Good afternoon everyone. My name is Erica Kay, Head of Value Add Programs at Macquarie Investment Management. On behalf of our team, I'd like to welcome you this afternoon to our third quarter Capital Markets Coaching Clinic event. Today, we'll hear from a panel of our emerging market investment special.
Now, we'll get started. Our discussion this afternoon features a panel our investment experts who focus on emerging markets. Combined, our group has over 50 years of investment industry experience. To meet our panel, I'll turn it over to today's moderator, my teammate on our strategic marketing team, product manager Devin Dougherty. Devin?
Hi everyone. This is Devin Dougherty again and today I'm going to be moderating the call. And I just want to thank everyone for joining us as we talk about everyone's favorite asset class lately emerging markets. As the title notes, what we're looking to do is provide a fresh perspective on today's headlines. So what are we seeing in today's headlines lately? We're seeing Turkey, Argentina, currency volatility, China, trade wars, tariffs. It really could be forgiven for thinking that emerging markets was near the brink of collapse. So today what we're going to do is we're going to hear from three Macquarie Investment professionals that are experts on emerging markets as we attempt to look past the headlines, past the noise and the confusion, and give our insight onto what's going on in these emerging markets. It is worth noting that each of these speakers today they come from completely separate investment teams. They have their own separate views, their own separate opinions, their own separate insights, so it should be a good conversation. First, we have Dan Ko. He's based in our Boston, Massachusetts office. And Dan's a Senior Analyst for our Emerging Markets Equity Team and the Delaware Emerging Markets Fund. His area of coverage is in Eastern Europe, the Middle East, Africa, as well as financials. Second, we have Gabriel Wallach. Gabriel's based in our San Diego office. And Gabriel's a Portfolio Manager for Global Ex-US Equity Team. And they manage the Delaware International Small Cap Fund. They also manage an Emerging Markets Small Cap strategy and Emerging Markets Opportunity strategy. Gabriel has a varied background, but spent a significant portion of his career focused on Latin America. And lastly, we have Mansur Rasul. He's here with me in Philadelphia at our headquarters, and Mansur is our Fixed Income Team and he's a Portfolio Manager for the Delaware Emerging Markets Debt Fund. In terms of today's format, we're going to be doing a Q And A, and we're going to focus on three broad topics. First, what's going on in emerging markets. Two, what it means for emerging markets longer-term. And three, is this an opportunity for investors? So without taking up any more time, let's kind of dive into the conversation. And for the first question, we're going to start with Dan Ko. Dan, emerging market is down over 8% year-to-date. Can you give us an overview on what's going on in emerging markets to get us started?
Sure Devin. Thanks for the intro. So yeah, there's a few things that have been going on this year that I think people have been worrying about. And what's interesting is that most of them really aren't new. US interest rates and dollar strength has certainly been in focus. International relations, particularly trade, have been in the news a lot. And, of course, we've had a number of major elections in EM countries. Again, all these have kind of been known. We knew the Fed's were going to rate hike and the market has gotten scared about maybe every 18 months or so. And trade was highlighted as a major issue back in the US Presidential Election. And obviously there were elections scheduled in the calendar for all these countries going back some time, but what's different is the market has just simply just gotten more focused on some of these things as they become front and center, and accordingly, now there's a lot more fear that's been built into prices.
Great. Thanks a lot Dan.
Thanks, Dan. This is Mansur here. I'd echo a lot of what Dan said, and I'd also generally say from the fixed income side the focus has really been on a tightening of financial conditions and a heightened sensitivity to idiosyncratic news flow from underlying emerging market countries, and that's really driven differentiated performance through the course of the year on the fixed income side. And similar to EM equities, it has been a tough year on the fixed income side as well. The Broad Institute that tracks sovereigns and quasi-sovereign down roughly 4% year-to-date. EM corporates roughly down 2% year-to-date. And most glaringly, local currency emerging market debt is down nearly 9% year-to-date.
Okay. Thanks a lot Mansur. And Gabriel, do you have anything else to add?
Yes. Good afternoon. I would add a couple of things. There have also been fears of contagion from some of the smaller markets that were mentioned earlier of Turkey and Argentina, in particular, have impacted the weaker markets in terms of current account or even fiscal deficit situations. But beyond the macro, the effects, I would also point to a bit of a sector rotation. The weakness in emerging market equities have hit multiples, which we'll see later in the presentation, and that's hurt some of the higher PE growth stocks and consumer stocks. And there's been a bit of a shift into interestingly more cyclical areas like materials and energy, which are dollar-based revenue companies that benefit from a stronger global economy, if not specifically China and the US, which we'll discuss again a little bit later. But overall, I agree with the comments made. The top-down factors, FX, interest rates in the US and elsewhere, as well as the concerns about China and Chinese growth, have definitely had a negative impact on EM performance this year, especially relative to last year.
Great. Thanks a lot, Gabriel. Let's kind of keep going on that theme around China. We continue to see volatility around these trade issues. I mean, China and the US is dominating the headlines. What's your view on this and really how do you see this playing out?
Yeah, I mean, trades been one other issue that's impacted sentiment obviously on Chinese equities, if not emerging markets broadly. I'll point to Mexico, which was an early market that was impacted by the US's proposal to renegotiate NAFTA. And that seems to have been resolved, to some extent, between the US and Mexico. Bilaterally, of course, they want to include Canada. But the North American Free-Trade Agreement or trade zone going forward is certainly beneficial to all three partners and the US, in particular. And I think also the size of the trade deficits between the US and Canada are smaller. Now, going to China, we don't see anything at this stage that shows that we're making any progress on the terms the US is requiring from China. And obviously, shrinking the trade deficit as well. So I think that will continue to create some volatility as it relates specifically to Chinese equities. But I think at the end of the day what really matters for emerging markets and of course, the US is global growth, US growth. In that sense, as I alluded to minutes ago, we are seeing a very strong cyclical recovery in commodities, in particular, but also an industrial [spots?], which are pointing to good growth. But regarding this specific question, yes, the trade issues that have come up between the US and China are still there, and we don't see a quick resolution to that issue.
When we look at the China trade issue, I think we try to simplify it into a couple of different frameworks from the fixed income side. And I think that there's the more achievable solutions and those that are more difficult and likely a source of greater volatility over time. As Gabriel mentioned vis-à-vis Mexico, the NAFTA renegotiation was more of a simple trade rebound thing, and modernization of the current NAFTA agreement from the US perspective really was a focus on reducing the nominal trade deficit vis-à-vis Mexico and Canada in creating fairer trade conditions. Now, I think that these similar types of issues can be resolved relatively imminently vis-à-vis China. And I think that the opening [silos?] of the rhetoric did offer some peace offerings of greater imports from the US, from China, etc. But there is another narrative and I think that that's more along the lines of a shift in the globalization framework and something that may be more akin to a clash of civilizations. This is much more of a geopolitical question as you see the US [stick?] to waylay or undermine initiatives such as Made in China 2025. So I think that the path of that trade dispute is going to be an important determinant of EM performance going forward, especially given that China makes up nearly 16% of global GDP.
Great. Thanks a lot, Mansur. And Mansur, while we're talking with you, let's talk about the dreaded word contagion. Can you discuss a little more on what's going on with some of these more vulnerable countries and does it risk further contagion within broader emerging markets in your opinion?
Sure. There's a couple of different issues at play here. I think that if we take a look at the chart that we have up regarding external balances or imbalances, it reveals some interesting differences between the underlying big-name EMs that we look at. Looking at the X-axis, we see a measure of the current account balance as a percentage of GDP. And on the Y-axis, the budget balance as a percentage of GDP. I think pretty clearly you don't want to be in the bottom left of this chart. You're most open to external funding stresses in this corner. Current account and fiscal position, not necessarily the whole story. FDI and foreign reserves can provide important capital buffers, but given the overall tightening in financial conditions, these types of stresses are driving the narrative that we are seeing broadly in emerging markets. And there's numerous acronyms to capture the worst performers out here, but it's difficult to escape. Interestingly, I would point out that places such as Brazil, which don't necessarily look optimal on the chart, are specifically beneficiaries of strong foreign reserves and strong FDI similar to Indonesia and Russia. Focusing more on what's been the problem children in the news - clickbait for those in the internet - Argentina, Turkey, and South Africa stick out fairly glaringly. The challenges are numerous, but adjustments can certainly help. On the fixed income side, there are some commonalities between these three countries, particularly the twin deficits, but the idiosyncratic nature of each of their problems are also important to take into account.
In terms of Argentina, clearly, they had a shock in a return to bond markets after resolving their previous debt crisis under the Peronists. And that actually muddied technicals and saturated the investor base on the fixed income side, which will take some time to work through. What I would point out with Argentina is that their transition to a Capitalist model is very important on a geopolitical front, and we would consider the US and IMF to strongly support their efforts in this transition, which could also help to normalize their economic results over the next two years. In Turkey, again, the twin deficit issue, but also generally a heterodox, monetary, and fiscal policy, as well as the threat of large external debt maturities that are impending. What I would say interestingly here is that Turkey actually may have the best chance at adjusting their economy in a short amount of time. How do they do that? They have a freely floating FX rate that is arguably trading at a cheap level right now, and a real effective exchange rate basis, and it's going to allow both imports to adjust lower and exports to potentially adjust higher in the future. And lastly on the geopolitical side, we've already seen rumblings of this out in the markets over the last few days, but the Pastor Brunson issue has been an impediment to normalizing relationships with the US. Though, it does seem that some diplomatic advances are being made and there is the potential for Pastor Brunson to be released in mid-October. And lastly, South Africa. I'd say a bit healthier than the previous two peers. They are being hit by a surprise recession as well as slow reform progress. Technicals could remain a bit challenging there, especially within the fixed income market, in terms of the [EM proxy?] and does exhibit some China sensitivity.
Great. Thanks a lot, Mansur. A lot of volatility going on. So as active managers, how do you go about navigating this? Gabriel, do you want to kind of start off here from an active manager's perspective?
Yes, absolutely. I mean, one strategy that we've implemented throughout the year is to become a bit more defensive. What that means is select stocks that may benefit from the current volatility in FX such as exporters. Another strategy is certainly to look at sectors, as I mentioned earlier, that have US dollar revenues and earrings. They may provide some downside protection. But essentially, what we do is we pick stocks out of a very large universe of equities across the market cap and geographic spectrum, and we find stocks that are not necessarily correlated to each other or to their market. We find strong secular growth ideas. And I think that's been really our strategy over the last couple of years, both in up and down markets. And the volatility at the company level tends to be actually a bit less if not quite a bit less versus the sovereign. And some of the macro factors we have discussed this afternoon are clearly at the macro level, and they affect the sovereign directly but less so at the company level. So our strategy has been consistently to look for-- as I said, we can call them defensive names, but essentially, they are companies with resilient earnings with good growth prospects properly valued relatively to their growth. And if markets get very difficult in terms of FX, in particular, you can certainly allocate to US dollars earners if not exporters.
Great. Dan, what about you from your perspective?
Yeah, so I think one thing that is important to keep in mind is that the reality is is that macro volatility is something that comes with the territory when it comes to investing in emerging markets. We've been in these markets for long enough that we know we have to be paying attention to these risks, whether or not they're in the headlines today or not. And so that's something I think we really should incorporate in the process. And when we look at a company, we want to understand how well setup is it to deal with what might be surprises? Whether it's currency devaluation, whether it's political noise, whether it's international relations and tensions there. So we really do what we always do, focus on the businesses that we own, understand how well they're set up to deal with the environment, and make sure that we're very confident about what the long-term prospects are. I think something that sometimes gets lost about periods like this is often they can be really good opportunities for stock selection because you find that companies that are really well positioned can actually improve their competitive positions in volatile macro periods as some of their peers end up struggling. So we see that sometimes. At the market, we'll just paint things with a broad brush, and when we really drill down into it, we find that the businesses that are going more valuable long-term are getting cheaper in the near-term. So these can be great periods for us to pick up stocks that we have a lot of conviction in at a really significant discount on intrinsic value.
Great. Thanks, Dan. So within emerging markets just to continue with you, there's a lot of tailwinds on its side, higher GDP, favorable demographics, growing consumer clash. But we are seeing some headwinds right now. Do you think this derails the longer-term emerging market story?
Yeah, I don't think it does. And I say that for a few reasons. Firstly, there's, honestly, a lot of adjustment that has already gone on in many of the major economies over the last several years which have already been tough. And you've seen that. They're generally a lot less reliant on foreign capital than they were say five years ago. You've seen some re-balancing going on towards more consumption-led growth in markets like China. And sort of despite all the near-term noise, I think the underlying fundamentals are still there that get us excited about the markets. There is the growth potential. The demographics are generally positive. You have a real emerging consumer and now your coupling that with valuations that are very attractive. Especially if you compare it to what's available here in the US, it's a really attractive bargain.
Great. Gabriel, you've spent a good portion of your career focused on Latin America. What's your perspective about whether the EM story is broken?
Yeah, I tend to agree that there's so many opportunities within EM. Clearly, not a broken asset class from this perspective. Now, having said that, Latin America has gone through some political changes. It's a very active election period. In Mexico, the Presidential Election has already occurred. In Brazil, it will occur next month. So that does create some instability in the outlook. But as Dan mentioned, we've gone through several decades of reforms - political, economic, in particular. Elections tend to have much less of an impact than they had in the past as policy remains very clear. There can be changes, of course, depending on the candidate. But in general, policy is very specific, and institutions have become stronger over time. So, specifically with Latin America, yeah, this year has been very active in terms of politics. But I think the outlook for the underlying economies are strong in terms of GDP growth. But also, we've seen earnings pick up nicely, particularly in countries like Brazil, that are coming out of a recession, which was quite rough, over the last two or three years.
Great. Thanks. Mansur, anything to add there?
Yeah, I mean, I agree with my peers on the demographic story. I'd also add that in terms of the current volatility that we're seeing versus previous bouts of volatility, it is important to note that EMs have largely installed floating FX regimes. Previously, we saw pegs that [inaudible] crises, particular crises, the Asian Debt Crisis, etc. And now it serves as a release valve for both imports and exports. We just spoke about it on the Turkey front. And it's also important to note that under these stress conditions, we are seeing positive policy adjustments, whether it be Orthodox monetary policy or fiscal consolidation. Some faster and some slower than others, but broadly, we're seeing an acceptance of a need for these policy adjustments being acknowledged.
Great. Thanks a lot, Mansur. Dan, kind of moving on, what do you think the rest of 2018 has in store for us in your crystal ball?
Short-term, it's going to always be-- it's always very hard to call about them. As Gabriel rightly pointed out, there is a lot going on in the near-term still. And I wouldn't be surprised if there's more volatility for a while around trade, around monetary policy, that could escalate or continue in the run-up to the midterm elections in the US. But what we've also seen in the past is typically periods like this where you have a lot of negative sentiment built into prices. Once there is kind of a turning point, once there is a catalyst, whatever it may be, you can have a very sharp rebound. So that's something to, I think, keep in mind is when we do get a snapback it could come quite quickly.
Mansur, what about you? What do you think the rest of 2018 has in-store for us?
I agree, [inaudible] to the trade, geopolitics, elections, etc. I think taking a dig further I'd say there are also some supportive factors to take note of here, particularly going into year-end, whether it be seasonal, Chinese demand and the potential for further stimulus if we do get more headlines on the trade front they could be supportive. I'd also say that acknowledging that there has been a bit of a potential bottom being reached here entering into the fall. Looking back at FX rates in China, specifically, we had Chairman Powell at Jackson Hole pretty much talk in a fairly gradualist note on tightening from the fed's perspective. It feels like the markets also interpreting today's hike similarly from the feds. We've seen China come out and kind of expound on the need for stability in the CNY, and that it's not going to be a weapon in the trade war. And then lastly, there has been some decent progress on the trade side. Obviously, with NAFTA, the market is rightly looking through to China, which has bigger knock-on effects, but we mostly acknowledged that there has been progress.
Great. Thanks, Mansur. Gabriel, the valuations looking even more compelling given some of the market weakness, especially relative to the US? How would you respond to investors wondering if now is the time to dip back into emerging markets?
Yeah, I do think so. I think we've hit a level that's pretty interesting in terms of an entry point, particularly for long-term investors that are looking for good correction. That has brought down valuations. And as the chart points out, not only are emerging markets less expensive versus the US, but historically if you go through several company sectors across different geographies you've had pretty a sizeable, multiple contractions as a result of all the concerns that we've talked about. Concerns about a slowdown in earnings, which has not materialized. So yeah, this is a very good entry point for the companies that I had mentioned earlier in the conversation. Secular growth stocks that trade at 20, 30 times earnings. I've seen a contraction down into possibly the mid-to-low teens. And that gives long-term investors a very good entry point for the secular growth stories that we've been pointing out. Now, versus the US, we also think-- the US has had a very strong run in terms of performance based on growth, based on an acceleration in earnings. A strong dollar as well. If some of those factors reverse, particularly on the currency, that might alleviate some of the pressure on emerging markets and allow these markets to recover quite nicely.
Great. Thanks a lot. So let's shift gears a little bit here. We talked a lot about what's going in emerging markets driving some of this market movement. Let's hear from each of our presenters about what makes them optimistic for an emerging market. Gabriel, let's start with you here. What makes you optimistic towards emerging markets?
Yeah, well, as you see in this chart, we can talk about Chinese trade concerns with the US, but the reality on the ground is that China has been growing across different sectors in different industries for the last couple of years if not the last decade, particularly since 2008. Investing in new areas of growth, particularly technology and energy as you see on the slide as well. And one of the reasons for that was diversifying the economy away from just exports. So to a certain extent, China is very ready for possibly relying less on trade with the US and more on trade with other markets, particularly emerging markets, but also domestic consumption. A lot of what has been talked about in terms of driving China is a shift towards a domestic economy. And that may be a bit too broad, but you can see here, there are specific sectors that we can look at, we can research, we can invest in, where China is possibly going to grow dramatically. Similar to the way that the tech sector, and particularly the internet sector, eCommerce, as well, has grown over the last couple of years in China. So if you do look at what's happening on the ground, I mentioned old economy sectors like energy and materials as well have seen quite a nice rebound in performance because of earnings, demands for the product, and deleveraging. One thing that we have not mentioned on the call yet is the fact that even though sovereign economies have seen some higher leverage over the last couple of years and corporates as well, by the way, in some of the markets we identified. In the case of the material's sector, for example, there's been massive deleveraging with higher prices. So you do have strong free cash flow and strong dividends. So looking at China as you see on this slide, there are definitely a variety of sectors that we can research, invest in, and see very high-potential growth, but also existing sectors that we looked at in the past.
Dan, what about you? What makes you most optimistic?
Yeah, I think more than anything, there's just very important secular changes that are going on in the way that people live and work in these countries. And that's going to happen kind of regardless of what the day-to-day headlines are. Consumer culture is really just starting to develop and that's happening in conjunction with technological change. And quite frankly, there's going to be a lot of wealth created. If you're able to find the businesses that can benefit from that that are really well positioned that's a great investment opportunity. And I think by way of comparison, you just have to kind of think back to the history of the United States and what kind of businesses we built in the post-war period when consumer culture was really growing and emerging and what an amazing opportunity that was. That's essentially what we have here and so that's I think what really gets us excited about the future in EM.
Great. Mansur, what about you?
Yeah, I'd say from a more tactical or short-term perspective, I'd say real effective exchange rates, cheaper will certainly help economies rebalance. I think a potential near-term top in the dollar that could be driven by Draghi's recent comments at the ECB will help [inaudible] dynamics, commodities, and external debt balances for EM sovereigns. And then given the idiosyncratic nature of the sell-off in EM debt relative to developed markets, we've seen some value created. It's particularly glaring in places like EM high-yield versus developed market high-yield bonds.
Great. Thanks a lot. Just getting a little more specific - and Gabriel, let's start out with you here - are there any particular industries or types of companies that you're looking at right now that are making you excited? We lost Gabriel for a second. Let's jump to Dan. Dan, any specific areas that you're looking at?
Sure. A few things. We still see a lot of opportunity in the [inaudible] space. That's in China, but it's also elsewhere. There's really interesting companies developing there. We've also found some businesses in the semiconductor space that we think are pretty well positioned where there's been real structural change in the industry and very good long-term demand trends when it comes to digitization in drivers like the Internet of Things, but valuations that just don't really reflect that reality. And I'll also mention Mexico, where I think within the last couple of years we've found more opportunities at a time when a lot of the political noise has been putting pressure on valuations, but that noise may be receding now. And we think a lot of these companies are really set up to do well in the coming years.
Great. With the good we also have to touch on the bad. So I'll throw this one towards Mansur, who's our debt guy. What concerns you the most going forward?
We're always looking to protect the downside. What I'd say is there's a couple of big-picture issues that do keep me up at night. We've largely benefited from a [COM?] US rate backdrop. Our base case is still only moderately higher rates, specifically for the remainder of the year. But if we do see economic exceptionalism persist from the US relative to emerging markets and that growth differential widens, we may see US rates actually rise more sharply. China and the nature of the trade debate is a concern for me. If it does veer towards the clash of civilizations, it could be a tougher pill for the global economy to swallow. Sanctions have been largely used as a normative force by the US. I think I'd be fearful that too many sanctions may drive geopolitical divergence as opposed to convergence. And lastly, very much a big picture consideration, I think we're always looking for EM to have better governance both at the corporate level and the sovereign level, and we are seeing a lot of players actually improve on that front, but there's still room to improve further.
Great. Gabriel, what about you? What concerns you the most?
Yeah, we spoke about the elections in Latin America. Next month's election in Brazil. At the local level, it creates quite a bit of volatility in that market. But more broadly, the cost of capital, rising interest rates, the US interest rate cycle, the strong dollar as we've discussed at the macro level has quite an impact on EM, particularly on EM corporates and EM sovereigns, that need to roll over a significant amount of debt. But definitely the correction this year has been, to some extent, justified due to these factors, and that's still concerning.
Great. Thanks a lot. So if you look at our next slide, emerging market returns over the past two decades. We see periods of very strong performance relative to the US. We saw this in this chart in that 2001 to 2007 period where EM significantly outperformed the US. Unfortunately, this was followed by a prolonged period of under performance following The Great Recession. The question really that a lot of us wonder is, how has emerging markets changed and should we expect something different that we've seen since The Great Recession? Dan, do you want to tackle this one?
Yeah, so I think something that kind of doesn't get appreciated is how much the universe is changing. It's not the same index that is was 10, 15 years ago. Natural resources used to be a huge part of the index, and it's still important, but you can see it's really calmed down quite a lot in terms of the waiting. And what you have instead is you have really a technology way, for example, that's basically tripled in size and continues to grow. And you have an emerging group of consumer companies as well. These businesses have very different characteristics, right? They're less cyclical. They generally have higher barriers to entry. Just the characteristics are totally different than if you're looking at a commodity company. And I think that means it's hard to compare with the past, sometimes because the universe is changing of what you're actually investing in. We see in many cases that this also creates better opportunities for minority investors, right? Because a lot of these growing sectors, the companies are less dominated by the state in terms of how they make decisions. They're more private companies in nature. And that's a plus for equity investors who are inherently in a minority position.
Great. Thanks a lot, Dan. Dan, did you want to touch on the next slide at all about some of the differences in some of the countries from [then and now?]?
Sure. And I guess this goes back to some of the earlier comments about adjustments. China, we still are seeing a transformation going on, but it is a country where growth is rebalancing quite a lot away from investment-driven growth that we saw in the past towards more sustainable consumption-led growth and so that's exciting. Brazil has had a lot of issues in the past and there's still uncertainties out there. But the country has come out of recession as Mansur mentioned. There are reform efforts underway. Though, of course, that'll depend on some of the political developments. Political corruption is still there, but it's becoming more out in the open. It's becoming less accepted, and that creates the possibility that you have better transparency, and you should see an impact on valuations if that becomes the case. Russia, this is another country where there's been a lot of noise between sanctions. Energy prices. Quite a big recession. Some of that is ongoing. At the same time, is you have all this sanction noise, political noise, going on. Energy prices keep going up. And this country has come out recession. For the companies that have survived and dealt with that, many of them are on very good footing. And lastly, the Fragile Five. People used to talk about this a few years ago, right? The countries that were most at risk when US rates started to go up because of their current account deficits. It varies a bit, but generally, those deficits come in a lot, and so you don't hear that term bandied about in the same way because many of these countries are just a lot less fragile than they were in the past. So I think some important changes on a macro as well as on a company level going on.
Great. Thanks a lot, Dan. So we've got in a number of questions from all the listeners on the line, so we really appreciate you guys sending them in. And this one we'll throw to Mansur. He's a good sport. One question is, how do currency moves affect returns and which currencies are the most vulnerable?
I think that they affect high currency bonds and low currency bonds in slightly different ways. From the hard currency perspective, both at the sovereign and quasi-sovereign level and the corporate level, a weak FX for those that are oriented towards the domestic economy can create fundamental stress. And from a hard currency perspective, it can shift sentiment in a negative way. And clearly, we've seen the fairly dramatic moves in EM FX shift sentiment negatively for hard currency bonds during the course of this year. For local currency, I'd say it's a little bit more a direct effect obviously. FX is a large component of the returns there. And in this environment when you see negative FX volatility, it certainly erodes returns. And you could see that in the dramatic relative underperformace of local currency bonds versus high currency bonds. In terms of which currencies are most vulnerable, I'd actually say which currencies will remain the most volatile because we've actually had a dramatic shift in valuation during the course of the year. It's still going to be those high twin deficit countries with a lot of political triggers that are going to be the most volatile. Argentine peso, Turkish lira, South African rand, specifically. Looking out a little bit further, I've talked a lot about how I see the Chinese trade progressing. And depending on how that flows, you could definitely look at the Asian block as a potential knock-on effect of Chinese demand weakness. It could flow through to countries like Malaysia or Taiwan.
Great. Another question we got if anyone wants to hop onto this one is, how do you view US dollar strength in relation to emerging markets and do you think it will be a continued headwind to EM equity? Would Dan or Gabriel want to help us out with that one?
I'll be happy to answer that. This is Gabriel. Basically, I mean, the US dollar strength, as we discussed earlier in the call, has been quite a negative, but it's not dissimilar to other cycles in the US economy coming off very low growth, very low rates. So the potential benefits - including today - continues to raise short-term interest rates. Now, the question is, how long can that continue? How long can US growth grow above trend or above international market? And to a certain extent, that will play out as the US grows faster. It will also increase its trade in current account deficit, the results of running a large fiscal deficit. So we have already seen signs of a flatter curve, indications that the US growth may have peaked. It's the 9th or 10th year of expansion. So to answer the question, it's been a headwind for EM. The fundamentals for most markets continue to be strong. So if the US should peak at some point in terms of both growth and interest rates, that will allow emerging markets, again, to perform much better as the macro situation stabilizes.
Great. Thanks a lot, Gabriel. So we're getting near towards the end of our presentation. And before I close us out, what would all of you like our listeners that walk away from this call with, some kind of parting thoughts, so to speak? Gabriel, how about you?
Yeah, I think one parting thought would be to understand or recognize that we have very large universal stocks outside the US that are quite attractive. Are delivering the growth that we're looking for at 25% a year. They're in different sectors, different industries, but we are flexible and able to look to those types of stocks and expose our funds to them. They are attractively valued and can also generate some good returns. So I think we're in a very attractive entry point, again, not just for EM but for market's ex-US that, for some reason of another, have been hit by the correction and that presents an opportunity. But there's definitely no shortage of interesting and successful companies in our universe.
Great. Dan, what about you?
Yeah, I would certainly echo those things. The macro near-term looks bad, but there's a lot that's built into expectations. And at a company level, there's a lot of resilience out there, and the long-term story is still very attractive. And maybe lastly, that it's a great stocktaking environment. And partly that's just the case in that they're less efficient markets. I think partly it's also the case when you have periods where macro is sort of dominating near-term stock movements. And I think it is particularly at this point in time because a lot of emerging markets are going through a transformation and what that means is the winners of the next cycle are going to be quite different than the winners of the past, and that that's inherently a great opportunity when you're trying to find stocks, and you're looking to the future.
Great. Mansur, what about you from a debt perspective?
Yeah, I mean, I would say that the contagion narrative has its limits, both from a relative value perspective as well as on a more fundamental basis. Cheap FX can help stabilize macro environments in these underlying countries. The [inaudible] will probably sink and create a lot of baby out with the bathwater situations. I believe Dan had mentioned the index composition has changed fairly dramatically on the equity side. We also mirror that on the debt side. If you look at a decade ago there were literally about 50 sovereign and quasi-sovereign included in the sovereign index by J.P. Morgan and only about 200-plus on the corporate side. If you look at them now, it's roughly about 150 on the sovereign and quasi-sovereign side and over 600 on the corporate side. So there's a lot of opportunity to exercise in active management and credit selection in a fairly varied environment.
Great. Thanks a lot, Mansur. So we are getting close to the end of our call today, and apologies if we didn't get a chance to answer any of your questions. But I'll end today's discussion with this. So just kind of reading through all the submitted questions that you're sending in and you sent around over the last couple of weeks, a lot of them center around the struggle with justifying investing in emerging markets given, one, the volatility, and two, some periods of underperformance. In terms of the volatility, it's not surprising. It is one of the most volatile asset classes. These are emerging economies. Each has their own host of growing pains. That's nothing new. Quite frankly, it's probably likely to continue. What sometimes is surprising though is that with this volatility has also delivered some of the strongest returns over the long-term. We see from this slide - this goes back to 2001 - this is the inception of MSCIEN net index. EMs actually largely outperform the S&P by over 150% if you go back long enough. What I also think gets lost in the headlines is really the sheer scale of opportunity in emerging markets. There's a reason why people are so attracted to this asset class and the potential that it has.
I mean, at a country level, the GDP, and EM continues to be doubled at developed markets. The middle-class in these countries, they're still standing at a rapid pace. For example, India's middle-class, it currently makes up about 12% of its population. Just 12% is the middle-class. This is expected to become about 80% by 2030. 2030 is not that far away, and that amount of growth is pretty amazing. We see similar growth like this with China's middle-class. Just in terms of size, emerging markets makes up 87% of the world's population - it's a massive part of the world - and this is expected to grow to 95% by 2034. Not only is it a massive population, but they have a labor pull advantage with better demographics. While the rest of the world's ageing, about 90% of the world's population under 30 lives in emerging markets. At a company level, valuations are very reasonable, especially when compared to the US. EM is trading about 12-times earnings while the US is trading at over 18-times earnings. And a lot of these companies are improving. They're fundamentally getting stronger. They're growing.
Dan alluded to this that we forget that the secular growth things like mobile, wireless, streaming that have been so powerful within our economy, they're still early innings in emerging markets and present a huge opportunity for the companies that could benefit from this. But it likely won't be without some bumps in the road, so this really is why we think it's critical to take a long-term perspective and try not to get distracted by all the headlines. So with that, I'll end with a thank you to our investment managers for joining us in this discussion today. Dan Ko from the Emerging Market Activity Strategy. Gabriel Wallach manages the International Small Cap Strategy, EM Small Cap, and EM opportunities. And Mansur Rasul from our Emerging Markets Debt Strategy. Again, I want to thank all of you for joining us today and listening to our call. We really appreciate it. And I'll hand it over to Erica with some closing remarks.
Yes. Thank you again to Devin and to our panel for sharing this conversation with us this afternoon. For more regular commentary from our investment team, please visit the insight section of our website and subscribe to receive updates when new content is made available. To learn more about our value add programs subscribe to receive our evolving adviser quarterly update email. So with that, I will thank you again for your participation in today's webinar. And I would like to use this an opportunity to promote our next two events, which will be in December, so please look out for invitations to those soon. Have a great afternoon.