rate by 50 basis points (0.5%) to 6.75%. Inflation continued to ease with consumer prices increasing 3% y-o-y in September, well below the Bank's year-end target. Recent data also showed continued improvement in industrial production with output declining 6% y-o-y in August, a significant improvement from the 9% contraction in July and 24% y-o-y fall in February 2009.

FEATURE OF THE MONTH:
TAKING A CLOSER LOOK AT THE RUSSIAN MARKET

During 2008, Russia was among the weakest stock market performers in the emerging market universe, losing more than 70% in US$ terms. But this year, the market has staged an impressive rally surging nearly 100% in the year-to-October period. The Russian market is among the cheapest in the emerging market universe and is trading at a discount of around 50% to its counterparts.

Today, Russia and many other emerging markets are now being driven by an excess in money supply in the international markets which means that these markets are experiencing an inflow of money for investments. Consequently, as Russia was more depressed than other markets, the upside is greater. At Templeton, we continue to find attractive opportunities in most sectors despite the recent rally as valuations remain undervalued. The Templeton Emerging Markets team continues to study individual companies and maintain a long-term investment outlook. Of course general factors such as trends in regional consumer expenditure, commodity prices and corporate governance policies are also taken into account.

We believe that Russia's equity markets are poised to climb significantly higher because even among Russia's blue chips you can still find undervalued stocks relative to global and sector peers. Take for example, Gazprom and Lukoil. Gazprom is the largest producer of gas in the world by reserves and production. The company's reserves account for nearly a fifth of the world's supply. It is also the biggest gas supplier to Europe and makes up for a majority of the gas production in Russia. Its valuations, however, remain extremely attractive with a P/E of just 4.5x and P/BV of 0.9x.

Lukoil is the second largest vertically integrated oil company in Russia and one of the largest in the world in terms of reserves. The company is engaged in exploration, development, production and refining of crude oil and marketing and distribution of crude and oil products. Lukoil is also trading at very attractive valuations with a P/E of 5.3x and P/BV of 1.0x.

However, there are still risks involved with Russia. The short-term risk is a downturn in money supply and a political event which could impact market sentiment while in the longer-term, it is a change in government attitudes towards privatisation and a market economy.

There are some sectors that we prefer over others within Russia. At the moment we like commodities and in particular the oil companies. We also like consumer sector given that it is a growing market in Russia. In particular we are finding good value in consumer products and distribution companies.

In general, our long-term outlook for Russia remains positive. The country has the world's third largest foreign exchange reserves at more than US$400 billion. Meanwhile, inflation has been trending down and due to timely and adequate support from the government to the domestic banking system, a new equilibrium for the Ruble has been established. As a result, the authorities were able to cut interest rates. Moreover, Russia owns large proportion of the world's natural resources and many of the country's commodity companies are among the world's low-cost producers.

Last but not least, it is interesting to note that based on current valuations, the Russian market is among the cheapest in the emerging market universe. With Price to Earnings (P/E) of just 9.8x and a Price to Book Value (P/BV) of just 1.2x, the Russian market is trading at a discount of about 50% to its emerging market counterparts. This gap should eventually narrow, which is why we believe that Russia could outperform its emerging market peers in the future. In addition, Russia is also trading at a discount to its BRIC peers (as represented by the MSCI BRIC index), which have a P/E of 15.8x and P/BV of 2.2x. Thus, the Russian market has significant upside potential and remains an attractive investment destination.

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: 9 November 2009