Four Horsemen of the Apocalypse, oil on canvas painting by Viktor Vasnetsov, 1887.

WEBINAR: Plague, War, Famine and the Fed.

By Fernando Assad, Gustavo Medeiros

This webinar was presented by Ashmore's Global Head of Research, Gustavo Medeiros, and Head of Active Equity, Fernando Assad. During this webinar they discussed how the four main headwinds for equities (in Emerging Markets) are fading and their view on where to be positioned.

Global markets had to deal with four very disruptive events in a short period of time. The Covid-19 pandemic (plague) increased geopolitical risks (war), shortages of goods, energy and food leading to rampant inflation (famine) and tighter monetary policy (Fed hikes).

Each of the events have discouraged investors from allocating capital to Emerging Markets, even though, in our opinion, most large Emerging Market countries navigated them better than initially expected. In this webinar we recap the global macro environment and discuss potential investment opportunities (themes) in Emerging Markets in each of the four events.

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Transcript is available below.


Ted Smith: Welcome to today’s webinar which is titled: Four Horsemen of the Macro Apocalypse and Opportunities in Emerging Markets. I'm Ted Smith, a member of Ashmore’s Institutional Business Development team, based in New York. Ashmore is a London-based asset manager specialising in emerging markets (EM) with over USD 64 billion under management in emerging market (EM) equities, fixed income and alternatives. Ashmore has a global investment team of over 100 professionals working from both London and offices that are located in the emerging markets themselves.

With me today are two key members of that team. Gustavo Medeiros is our Head of research. He's responsible for researching macro and political developments in the emerging markets. Gustavo has been with Ashmore since 2011, and before his current role, he managed both local and external debt for Ashmore. Also, we have Fernando Assad who is Head of our Multi Asset and Active Equity strategies at Ashmore. Fernando has been here since 2007, and in addition to managing our EM Active Equity portfolio is one of five members of our Investment Committee which oversees all global portfolios for Ashmore.

Today, Gustavo and Fernando will talk about four important macro events that have been a headwind for EM markets and valuations this year. In no particular order, the ‘Four Horsemen’ are:

  • Plague: that's COVID and its many variants
  • War: specifically, the war in Ukraine and conflicts elsewhere around the globe
  • Famine: scarcer resources, especially in poorer countries around the world
  • The Fed: everyone's favourite topic, the US Federal Reserve (Fed)

Moreover, Gustavo and Fernando will focus on how Ashmore is positioning our EM Active Equity portfolio to benefit from these events in the upcoming months. Today's discussion will be without written materials and we're hoping it will be interactive. Please submit your questions through the Zoom portal, and I'll pose them to Gustavo and Fernando at the end of their prepared remarks. With that, I'll hand things over to Gustavo to begin our discussion.

Gustavo Medeiros: Thanks Ted, for the introduction, and hi everyone. Thanks for joining the webinar. It's a pleasure to talk to you virtually again, it's an even bigger pleasure to have the lead portfolio manager of Ashmore’s Active Equity strategy, Fernando Assad, with us to discuss the key macro events that are shaping the economy, politics and markets. And most importantly, to understand how to position in emerging market equity portfolios, given these events.

You may be familiar with Ashmore’s house view, that we are in a very different macro environment today than we experienced over the last 40 years. From 1980 to 2020, investors benefited from a benign ‘Goldilocks’ macro environment, where GDP growth has been above trend, but inflation has been below trend. The social backdrop going into 2020 and the current events we’ll be describing mean that investors will have to learn how to build portfolios to withstand a much more volatile macroeconomic environment, as supply side constraints are leading to more elevated inflation across the world.

There are four structural reasons why inflation is likely to remain more elevated and we've been discussing these reasons in various places over the last few months. First, elevated indebtedness across the world was challenging G10 central banks’ abilities to keep monetary policy (interest rates in particular) at positive real levels. Second, policies designed to reverse inequality have been leading to higher purchasing power of the lower end of the population, which in the past – and today – have always driven higher demand for commodities. Typically, demand for commodities increased at a much faster pace than the ability of the increasing supply of commodities, hence much more inflationary pressure.

That’s happening against the backdrop of the energy transition, which is the third structural theme we’ve been highlighting for some time. The energy transition has been pushed at an accelerated pace after a decade of underinvestment in the energy space. The fourth element is more taxation and greater regulation across sectors that have been leading in terms of market performance over the last decade, and also been keeping inflation at relatively low lows. For example, technology and consumer discretionary companies that have been able to manufacture products at very cheap levels of the last few decades, thanks to globalisation, are now getting disrupted by the themes we’re going to discuss.

So, to return to the Four Horsemen theme of this webinar, plague came in the form of COVID-19 which hit in March 2020, we have War happening in Europe for the first time since the Second World War, alongside another arguably more important conflict – the cold war between the US and China – that is leading to de-globalisation and the changing of supply chain conditions. And we have Famine as a consequence of these wars, in the form of shortages of energy and agricultural product shortages, as well as potential shortages of industrial metals. Finally, the Fourth Horseman is major monetary policy tightening, led by the Fed – the most important central bank in the world today – which is accelerating or exacerbating market volatility. Historically, it's important to emphasise that all these four events have been past triggers for a shift in market leadership. We don't think this time is going to be different.

But Fernando, perhaps let us start with the first Horsemen of the Apocalypse, from the beginning of 2020. Many investors proclaimed that EM as an asset class would not survive the COVID-19 pandemic. Can you give us an update, particularly focusing on China?

Fernando Assad: Sure, Gustavo, thanks. And thanks, Ted, for the introduction and thanks everyone for tuning in and watching us. We appreciate it.

Within our travels, both virtual and real, over the last two years, we heard almost every three months that EM was going to ‘blow up’ because of COVID. Today that looks almost like outdated thinking, but since March 2020 China was under a significant version of its lockdown, Brazil had the Gamma variant, India had the Delta variant and South Africa had its Omicron variant. Every time there were discussions about healthcare systems being overwhelmed and a lack of ability to control the monetary and fiscal basis But net-net, we are hopefully out of the woods in the pandemic sense, moving from pandemic to endemic.

Gustavo, we looked together at EM primary fiscal deficits are back at 2019 pre-pandemic levels, they went from -3% to -7% in 2020, but are expected to be back at -3% or less by the turn of the year. In 2019, EM GDP growth was 3.7%, and now it is back at those levels in 2022. But what is not back at those levels are what we’re calling the general COVID discounts.

Looking at EM equities and developed market (DM) equities on a standalone basis, US equities are trading around 18 times forward earnings versus 18 times prior to COVID in 2019. China is trading at around 10.7 times versus 12 times prior to COVID-19. EM ex-China is trading at around 11 times forward earnings versus 13 times prior. So, the first big picture point I would highlight is COVID. Hopefully, it's almost gone out of our economic and healthcare systems, and becoming more like an endemic influenza, but the big risk premia is still there to be harvested when it comes to EM equities.

As you mentioned, China is still where there COVID is a significant, meaningful economic reality. We had that second big COVID scare in late February 2022 which resulted in the Shanghai lockdown, and this has taken much longer to dissipate that the 2020 lockdowns. But what is meaningful, particularly at the human level, is that deaths are at a minimum, and infections are much more controllable compared to the rest of the world. Plus, we're now also seeing concrete action to fight the pandemic from an economic standpoint. There has been a quiet, but very real, change to the zero COVID policies within China, including more localised lockdowns, closed loop production, and a more stable and productive way of handling things, which has improved the level of economic activity.

GDP expectations for China were around 5.5%, the magical target about a year ago. They're now at 3.5%. But without COVID, US GDP forecasts have moved from 4.3% to 1.6% over the last 12 months as well. On the cases themselves, we have hopefully experienced the last part of the latest mini wave. Seven-day moving averages for cases came down to 1,500 versus 2,000, and a big outbreak in the Hainan Province seems to have been contained. Not only that, but people travelling to different holiday destinations over the summer did not spread new infections around all the different provinces.

From an economic perspective, May and June saw a rebound from April and March lockdown levels, although July was a bit disappointing. We currently have around 28 cities with around 11% of the Chinese population in some kind of restricted mobility. But speaking to companies, the data for the next six months is supposed to be sequentially stronger than the last three months, and stronger than one year ago. So, China is definitely at a different stage of the cycle compared to the rest of the world. Last but not least, China has six mRNA vaccines on trial, and hopefully we will see some approvals in the next couple of months and we might be saying goodbye to COVID in China as well.

Gustavo Medeiros: All right, good. So, to summarise, lockdowns in China have been getting less stringent than what was seen in Shanghai and Beijing in the first two quarters of the year. And that's been positive. We've been seeing that in the data for the Purchasing Managers’ Index (PMIs) recently too. It's also going to be important to monitor as you pointed out, how China manages to contain the virus going forward. We’ve just seen a headline saying that the Congress Party is likely to start on the 16th of October in China. That's when we might get a new Politburo, significant fiscal stimulus to counterbalance the effects of the COVID-19 and to help the real estate sector, and hopefully slightly less stringent COVID-19 policies, because turning the page and closing this chapter is important.

Now, let's move to the second of our Four Horsemen, which is War. Obviously, this year we have had the tragic invasion of Ukraine by Russia. But the most important conflict of our generation is likely to be between China and the United States. China is defying the US political economic hegemony for the first time, and I think it could be characterised as a second Cold War. China and the West have been having conflictual relationships across several levels, including a trade war an economic war – including tit-for-tat war in the corporate space for different sectors of technology. But as yet, there has not been a physical war, which is very fortunate.

I like to tell investors that we have two very simple rules during times of geopolitical conflict or turbulence. The first rule is you want to buy neutral countries that are in a position to benefit from economic arbitrage from both sides of the conflict. In this respect we would

think about India, for example, which has benefited significantly from foreign direct investment from the United States and from US companies. We have just seen Apple announcing it will start producing iPhones in India, for example. At the same time, India is

buying very cheap energy from Russia, buying oil at a 30% discount to international prices.

And when you look into where these neutral countries are located, the vast majority of them are in emerging markets. Latin America stayed neutral across the First and Second World Wars, and historically Central Asia and the Middle East have been mostly neutral as well.

Our second rule is a little trickier. In our view, we don’t want to be trying to pick winners very quickly. Who will be the ultimate winner of the economic disputes between the US and China? It’s very hard to tell, and if you don’t know you shouldn’t put all your eggs in one basket.

But Fernando, please tell us how you’ve been positioning our equity portfolios in light of geopolitical events, and in particular given the recent visit of Nancy Pelosi to Taiwan.

Fernando Assad: Yes, absolutely. When we think about War within the Four Horsemen, really, we are talking about the whole multi-polar world thesis that is much bigger than just Russia and Ukraine. For us, the focus on China vs the US started in 2013-14, with China’s announcement of its ‘One Belt, One Road’ initiative. What can we do as active investors? We are top-down driven, so we focus on the more fertile macro environments and try to avoid what we call ‘volcano farming’. Also, we look at different countries and through into different industries from a tactical perspective.

In the case of Taiwan, after we heard about the US congressional visits, we tactically lowered exposure (due to us holding ultra-liquid assets). As volatility and concerns over the visit went up, we ‘faded up’ and increased our exposure during the actual event. Although we maintain our general neutral country exposure in Taiwan, we recognise there are big winners and losers out of the situation. For example, we took the opportunity to increase our overweight in the world's favourite foundry, and in semiconductors, 92% of the leading-edge chips come from Taiwan. Neither the US, nor the West in general, can live without those at the moment, not even China.

We're underweight the domestic Taiwanese stock market in general now, moving further away from Taiwan and thinking about the multi-polar world. There are definitely key beneficiaries of this new world order within EM, and the one I would highlight today is Mexico – particularly Mexican financials and retailers, which benefit from nearshoring.

Looking at the macro environment in Mexico, there’s already a more compelling case. Remittances have remained high at around 70%, wage mass is up 7%, and minimum wages are up about 70% over the last three years. Also, listed companies' revenues are growing at around two times inflation. Second quarter results are almost over, and it should be around 13% year to date. Having said that, a lot of risk premia surrounding COVID, and prior to that the Trump presidency, has been built in into Mexico, and this risk premia hasn't really come off yet, and is still there to be harvested.

Mexico used to trade at par with US equities, and the long-term average for both is around 15 times. Mexico trades around 11 times now. So, that’s a 30% to 40% discount to its own history, and to the US, its closest trading partner. We think Mexican banks and retailers are significantly benefitting from this, and will continue to do so in the future.

Gustavo Medeiros: Thanks, Fernando, a pretty good summary again. So just to point out, the key takeaways here: we're in a multi-polar world, and have been for almost a decade now. In that space, we need to be active, and we can take advantage of big themes and theses. Taiwan today is probably as important strategically as Saudi Arabia was in the 1970s, with its key leading-edge foundry, and semiconductor industry. Mexico, a key beneficiary of friendly nearshoring. So obviously, quite a lot to take advantage here in equity portfolios. Now, the third Horseman is Famine, which, in our particular world, is represented by the shortages of energy, fertilisers and food, and also, potentially, shortages of industrial metals, which are a consequence of the war between Russia and Ukraine, but also a consequence of the global macro picture that we discussed earlier. Is that a key theme that we can benefit from in emerging market portfolios, Fernando?

Fernando Assad: Yes, great point. Within the Active Equity portfolio, we have tried to build exposures, and have done so successfully over the summer. I think the famine point predates the Russia-Ukraine war, but the conflict just turbocharged this idea that really, the real world is quite small compared to the digital world that has been put into place and grown during the COVID years. As background, we have lower inventories of global commodities. JPMorgan puts all the inventories of all commodities together. They are now 64 days. They were 76 days, five years ago. So, it's not just a year situation. It was 70 last year. We look at inflation pressures potentially peaking, but what is not necessarily peaking is this significant transfer of wealth.

As investors, we look at aspects of the financial markets, and potential disconnects from the real world. The value of commodities consumed globally has gone up, from 6 trillion pre-COVID to 12.5 trillion now. That's a doubling of its percentage, as well as a doubling of world GDP, from 6% to 13%. That flow of funds is going to be going somewhere, primarily to the net commodity exporting countries. This is a delta very similar in magnitude to the '70s oil shocks that economists refer to. Energy, agricultural commodities and industrial commodities did suffer a correction in the second quarter, based primarily on the Shanghai lockdowns, and on higher volatility of global markets leading investors to reduce their positions. But we think the tide is turning again. There is a realignment of fundamentals and commodity prices, and we have managed to construct a portfolio to benefit from it.

Looking at portfolio construction in particular, we continue to avoid the tough macro environments. Therefore, no Central Eastern European exposure. The European Union (EU) still imports 61% of its energy from Russia. We still don't know how the EU is going to square that circle, but we do know who clearly benefits from it. As Gustavo mentioned, historically neutral countries have the best chance to navigate – and benefit from – these tough times. Net commodity exporters, including Saudi Arabia, United Arab Emirates (UAE) and Brazil have around a 5% positive commodity trade balance as a percentage of GDP.

If we look at the world right now in terms of GDP expectations and revisions, it has been generally dreadful, with GDP expectations coming down everywhere to -1% or -1.5%, except for Saudi Arabia, UAE and Brazil, which have had a +1% to +1.5% increase in GDP expectations over the last three months or so. But the market consensus and economic consensus has still refused to price this persistency of higher commodity prices into the future – we’re not seeing those upgrades come through yet. However, we’re seeing markets still expecting US/EU to achieve a soft landing of around 1% growth, and we think at least one of those is not going to come through. My final point here is that the general consensus has moved the other way. Because for Europe, the Middle East and Africa (EMEA), there are a lot of semi-passive investments out there. When the Russia-Ukraine conflict broke out, we saw EM outflows and EMEA outflows. This meant people actually sold down their Middle East exposure. The Middle East was probably the most interesting place to be globally to counter those commodity price-related risks. We saw global emerging market funds moving from a 5% underweight to a 5.7% underweight from the end of the year to March.

So, while we're not technical investors, we do look at market forces when they are extreme and try to take advantage. Right now, it's still an extreme situation. Around two-thirds of investors polled by emerging portfolios still have zero exposure to Saudi Arabia, while 90% of those investors are still underweight the Middle East. We think that fundamentals and valuations do not stack up with the current positioning, and we think most investors will be there, adding exposure to it, particularly because of such a solid earning season.

Gustavo Medeiros: Thanks, Fernando. Throughout the investor roadshows we've been doing, we’ve been highlighting that the supply chain issue in commodity sectors predates the war. And along with the direct impact you mentioned, the increase from $6 trillion to $13 trillion in the value chain of commodities, there is also a huge wealth effect, and a virtual cycle that typically follows on from these massive changes in terms of trade. It was very interesting that investors are still very underweight in large countries that are going to be generating a huge amount of wealth within these new macro environments.

Now, finally, we get to the last of our Four Horseman, which diverges from the biblical analogy. There was no Fed in those times, but the impact of the Fed’s decisions have gained a huge relevance since Bretton Woods. Today, it's almost impossible to talk about positioning portfolios without discussing the Fed, and determining the impact of Fed  tightening on the US dollar.

Back in late April we published some research that said we expected to be very close to peak Fed hawkishness, and that the Fed was about to try to hike rates much more than they were signalling back them. That’s precisely what we’ve been seeing since, and we still saw a  very hawkish message from Jackson Hole by Fed Chair Jay Powell, not only a sentiment shared by everybody from the Fed, but also from the European Central Bank (ECB) and the other major global central banks.

The 10-year US Treasury yield is still below the levels seen back then in April, when we put that piece together. So, with the yield curve flattening quite significantly as the market appreciates, this high indebtedness dynamic playing out with the monetary cycle, means that any hiking cycle today will have a much bigger impact on the economy than it had in the past. In a hyper-financialised world with too much debt (which has been the case since 2008), then, obviously, the impact on monetary policy becomes much more pronounced.

My key view here has been that we are close to a peak Fed, and a peak hawkish US narrative. But, Fernando, how are we seeing that? How are we playing? Try to enlighten us here in terms of portfolio construction again.

Fernando Assad: Both the Active Equity team and the Research team have done a lot of work together over the last few months, building some of our quantitative models to look at flattening inflation paths. I joke that my model is just a look at US gasoline, and everything else will come through, but that's exactly what we saw. A little bit of hope on the inflation side, and markets running with the perception that Jay Powell threw all of us a bone with the "we're now at neutral", whatever neutral means.

We discussed in our Investment Committee this morning, that we are probably somewhere around peak Fed hawkishness, but in terms of portfolio construction, it's all about sequencing. Returning to Jackson Hole, the term 'hole', is derived from early trackers to mean a large valley where it's very fertile ground to hunt. So, it's a good place to track both the market bulls and the bears at the moment. We think the pivot will come, but only after some lowering of US earnings expectations, and economic activity expectations as well.

So, from an overall active equity portfolio construction perspective, we're following Jay Powell's advice. He said at the turn of the year, the Fed plans to stay humble and nimble. That's what we plan to continue to do as well.

In these last few months of summer, we reduce our exposure back to zero, to the longest implied durations and high multiple stocks out there. We had some exposure that we built in into the second-quarter lows, and those have gone up 10%, 20%, 30%. We also reduced our pan-Latin and Southeast Asia internet companies exposure back to zero. We think it's still a tough global economic environment out there. Also, we increased a large underweight in Korea, in particularly in domestic Korea and exporters outside of semiconductors, which should suffer the brunt of developed markets' growth deceleration, which we think will come because those dollars will have to be used to pay for oil and natural gas and other energy inputs from the likes of Saudi Arabia and UAE.

The reason why we called the Fed one of the Four Horsemen was to refer to the biblical sense of a false prophet. We were not just picking on the Fed, but referring to policymakers in general, including China’s policymakers as well – who have finally stopped talking and started acting, which is key.

This is the most central point to emerging market equities, because the reason why emerging market equities are down 30% since the highs of February 2021, is not because of the Fed. It's because regulatory pressure, economic slowdown and zero COVID policy in China have driven down earnings.

But now, over the last few weeks, we have seen action from Chinese policymakers. On August 15th, the People’s Bank of China (PBoC) cut rates. Yes, only by 10 basis points, but it's likely we will see rates lower than the US within a month now. It’s also the first time the PBoC has cut rates since January. On August 16th, the premier talked with six major province officials to discuss maintaining GDP.

We are lucky at Ashmore, with our integrated approach, that we, Gustavo or myself can go to, on the same floor, our Corporate Debt team and discuss what are we really seeing in terms of China and real estate exposure. And while three, four weeks ago, our Corporate Debt team was saying there was no new news out there, now we're seeing some selected private real estate companies issuing debt with state guarantees at sub-5%. That's a type of debt that it is actually sustainable, from a medium-term perspective, and it’s the first time we’ve seen this in over a year.

On August 22nd, we had five-year loan prime rates cut as well. On August 23rd, the PBoC governor mentioned he had met with major banks. The last time this happened, credit growth spiked to 10%, 12%. While we are not there yet, we are inching towards a TARP-like local government fund worth around 200 to 300 billion Chinese yuan, that would be used to restructure some real estate projects. And through our Equity team, we're finally seeing evidence of lower mortgage rates, lower down payments and more purchase restrictions.

And then last Friday, the almost unbelievable happened. We had mentioned to some of our Active Equity investors that we had evidence the US and Chinese sides were talking still about avoiding American Deposit Receipts (ADR) delistings, and there was a chance that some compromise would be found. We also had the announcement by the US Securities and Exchange Commission (SEC) and the Chinese Securities Regulatory Commission (CSRC) that the auditors out of the SEC, will be allowed to go to China in September, and will be conducting some work on the Chinese auditor side. This should result in some feedback in December. So, we're not out of the woods there, but there is now concrete evidence that the two sides are working together to avoid ADR delistings, which is a good thing in terms of reversing some of that risk premium.

From a portfolio construction perspective, we’re no longer have a long-term underweight to China. We are neutral China at the moment. We think the companies that will benefit the most are the ones on the internet retail space, which have experienced a lot of headwinds from the regulatory resets, but are now on the other side of it. We think that over the next six to 12 months, these companies will be achieving 10%-20% earnings growth, and trading at a significant discount valuation to history and to their big peers in the US.

Gustavo Medeiros: Thank you, Fernando. Again, there's a lot to unwrap there, but if I can try to summarise very quickly. The Fed thinks it will be able to hike rates by a lot. But what is key here is to see how much they will actually be able to deliver. The market and leading economic indicators, as well as several internet companies and housing markets, are suggesting we're very close to peak hawkishness.

China, on the other hand, is experiencing a very different dynamic, easing fiscal policy, and is actually accelerating measures to shore up and to boost confidence in the real estate sector in order to arrest the current downward spiral. If you want to simplify emerging markets opportunities, think about global GDP growth, and China GDP growth is a very good proxy for that. Once China growth starts recovering, then that's a fantastic market environment for emerging markets. That's the opposite of what we had over the last 12 months, but I think we are in much better shape on a forward-looking basis.

Finally, the last point to discuss here is how EM ex-China has been very much ahead of the curve when it comes to monetary policy tightening and monetary policy adjustment. In my view, in 2021 we saw the most obvious policy mistake by global central banks for more than 25 years, since the beginning of my career.

Central banks were failing to hike interest rates when the global economy was overheating. We had several supply chain problems, and inflation was accelerating. It was quite clear to us, that inflation wasn't transitory. I think we might be in an environment where the Fed is forced to U-turn, which will be very hard to time correctly. But what is important, are the dynamics, which I think, are very favourable to emerging markets.

Finally, just to summarise the call, I think there's a very good chance we will be in a very different environment in the decades to come. Compared to the previous four decades of a Goldilocks environment. The four Horsemen mentioned in this call have in the past been very important catalysts for a change in market leadership. Whereas over the last 10 years or so, US stocks outperformed the rest of the world – and we’ve heard about US exceptionalism at length – today we have the exceptionalism of commodity exporter countries. As Fernando mentioned, countries that export commodities, are the only places where we had GDP growth revised higher in 2022. Fernando mentioned the Gulf Cooperation Council (GCC) countries and Brazil, but there are others like Indonesia, for example, that have benefitted. That suggests a very different macroeconomic environment.

Asset allocators typically take a long time to change their position, and to change their portfolios. However,  we think that within the next five to 10 years, we're going to see a very different shape of total returns. That is quite likely to favour emerging markets. So once again, these four Horsemen of the Apocalypse are, in our view, very likely to be bringing a change in market leadership again. So, thank you very much for your time. If there are any questions, Ted, I will pass over to you.

Ted Smith: Great. We did have a number of questions. I won't be able to get through all of them. But the first one relates to that energy theme: do you see opportunities that are in the energy sector, but also consistent with a climate-conscious portfolio?

Fernando Assad: I'll take that. Yes, we do. With a number of our EM corporates, we are discussing and engaging with them to make sure we're in the right direction from a climate perspective, and within our environmental, social and governance (ESG) parameters as well. If you don't want to invest directly in oil and gas, we focus primarily in looking at the countries that are key net beneficiaries of this commodities boom. As I mentioned, Saudi Arabia, UAE and Brazil are that. Outside of that, we have a high exposure to what we call the ‘green transformation’ and green infrastructure companies that are benefiting from the move into improving and optimising the electricity grid. We also have three or four companies, particularly in China A-shares, that we think are global winners there, and they are significant positions in the portfolio.

Ted Smith: Thank you. We did have questions specifically about two frontier market countries, and I know while frontier markets are not a huge part of your portfolio, they are something you do look at. Specifically, two very different countries: Vietnam and Ecuador, in light of your comments from today.

Gustavo Medeiros: I think Vietnam has so far benefited most from the change in the supply chain from China towards more friendly nations. So, if you look at total exports in Vietnam today, we're very close to South Korea and Taiwan levels, pretty staggering numbers. If you look at the data, total exports coming from Vietnam has been increasing quite significantly. Vietnam has been benefiting from a very stable macro environment, and they had a very similar beginning of the pandemic as China, but right now, they have much more laissez-faire policies, if you will. They are not trying to get to zero COVID or anything similar.

So, Vietnam is a key part of the new Asia-centred global supply chain. And for those saying we’ll see the death of globalisation as a result of this second cold war between US and China, my response is that this is not really a death of globalisation, but more of a rejigging. Vietnam is a key beneficiary, alongside Mexico, and alongside other frontier economies like Bangladesh and other emerging market countries such as India as well.

Ecuador is a Latin American country, and they are net exporters of oil and of agricultural product. So, they have favourable terms of trade. Ecuador has also been  benefiting from a centre-right president, Guillermo Lasso, who won the presidential election two years ago, on his four or fifth attempt. Lasso is a former banker from Guayaquil, and has been implementing a very liberal economic reform-based approach.

Ecuador is a dollarised economy, so it's been struggling significantly over the last 10 years with a strong dollar environment. They're in a straitjacket, whereas all other emerging market countries have been devaluing their currencies, Ecuador’s economy has been at much lower productivity levels. We think Ecuador could benefit if the dollar sells off from here. Importantly, Ecuador started a VAT restructuring about a year-and-a-half ago, which means it has very little debt repayments to make over the next three to five years. So, Ecuador is very different than other EM frontier economies and smaller economies that suffered more as a result of the pandemic and as a result of the Fed hiking. In our view, Ecuador has a pretty decent, path ahead as an opportunity to invest in the frontier space.

Ted Smith: We only have about three minutes left, so I'll give some quick questions. Let me just ask Fernando, specifically, what do you think the rest of the market is getting wrong about China?

Fernando Assad: I think with China watchers you see this type of thinking time and time again. Every few years, everyone is super-negative about China, that China is going bust, and the GDP forecast will go close to zero, leverage is too high and so on. What tends to be forgotten is despite there only being one party in charge, there's currently a significant leadership change going on. Not quite at the top, but where everyone else is trying to understand which positions they’ll move to. That's normal in DM and EM elections. Once the dust of a political event settles, people come in who are trying to do the best to keep moving ahead in their political careers. The head China’s economy, Premier Li, is most likely retiring. So, the next premier will most likely want to show results straight away. I think we shall see a front-loading of measures to get the Chinese economy back to a healthier status. What’s different to past periods is that the valuations do not reflect that.

Ted Smith: Great. Thank you. I'll make this the final question, because of time, and I apologise to those who I wasn't able to get to. I'll direct this one to Gustavo. We'd like to understand where the tipping point might be for EM equity beginning to outperform DM equity – specifically US equity. And if you could, just mention a specific date.

Gustavo Medeiros:  I won't give you the date, because I don't know. But if I had one question to ask the genie in the bottle, I would ask “tell me what will happen with the US dollar”. The US dollar is the reserve currency of the world, and when the dollar is strengthening, that is a massive headwind for the rest of the world. And when the dollar is weakening, that typically eases liquidity conditions and increases capital availability for the rest of the world.

So, my best framework for change in market leadership is that it will come once the dollar starts depreciating against other currencies. So far this year, the dollar has been strengthening, not due to the fact that the US has better macroeconomic conditions than the rest of the world. It's not even that The Fed is more hawkish – everywhere else has turned more hawkish this year. The fact is that the US is the only one of the large economies that is a net exporter of food and agricultural products.

So, between Europe, China, Japan and the United States, the US is the only economy that is self-sufficient, thereby benefiting from its terms of trade. But the problem, on the other hand, is that the US has been running with a massively imbalanced picture for a long, long time. Right now, the current account deficit is approaching 5% of GDP, for example. That, everywhere and anywhere, in the past, has been a key leading indicator for currency weakness. The US has $17 trillion of net liabilities versus the rest of the world, which is more than 70% of US GDP.

Right now, there are better places to take advantage of terms of trade than the United States. The US energy exceptionalism is likely to be short-lived, particularly if it starts exporting energy to Europe, which is a key part of the commitment they've made on the Ukrainian framework. I won't put a date on it, but I think all indicators suggest it's a matter of time.

Fernando Assad: I will put a date on it. I think it's November and December. I think it will stem from a combination of the Chinese policy stance getting even stronger and the Chinese credit impulse, which is the leading indicator of the world. By then, we can all calm down about the Fed because it will be clear that rates will be peaking at somewhere between 3.5% and 4%. Then we can all go back to looking at the day-to-day macro and micro fundamentals, with earnings perhaps growing at double digits again in China, driving EM earnings up.

Ted Smith: Fantastic. So, let me thank both Gustavo and Fernando for their time. Thank you all for attending the webinar. I know we had a lot of participants today, and we hope to talk to you soon when we find out whether some of these predictions have come true for us. Take care.

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