Beyond Bulls & Bears

The Winds of Market Change

As we cross the mid-way point of the year, you might say the equity and fixed income markets have been a lot like the recent weather in much of the world: uncertain, and tending toward extremes. The perception of a stormy economic climate has driven some equity valuations to extremely low levels, particularly in Europe, and investors have been pouring into fixed income despite extremely low yields.

For a temperature check of Europe and emerging markets, we turned to Dr. Mark Mobius, executive chairman of Templeton Emerging Markets Group, and Dr. Michael Hasenstab, co-director of Franklin Templeton Fixed Income Group’s® International Bond Department, for their long-term perspective on where shifts in the changeable economic climate could occur.

Mark Mobius

Mark Mobius

  • There’s no question the status of economies in Europe is weighing on the entire financial system, but my view is that the situation should get better with time.
  • Looking at companies around the world generally, we are finding valuations looking rather cheap right now.
  • Despite the possibility of somewhat slower growth in the Chinese economy this year, there are a lot of companies with what we believe are good valuations and good earnings growth potential in China.
  • In my opinion if Greece can privatize state-owned enterprises, collect unpaid taxes and reduce the size of the government, it should have no need to raise taxes.

As Mobius sees it, emerging markets are generally in a good fiscal position right now compared with some of the more debt-laden developed markets, and going forward, he believes economic growth rates in emerging markets should outperform developed markets.

“There’s no question that the status of economies in Europe is weighing on the entire financial system. Emerging markets have been reducing their exports to the U.S. and to the EU, although economic problems (in the U.S. and EU) going forward could still bear significant impact. Eastern Europe of course has been affected by what’s happening in the rest of Europe. We are finding a lot of the opportunities there from companies where valuations have dramatically wiped out, many unfairly, and provide opportunities for long-term holdings.

My view of the European situation is quite different from a number of economists. My view is that the situation should get better with time and as the Europeans solve their fiscal problems.  A case in point, of course, is Greece. Greece was originally part of the emerging markets realm until it joined the European Union, so we therefore have had some past experience investing in Greece. The challenge for the government now is to make some giant steps toward reform. This means privatization of state-owned enterprises that have been a drag on productivity and government finances, collection of taxes that are owed but not paid, and reducing the size of the government. If those three measures are taken, in my opinion there should be no need to actually raise taxes. Moreover, entrepreneurship should be encouraged. Greece has very strong tourism and shipping industries which I think can be the launching pad for growth in the future. 

Looking at companies around the world generally, we are finding that valuations look rather cheap right now. The price-earnings ratios of emerging markets averaged about 9.6 ( based on the MSCI Emerging Markets Index 12-month forward P/E), compared to a world index of 11.4 (based on the MSCI World Index 12-month forward P/E) and the U.S. average of 11.9 (based on the MSCI US Index 12-month forward P/E), as of July.1 The dividend yield average for emerging markets was 3.0%, while the world average was 2.9% and the U.S. was 2.2%, as of July, based on the MSCI EM Index, World Index and US Index.1 So, as value investors, our team has been finding lots of opportunities in these markets that we think should bode well longer term.

Despite the possibility of somewhat slower growth in China’s economy this year, there are a lot of companies in China with what we believe are good valuations and good earnings growth potential. Southeast Asian countries are also doing very well in our view, particularly Thailand, because the economy has been growing at a good pace and it is benefiting from China’s expansion.”

Some other markets on Mobius’ radar screen include places less adventurous investors may not even be considering right now.

“We believe taking a bottom-up, company-oriented approach is best because we can find opportunities in places other people are ignoring. We are excited about frontier markets, particularly Africa, because African countries have been growing at a fast pace. Of the 10 fastest growing economies in the world in the last 10 years to 2010, six of those were African.2 And in a country like Pakistan, which many people consider to be a very risky place, we are still finding opportunities simply because it’s so unpopular.”

Michael Hasenstab

Michael Hasenstab

  • Some of the markets that traded off pure contagion and ‘Armageddon’ fear have now begun to recover.
  • We see a lot of value in many emerging countries, but need to be cognizant of possible inflation risks longer term.
  • Emerging markets are probably the most vulnerable to the immediate inflationary impacts of massive global quantitative easing.
  • We don’t see value in the countries that are printing money and debasing the value of their currencies.

The Eurozone crisis whipped up quite a market storm this year, but Hasenstab has held steadfast in his belief that leaders there would find solutions, and that sky-falling forecasts were probably not warranted. He’s not ruling out more market chop for the rest of the year, but is seeing signs of calmer conditions.  

“I think the recovery has been somewhat apprehensive thus far and really has not returned full fair value to a lot of these markets, but clearly we are on that path. We still think there’s a long way to go, but just about 10 or 11 months ago we were in a period of much greater uncertainty. It was during that period that we really highlighted our long-term conviction that the eurozone wouldn’t split apart because the European Central Bank (ECB) ultimately would be the lender of last resort (despite ongoing problems in Greece), and that China’s growth rate would moderate but would not face a hard landing. As the year progressed, we saw increased evidence that those core convictions were holding. I think now we’re moving closer to further clarity that the ECB will likely prevent breakup of the Eurozone, and the key countries such as Spain and Italy are taking some steps to improve their long-term finances. The fact that ECB support will likely be conditional is good for two reasons: it can help prevent a vicious cycle and provides liquidity, and it provides some sort of fiscal discipline. This has given a bit of calm to markets and as a result, some of the markets that traded off pure contagion and ‘Armageddon’ fear have now begun to recover.

In a world where there are no risk-free assets anymore, I think one has to accept some degree of market volatility, but I think our ability to hold onto our long-term convictions and not panic, not flip around because of market volatility, has been beneficial.”

Turning our Doppler radar back to China, a market some predict is heading for a crash-landing, Hasenstab believes that, toward year-end, growth there should gain a bit more altitude or at least stay on a stable course. Structural changes in the economy are creating new challenges, he says, but notes China has “more powder,” should it need to engage in further stimulative measures. 

“In China, there are some very important long-term structural reforms that are underway. The reforms in China that began in the late 1970s are now entering their fourth phase. The first phase was the reform of the agricultural sector, the second phase was the reform of state-owned enterprises, the third was the opening of free trade, and this next, close-to-the-final phase would be the liberalization of the financial markets. It’s probably one of the most exciting phases of their reform, and if China can succeed in this—and we have every reason to believe that China should—it really has the potential to elevate China from a middle-income to a high-income country over the next decade or so.”

Like Mobius, Hasenstab sees value in many emerging markets right now. However, he’s cautious about taking longer-term interest rate exposures there because the easy monetary policies many central banks around the world have been engaging in for years could leave emerging economies vulnerable to trickle-down inflation.

“These emerging countries generally do not have the indebtedness problems that developed countries in general currently have, and even though their absolute growth is slowing on a relative basis, emerging growth rates remain much healthier than developed growth rates. There are exceptions, but by and large we see a lot of value in many of these countries, but we would be cautious that there are going to be inflationary risks. We think it’ll be good for currencies but we would be cautious about taking a lot of interest rate risk.

We have the Bank of England, the Federal Reserve in the U.S., the Bank of Japan, the ECB, the Swiss National Bank, all printing an unprecedented amount of money. Never in the history of central banks have we experimented with this amount of printing, and to think that there are no longer-term consequences would be naïve. Those effects may not be felt immediately, but ultimately the money that is printed in those countries will flow globally. Emerging markets are probably the most vulnerable to the immediate inflationary impacts of this massive quantitative easing.

On the currency side, we don’t see value in the countries that are printing money and debasing the value of their currencies—we continue to look for opportunities in countries which are not printing money.”

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What are the Risks?

All investments involve risks, including potential loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability, and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. Current political uncertainty surrounding the European Union (EU) and its membership may increase market volatility. The financial instability of some countries in the EU, including Greece, Italy and Spain, together with the risk of that impacting other more stable countries may increase the economic risk of investing in companies in Europe.


1. Source: MSCI Emerging Markets Index, MSCI Emerging Markets World Index, MSCI US Index, July 2012. Indexes are unmanaged and one cannot directly invest in an index. All MSCI data is provided “as is.” MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI. Past performance is not indicative of future results.

The price-to-earnings (P/E) ratio for an individual stock compares the stock price to the company’s earnings per share. (This figure is often calculated using trailing 12-month earnings, but some use forecasted earnings.) The P/E indicates how much the market will pay for a company’s earnings. A high P/E can indicate a strong belief in the company’s ability to increase those earnings. A low P/E indicates the market has less confidence that the company’s earnings will increase. 

The dividend yield is the sum of a company’s annual dividends per share, divided by the current price per share. It is often expressed as a percentage.

2. Source: International Monetary Fund; 2001-2010.

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