In the world today, China and emerging market inflation problems still loom large in the consciousness of global investors, but these have been somewhat overshadowed as European countries have wobbled on the brink of bankruptcy and uprisings have broken out in Middle Eastern countries.Drummond Brodeur, global strategist for CI Funds and Signature Global Advisors says the challenges faced by Greece, Portugal, Spain and others are economic, “but politics are going dictate the solution.” A report put out earlier this year by analyst and author, George Friedman, sheds light on just how this would happen:
If pushed, “both Ireland and Greece and the others will choose bankruptcy and default as the most rational solution to their problems because they’re going to regard a European bailout as carrying too much political cost,” he writes. “I’m not predicting it will happen, but if the Germans get extremely aggressive in trying to set rules for these countries, their calculation is not simply about paying off the debt, it’s also about keeping their sovereignty.
“Managers though, say this uncertainty has already been priced into the region’s stock prices. Chuk Wong, Dynamic Funds vice president and portfolio manager, points out that markets suffered a global selloff last year when Greece ran into trouble. Last November when Ireland followed suit there was a regional selloff but when Portugal blew up earlier this year, markets barely blinked. “It was more like a non event,” he says. “There wasn’t a global or regional selloff.” Today, he says he’s paying close attention to the region and looking for a reason to buy, not for reasons to stay away.
Although he has a very different investment style, Mackenzie Financial senior vice president, Mark Grammer has similar views of the economic landscape and the markets in which he and Wong both invest. “I’m not that concerned about Europe,” he says. “I think the U.S. is the one you need to be concerned about.”
Quantitative easing measures (QE2) in the United States are set to end in June this year. When that happens, Mr. Wong points out that there is a chance credit ratings services could downgrade the U.S. sovereign rating. Although he doesn’t think there is a high probability of that happening, it is a possibility that could surprise investors. “The market seems to be a little bit complacent. I think the market doesn’t believe that the U.S. sovereign rating will be or could be downgraded,” he says. “That could be a surprise.”
Mr. Brodeur, meanwhile, is cautious about currency-related politics: “You’ve really got to watch the currency reform process taking place in China today,” he says. “The rest of the world is trying to get off the U.S. dollar standard. That is not well understood here. It will take several years but we’re talking three to five years, not 10 to 20.”
When investing, Mr. Wong says emerging market banks are good proxies for a country’s underlying economy. He prefers to invest in shares directly, rather than make indirect investments in more established companies that have exposure to emerging market growth. Mr. Grammer’s portfolio, on the other hand, includes a large number of companies based in other parts of the world which benefit from emerging market demand.
Both managers are overweight in Asian equities but Mr. Wong leans more towards investing in emerging markets, saying equities there are cheap and offer faster growth relative to the other options out there. “They’re traded at a discount to the U.S. and to other global equities.”
He says United Kingdom equities are also cheap. “We can find value opportunities there but it’s not a country or macro call,” he says. “The UK economy is still very sluggish.”
Overall, he is currently overweight in financials, banks in particular, and in the industrial sector. He is currently underweight in healthcare and utilities but says this is simply the result of stock selection. “We find better opportunities elsewhere.”
In addition to being underweight in U.S. stocks, Mr. Wong is also underweight in Japan, trimming his exposure there to almost zero, even before earthquakes shook the country back in March.
“Japan is just not that exciting,” agrees Mr. Brodeur. “There are some long-term structural issues there that will be hard for them to overcome.” Plus, he says, cheap isn’t good enough in Japan. “You have to understand that Japanese companies are not run on behalf of shareholders. You have to apply a discount until management teams demonstrate that they’re going to deliver that value.”
Unlike others, Mr. Brodeur’s teams start with the macro view before different sector managers go about selecting stocks. Currently his group is overweight in healthcare, a sector he says has been completely unloved for about a decade; overweight in industrials and underweight in utilities.
He says he is primarily concerned about regulatory oversight issues in the utilities sector, combined with slower growth in the developed world that stops companies from passing through their higher costs to consumers.
Although it will be interesting when data plans take off in emerging markets the way they have in the developed world, his group is also underweight in the telecommunications sector, thanks to a slowdown in the rollout of smart phones, increased competition and data plans that are still a little too expensive.
He also says “the notion that the internet should be free for everyone and no one should have to pay for it” is also becoming a bit of a problem. “Massive capital is required to handle the amount of data that is trying to flow out there. The statistics are just absolutely staggering – Blackberry devices alone send 1.3 billion emails a day. The amount of data and capacity that you need is just mushrooming. Someone’s got to pay for that.”
Across the board, managers say the Middle East is a risk and a wildcard that could impact investments going forward. Mr. Wong even says some events playing out in the Middle East could be as significant as the fall of the Berlin Wall in the late 1980s.
“We’re talking about major events across a whole region. That has a fundamental impact, not to mention that if there is any more uncertainty, it’s going to have a strong impact on the energy sector,” he says. “My concern is whether the tension will spill over to, say, Saudi Arabia or Iran, which are the two major oil producing economies of the world.”
Mr. Grammer adds that oil prices over $100 can drag significantly on the global economy. Its effect on inflation in emerging markets and Asia in particular “has been a concern for investors which has lead to underperformance relative to the developed markets so far this year,” he says.
Dan Hallett, vice president and director at HighView Financial Group and Salman Ahmed, fund analyst at Morningstar Canada are both charged with the task of analyzing the different managers who work in this environment. Both say fees are a good place to start filtering the funds available. “A lot of funds in the global equity category can be a little more expensive, just because they have the global name on them,” says Mr. Ahmed. Mr. Hallett, meanwhile, says he’s generally not interested in any fund with management expense ratios coming in over three per cent.
Mr. Hallett also sounds a cautionary note about style diversification and about diversification in general, saying managers tend to stick to their own particular style or specialty. Too much of one or the other can cause a client to be over-invested in value stocks or growth stocks. Similarly, they say it’s also important to avoid overlapping investment in certain companies that might be included in a global fund and one invested in U.S. or Canadian equities as well.
Finally, Mr. Ahmed says it’s worth paying attention to whether or not a manager is sticking to their strengths or skill set. “Maybe they’re not very good at managing currency but they take currency bets in their portfolio…We have to look at the manager’s strengths and where they’re making their stock selections.”