MASTERCLASS: Fixed Income - January 2020
December 19, 2019
Remy Blaire: Welcome to your International Investing Masterclass. There are only a handful of weeks left until 2020. The year started with uncertainty in the investment landscape. And the current late-cycle economy in the US focuses on growth and the outlook for the federal reserve. Overseas, negative rates are becoming the reality alongside a pullback in economic expansion.
Joining me to take a closer look at the international investing landscape amid the uncertainty is Sam Polyak, Portfolio Manager at Fidelity Investments, and Danton Goei, Portfolio Manager of Davis International and Global Strategies.
Gentlemen, thank you so much for joining me for today's masterclass.
Danton Goei: Well, thank you for having us.
Sam Polyak: Great to be here.
Remy Blaire: Well first and foremost, let's start out by looking at global fundamentals. When we look at US hard data, we're seeing a more positive data, with the exception of the manufacturing figures that have been coming out.
But Sam, starting out with you, what data points are you keeping your eyes on, as we head into the final quarter of 2019?
Sam Polyak: Yeah, great question. Most of it has to do with global fundamentals. When we look at PMIs in Europe, PMIs in the US, PMIs in emerging markets, they're basically telling us that things are slowing, even though the US numbers have been pretty decent, unemployment numbers are decent. But we are seeing that slowing growth.
And that's not necessarily a bad thing for emerging markets. It actually can be quite good, because if things slow down, in kind of a Goldilocks scenario, that means the rest of the world starts to ease their macro policies, the US dollar might weaken a little bit, and that will be great for emerging markets.
The only way it would be, actually, negative is if all of a sudden, we get to a really bad, nasty recession. And then capital would flow out of EM, and it wouldn't be the best scenario. But otherwise, it's not the worst thing, for things to slow a little bit.
Remy Blaire: Mm-hmm (affirmative). And if we think about where we started at the beginning of this year, we've come a long way. But as we head into the rest of this year, we know there's plenty of uncertainty on the horizon.
So, Danton, I want to get your take on China. I understand that you returned from a research trip recently, and you're back in the US, so can you give us your perspective on what you saw, in terms of the macro landscape?
Danton Goei: Yeah, absolutely. So, we just returned from a trip in China, in Hong Kong. And one thing is very clear, is that economic activity is still relatively robust. If you look at just the indicators there, but also just if you look at traffic and air traffic and passenger traffic, still very strong. Retail sales over there are quite strong. And what really impresses me every time I go back there is both the quality of the companies that we met over there; we met about 30 companies over a week-long trip. And the quality of companies just remains very, very high; in terms of the business models, the strength of the cashflow and balance sheets they have, identifiable competitive advantages. And certainly, a focus on long-term. And this is something driven by the quality of the management teams. Very entrepreneurial, owner-operators for a great part of them, and very driven and knowledgeable. So, the quality of the management teams, quality of the companies continue to impress. And it's also confirmation that, in our funds, we've really focused on the consumer sector. And the consumer sector over there in China continues, still, to be relatively robust. And it's been a confirmation that that's an area that we think you want to be in, just because today consumer in China is about under 40% of the GDP. And that's a relatively small number, when you think about the US being about 68% and Europe being about 55%. So, a lot of room to grow, and we think that's going to be a multi-decade theme, there; where you're going to see these companies continue to do well.
So, the consumer sector continues to do well. And we think that, actually, despite all the headline risks that you hear out there and the negative sentiment, the greater risk is not being in China, rather than investing there. When you think about it being the second largest economy, soon to be the largest economy, and the companies and the qualities and the management teams there, we think it really is a place to be.
Of course, there are risks. You want to be aware of them, you want to be aware of the pace of economic reform. If valuation should spike up, you want to be able to adjust. But we think that that's one of the big advantages, basically, of being an active manager; is that if, for example, valuations get much higher, you can pull back. Because we're not married to any single region. And as an active manager, you can adapt.
Remy Blaire: Well, I think we've covered a lot of ground there, and we'll take a closer look at some of the points that you just mentioned, Danton. But we can't have a conversation about international investing without taking about global central banks and interest rates. So, let's talk about monetary policy and what we're seeing, not just in the US, but abroad, in the other major economies, as well as the emerging markets.
So, Sam, what do you make of the outlook for growth in EM versus what we're seeing in the major economies of the world?
Sam Polyak: Well, so merchant markets have had a bit of a tough time. Last number of years, places like Brazil have struggled. Turkey has struggled. South Africa has struggled. And more recently, India has started to slow down. So, a lot of it has to do with the fact that we've had a really tight central bank policy, where the US was hiking rates a fair amount. And so that had an effect; you had a strong dollar, you had higher rates, so the cost of capital for emerging markets was going up.
And so, because of that, a lot of emerging market economies slowed. So, Brazil went through a pretty nasty recession; just starting to come out of it. China started to slow because of the trade situation. And so, things aren't accelerating in emerging markets.
But the really big positive is that there's really pent up demand. So, you've had this situation where things have slowed. The governments have been more appeasing. So, because of that, they've been cutting rates more aggressively than the rest of the world. And like I mentioned, the pent up demand, I believe, is going to flow through, as rates start to come down, as Europe continues to slow, which it is slowing; US, the pace of growth decelerates a little bit, which there are signs that that's happening. Even though it's still strong, it's stronger than the rest of the world. But the second derivative is moving a little bit lower.
And so, because of that, I think that emerging markets can come out of this looking really good. China, and I agree with what Danton said. I think China's a misunderstood country. We've never seen a country evolve that quickly, as quickly as China has. And there are some really good companies in China that create value through time.
And so, I think as long as the central banks get out of the way, as they have in the last few years and you have a slightly weaker dollar, this would be great for emerging markets, as a whole.
Remy Blaire: And Sam, before I move away from you, you've mentioned the US currency. And we understand what role this plays when we're talking about international investing. But for the viewing audience, can you explain the significance of the US dollar and how fluctuations in the currency affect what happens abroad?
Sam Polyak: Oh, absolutely. So, when the dollar is strong, it, a lot of times, has to do with the fact that US interest rates are higher than the rest of the world. And so, what happens is, US capital or foreign capital flows to the US assets. And so, when that happens, the US dollar starts to strengthen, because just supply and demand. There's more demand for dollars. When the dollar strengthens, something has to weaken. And so, because of that, emerging market currencies weaken. And when they weaken, that has a really significant effect on consumption in these countries. Because if you're an Indian worker, middle-class, earning a wage, would like to consume a little more ... you have less discretionary income, because more of it goes to paying for your day-to-day needs, which are now more expensive because the rupee has weakened versus the dollar.
So that's just one example, but you could say that for the Brazilian real, the South African rand; it just goes across the board.
Remy Blaire: I think that's very helpful. And thank you for that explanation.
Sam Polyak: Sure.
Remy Blaire: Now, Danton, moving back to diverging monetary policies that we're seeing from the global central banks; how do you see this playing out as we head into the end of this year, as well as 2020?
Danton Goei: For global central banks in ... Right now, it's hard to see. I mean, we're seeing in the United States, interest rates weaken, unexpectedly so. I mean, if we were all sitting here in the room a year ago, even, I think we would've been surprised that it's happening.
So, I would say it's very hard to kind of say where rates are going, but we definitely are seeing rates weaken. That is probably going to weaken the dollar, to some extent. And that could be good for emerging markets, overall. And a lot of the banks, though, outside the US, they do look at what the US central bank does. Obviously, some of the currencies out there like the Hong Kong dollar are directly pegged. And so, we'll probably see a kind of follow-on movement, as well, lowering their rates just as the fed does here in the United States.
Remy Blaire: And before we move away from this discussion on global central banks, we know that negative interest rates have been a topic that's been gracing headlines.
So, what do you make of what's happening with the central banks that have had to go negative?
Danton Goei: Yeah, it's a ... Again, that's just an amazing development; the fact that investors are paying banks. And not only sovereign banks; but even now, corporations to hold onto their money. The fact that there're actually corporates out there that are issuing bonds at negative interest rates is pretty amazing. And it is causing a lot of distortions out there. I mean, I was just looking at last month, just a US company like AT&T, for example. A relatively indebted company; has almost $200 billion of debt, not expected to grow a lot. Its PE is about 10 times. Yet, it issued seven-year bonds at 25 basis points and issued 21-year bonds at 80 basis points. And even issued 40-year bonds. And so, it is amazing to kind of see these developments percolate from the sovereign level down to the corporate level. And it just kind of shows you how starved people are for yield, out there; when even corporates are issuing at such low rates.
Sam Polyak: If I could just add, it's just amazing; there's now $16 trillion worth of negative yielding bonds. And then when you think about it, in a country like Finland ... Finland's a great country, great place to be. You can buy a home and the bank will pay you for your mortgage with them. It just doesn't make much sense to most of us, but that's kind of the side effect of negative rates, and it's a little perverse, but at the same time, it makes an asset class like emerging markets that much more attractive; where you could get a decent yield and pretty good growth, in the face of your alternative being paying the bank to hold your money.
Danton Goei: Yeah, it certainly makes equities look like a pretty good place to be.
Sam Polyak: Agreed.
Danton Goei: Right? Relative to fixed income. And then, if you can have, also, equities in countries that are growing relatively nicely, that's a big bonus.
Sam Polyak: Agreed.
Remy Blaire: And are there any areas, when it comes to equities, that you're seeing as a good opportunity?
Danton Goei: Well, we're looking at emerging markets, as well. And we think that there's a number of places there. I think you have to be, though, very selective. And so, for example, in our international and global strategies, we're in, actually, only four out of the 25 emerging markets out there. So, I think you have to be very selective.
But there are attractive opportunities, especially once you look at the company level, and you look at the corporate fundamentals, and you kind of steer away from the headlines, the negative sentiment, and the news cycle, you can find some great companies. Whether it's in the consumer sector, like we were talking about a little bit. And there are emerging market consumer sectors that are doing very well. But also, even some overlooked sectors, or unloved sectors like financials. I think there, you can also find, just because they are unloved.
So, I think it is actually, a great stock picking environment. Because there's a lot of differences between countries and different industries. All right? There’re some industries that are beloved now because they are paying a 3% dividend yield. Yet, they are sort of growing at 0% to 2%. I'm thinking of like the consumer staple companies or utilities. And those companies, though, even though they're only growing sort of 2% or 3%, they're trading at 25 times earnings, because they have a 3% dividend yield.
Yet, if you look at the banks in some countries, they're trading at 10, 11, 12 times earnings; still growing earnings 5% to 10% a year with also a 2% to 3% dividend yield. Yet, they're financials, and so they're sort of unloved. So, I think you can, as a stock picker, really find some good opportunities out there.
Remy Blaire: And you did mention headlines, so I want to talk about volatility that we're seeing. Now, if we were talking about the US, we know the role that social media might play when it comes to what we're seeing in the broader market.
So, Sam, first and foremost, how do you react to all of the political chatter, as well as headlines that we see on a daily basis?
Sam Polyak: Well, there seems to be so much of it. It's really tough to drown out the noise. Most of it, I'd say 90% is noise. And so, the hardest thing to do, most of the time, is to just not react to it. Because a lot of times, you see a headline, something happens in terms of policy change from a government, or something happens in terms of protests on the street, or what we had in Saudi Arabia with the tax on their oil processing facilities. And you want to react one way or the other. And the hardest thing to do, which, most of the time, is the right thing to do, is just stay the course and not overreact to the news.
We buy good companies; we buy good businesses in countries that are growing. And a lot of times, it's really important to just stand back and say, "This is why we own it. We're not going to change our mind just because one little piece of news," which could change again tomorrow, "comes out." And so that's basically it. It's not overreacting.
Remy Blaire: Mm-hmm (affirmative). And nowadays, if you step out for lunch and come back, you might see a major movement across all asset classes, and you scratch your head wondering what on earth just happened. So, I understand your sentiment, and I agree with that. And indeed, in our viewing audience, there are a lot of financial professionals, as well as advisors.
So, when it comes to international investing and the unknown when it comes to politics and geopolitics overseas, Danton, what would you advise to the viewing audience?
Danton Goei: Yeah, it's hard, I think, today, for financial advisors to get their clients to focus on international. And understandably so, because the last 10 years, the US has outperformed international. However, if you take a step back ... One, you think about where the opportunity is. Today, 96% of the world's population is outside our borders, obviously. And 80% of listed stocks are actually outside the US. Three-quarters of the world GDP is outside the US. So, the opportunity is there.
And then, if you think about ... There's been long periods of time, even though the last decade has been very much, in terms of a US advantage versus international markets. There's been long periods of time where international markets have outperformed, as well. So, if you look at the last decade leading up to, say, December 2007, that decade, international stocks outperformed US ones by over 300 basis points a year, for a decade. And if you look at the decade ending in December '89, that decade, international stocks outperformed by over 600 basis points a year for over a decade. So, we think that, for a long period of time, international stocks can outperform.
And then finally, you look at the starting point; where we are now because of this strong out-performance of US stocks. And we know the S&P today is trading at about 17 times forward earnings. Then if you look at the international index, it's trading at about 13 times. Well, that's a big difference. And then if you look underneath that, there are pockets where the MSCI China index is trading at about 11 and a half, 12 times. And the Hang Seng is even cheaper than that.
So that big difference in valuation is probably setting us up for the next decade, where we think that international is probably the place to be. And so, we think that that's what advisors should be telling their clients, even though the headlines are very negative. The starting point, the fact that, in the past, international stocks have outperformed. And then also the opportunity that's out there are all good reasons to be looking at international.
Remy Blaire: Mm-hmm (affirmative). And gentlemen, both of you have been in the markets for several decades, so you bring a lot of experience. But for some of our viewers, they might be fairly new to the investing environment, in that they didn't live through the financial crisis. So that could impact the way that they advise their clients.
But when it comes to international investing, what are some of the key points, when it comes to the regions? And how do you differentiate between then?
Sam Polyak: Grab that one? Well, it's changed a lot. So, the biggest piece of advice I could give them is that you should look at how much things change through time. I mean, I don't do international, I do merchant markets. But if I recall, Japan was, what? 50%, 60% of international in the '90s. And it's come down a lot. Malaysia in the '90s, that part I know, was almost a quarter of emerging markets. And today, it's like 3%.
So, it changes because certain countries evolve and grow. China used to be less than 10%, and now it's a third of emerging markets. And it's the countries that actually innovate and grow, that really have a great opportunity. And that's why I'm really excited about emerging market versus US, versus international. Because international is ... There’re some good companies, don't get me wrong. There’re some really good consumer companies. There's a couple of good tech companies. But overall, it's a lot of banks. And it's a lot of kinds of luxury and consumer brands.
In emerging markets, you have some really innovative companies. You have some really good businesses, good companies that I think it's a real advantage for emerging market versus ... I mean, I'm not saying US has bad companies. US has great companies. But when compared to Europe or Japan, or Australia for that matter, which would be kind of the other options for international investing, I think emerging market has a real advantage, longer term, I believe.
Remy Blaire: And Danton, moving onto you, I want to take a closer look at emerging markets. And so, we started talking about this, but you believe that investors should not use a passive index or tentative approach when investing outside of the US. So, can you tell us why?
Danton Goei: Yeah. I mean, if you look at the index, the international index, it has over 2,000 companies in it. Now, we know that they're not 2,000 great, or even 2,000 good companies out there. And a lot of those companies are companies that you wouldn't actually want to invest in in the first place. A lot of them are state-owned enterprise companies, secularly challenged, old industrial telecom utility companies, some old state-owned banks that you wouldn't think you would want to invest in, but you are going to if you invest in the index. And maybe the key point there is that a lot of these companies, they're not shareholder-focused. They have other priorities rather than growing shareholder wealth. That's not the first thing that management wakes up in the morning thinking about, which is what you want. But that's not what they're thinking about.
And so, we would say that passive investing and buying the whole index is not the right approach. I mean, for example, the average position is about five basis points so that it's overly diversified and not selective enough. And if you look even historically, active management actually has done a very good job beating the passive index. In the last decade, for example, 92% of large cap international managers have beaten the index. So that's a pretty telling tale.
And so, index investing is definitely not the way to go, internally. You want to be selective. For example, in our international and global strategies, we have about 40 names. And so that has helped us develop a portfolio where, on average, the companies are growing faster and trading at lower multiples than the average company in the index. And that's because you're able to choose sort of best of breed and choose a selective group of companies, rather than sort of scatter shot, 2,000 company approach.
Remy Blaire: Mm-hmm (affirmative). And Sam, you highlighted the regions that attract you, in terms of innovation. But are there any areas that are concerning to you right now?
Sam Polyak: Sure. Some people love China, some people hate China. Some people love Brazil, some people hate Brazil. Everybody loves India. And that's a concern, because ... And there are some terrific Indian companies, and I own a bunch in the fund. But India's slowing significantly. And more significantly than the rest of emerging markets. They went through some really painful reforms, there's been some side effects of that. And the side effects have been on growth. So, consumption grown has been pretty week. Infrastructure growth, private investment has been weak. And now they're having a bit of a financial difficulty.
So, India ... And the big concern there is the fact that everybody loves India, and so everybody owns a lot of India. And so, if India has some disappointment, that could be a big concern.
Now, having said that, the Indian government has reacted. So, they've cut tax rates, they're lowering interest rates. And so, they're trying to do the right thing to stabilize growth, but we just don't know the effect this will have, because this bit of a financial crisis that they're having is still in its early stages, and so we'll find out.
So that's the one area in emerging markets that I definitely have some concernsabout. The rest of it, there are pockets here and there. I mean, South Africa's still recovering. Mexico, there's some political uncertainty. But overall, it's okay. But India's the one area where I'm a little bit concerned.
Remy Blaire: Are there any regions ... Since you mentioned India, does Brazil concern you at all, given the recent pension reforms?
Sam Polyak: I'm excited about Brazil. I think the pension reforms were terrific. We were worried that they may not happen. Say what you will about their President, he's actually trying to do the right things in terms of changing the corruption structure that the old government was kind of running on.
And so, you have some ... We just were in Brazil a few months ago, as a team. And the biggest change in Brazil ... I've been going to Brazil for almost 20 years. The biggest change is this entrepreneurial culture that took off. The only other country I can think of that's like that is China. There really isn't. And we meant the Chief Strategy Officer of Tencent, maybe six months ago. And he said the one area where they're seeing the most opportunity, in terms of innovation, in Brazil. Which I wouldn't have expected them to say that a year ago, two years ago.
And so, going down there, on the ground, meeting some of these companies, there are some really interesting businesses there. They have their issues, and they're still struggling. When I was ... I was just in China, as well. I went to the mainland and met some A-shares. And there are cranes everywhere. Still, construction still going on. You know? Property prices might not be doing great, but there's still a lot of construction.
You to Rio, São Paulo, no cranes. Maybe one or two cranes, you'll see. And it's just because things have been so bad. But the positive of that is that there's some pent up demand. And then if things can get going and the real stabilizes, you can get some really exciting opportunities in Brazil.
Remy Blaire: And gentlemen, both of you have brought up the term innovation. And what we think of innovation, perhaps, in the US, may look quite different when we're talking about other regions of the world. So, can you give us some examples of opportunities in innovation that you're seeing?
Danton Goei: You know, Sam mentioned a company called Meituan, which is a ... It's a Chinese online company, but they're doing what's called sort of O to O. You bring, basically, the online to offline, and running a physical network and infrastructure. And so, in the United States, we do have food delivery in a lot of cities, but not like in China. And not on the scale that you can see over there, where you've got well over 100 cities with over a million inhabitants there. This is a really ... Food delivery is really an urban product. So, the scale that you're seeing there, put these ideas into effect is pretty amazing.
And then the other thing that's driving a lot of these companies is just artificial intelligence, machine learning. Of course, it's something that we've heard, and a lot of the leaders in that space are here. But it's not really something that you think of an emerging market phenomenon. But certainly, in China, it is a big driver of a lot of these businesses. And there're actually a lot of innovative companies in that field, whether it's sort of facial recognition, image recognition, and in other areas, AI. So, I think AI is something that, in other markets, and especially in China, is a big driver of innovation, as well.
Remy Blaire: And Sam, what about yourself?
Sam Polyak: There's Huawei, there's a couple other small Chinese players. But Samsung is benefiting from that. And also, as the telephone networks for 5G continue to be built out. And 5G's going to kind of revolutionize things once it rolls out. I think it may take a little longer than people think. I think a lot of people thought that 5G was going to be rolled out next year. It's probably going to be over the next three to four years. But when it does happen, Samsung's going to be a very big beneficiary of that, and I don't think that's really in the price just yet.
Remy Blaire: And because you brought up China, as well as the trade war, I would like to transition to a focus on China. Now, Danton, you returned from your trip to China. It was a week-long research trip. So, can you share some of your key takeaways from that trip?
Danton Goei: Yeah. So, we go to China on a regular basis. In fact, last year, I spent two months over there meeting with companies. And this year, last month we went to China for a week-long trip. And what's amazing is just the vibrancy of the companies, I would say, over there; of the management teams. So that if you look at the fundamentals of the company and look at sort of the growth rates and health of their business, you wouldn't know that there's a trade war going on. You wouldn't know that the economy, supposedly, is slowing down tremendously. And it is having some knock-on effects, certainly. And there are parts of the economy that are being impacted, for sure. Certainly, in certain export parts, capital investment is slowing down. So, we're seeing that.
But I think one good thing to remember is that trade, as a percentage of the GDP has really fallen a lot over the last decade. So, if you look at 2007, for example, net exports as a percentage of the GDP was 9%, over there. So that's exports less imports. That fell down to 2% in 2017. And then last year, it fell down to 1%. So, the slack has really been taken up by the consumer. So, as exports and the importance of exports have fallen off, the Chinese consumer has really taken up the slack. And so, I think that, as an active stock picker, is something you want to focus on. And there's an opportunity there.
Remy Blaire: And due to the fact that you just mentioned the US trade war and the implications, there are financial advisors that are watching this and have to answer questions from their clients regarding the implications of tariffs, whether we're talking about EU or China. So, what is a good way to explain this to clients, in a nutshell? What are the real implications as we drag out this trade war between the US and China past 15 months?
Danton Goei: So certainly the trade war has had an impact on both the exports of Chines goods to the United States; and then because of retaliatory tariffs, US exports to China. Just because they've become, now, more experience, here in the United States, and then in China, as well. Now, other countries have taken up the slack. Right? So instead of importing goods from China, we might be importing them from Vietnam, from Bangladesh, from other emerging markets where they also have low-cost labor but aren't burdened by the tariffs. And conversely, China's been important Argentinian soy instead of from the United States. Or, thinking about buying good from Europe instead.
So, it has kind of hurt the two participants in this trade war, sort of locked in. It's tough to see, from a political point of view, what's going to kind of change and get people to the bargaining table. There's a lot of political considerations, now, in terms of sort of saving face and how you look, whether you'd look strong or not. There's also quite a bit of turmoil here in the United States, in terms of the political environment that might want the Chinese to maybe kind of delay and wait for a more stable environment to make a deal. So, it's hard to say when ... We do think that eventually, a deal is going to happen. Just because both participants are losing, at the expense of others. Right? They're both hurting. It's sort of like ... Someone characterized it as a duel, where both participants end up shooting themselves in the foot.
And so, we think that that'll eventually take care of itself. In terms of the timing, though, tough to know whether that's going to happen in the next year, or it might take a little longer.
Remy Blaire: Mm-hmm (affirmative).
Sam Polyak: If I could just add to that. I think the one true conclusion of the trade war is that the consumers are going to have to pay more. Cost of goods is going to go up. Everybody that imports, and a lot of people import production from China, are raising prices. And so that's effect one. Two, some industries are going to have to move. And in China, there are textile companies that are moving to southeast Asia. And so, there are manufacturers of consumer goods that are relocating.
The other big effect, and this is one of the themes we have in our fund, is automation. It's going to force automation onto the rest of the world, because you can't buy cheap component costs from China anymore. One, they've had wage inflation. But two, with the tariffs, it's going to make things a lot more difficult.
And so, in effect, it's a positive for a lot of ... Because there's a lot of automation related companies, international; a lot of them in Japan, some in Europe, but also in emerging markets, as well; in Taiwan and China. And so, a lot of these automation companies are going to be big beneficiaries from this, as the world has to adjust to this new reality.
Remy Blaire: Mm-hmm (affirmative). And before you move away from this topic, you mentioned some of the beneficiaries of this being Vietnam or other surrounding southeast Asia countries. But in terms of economics, how is this affecting the local economies?
Danton Goei: So it can be good for some of these other countries that are seeing ... Now, this has been a trend for the last decade or so. I mean, the cost of labor has been rising double digits, in a lot of areas in China. And so that's been driving more and more sort of the manufacturing that's more labor-intensive to Vietnam, to Bangladesh.
But this trade war has probably just accelerated that trend, for sure. And so, you're seeing, in those local economies, more investment. And it'll be probably good for sort of incomes and investment levels over there. And then the key will be to see whether whole supply chains start moving. Because if one or two companies move, it's hard for the really big companies to move, as well. But if you see the whole supply chains starting to move, as well, that could be sort of the inkling that something big is afoot, and that you're going to see a major shift. So that's something that we're following, for sure.
Remy Blaire: Mm-hmm (affirmative). And Sam, sticking to the subject of China, why has the Chinese market cap not followed the growth of GDP, or even earnings for companies, as in the US?
Sam Polyak: That's a great, great question. And we debate this one a lot. And I think it has to do with something that Danton mentioned earlier. In China, historically, you've had a lot of state-owned enterprises. And so, a lot of these state-owned enterprises, whether they be banks or industrial companies or consumer companies, or cement companies. Their goal is the goal of the country, which is improving infrastructure, improving general wealth. It's not necessarily the needs of shareholders.
And so, because of that, when the banks saw listed, they used to trade at four times book, three time the book value per share. Now, they're all below book value because the market's not paying them for that value that market participants don't see as being sustainable. Now, it's catching up because some really innovative companies, some of the ones I mentioned earlier, have come along. And their GDP, their market cap has gone up a lot, and over the last few years. So, it's starting to catch up. But if you look at the starting point being 15, 20 years ago, definitely hadn't kept pace with the strong growth of GDP. But now, because GDP is kind of plateauing a little bit, still growing faster than the rest of the world, but not growing at 10%, 15% that it was before; growing at more like a reasonable 4%, 5%, 6%, depending on what numbers you believe. Some of these other companies are growing much faster. And so, it's starting to catch up, but it's going to take some time.
Remy Blaire: And some of the sectors that you've highlighted include financials as well as technology including automation as well as artificial intelligence. But when it comes to China as well as some of the emerging market countries that you've mentioned, what sectors do you see the most opportunity in, and what would you stay away from right now?
Sam Polyak: So there's some themes that I have in the fund, and there's some really interesting companies. First is eCommerce and fintech. But there's all sorts of others. Maiduan, as well, falls into that; where a lot of these companies are taking market share from traditional retailers and regular department stores. And then also the fintech guys are hurting the financials a fair amount, as they're starting to kind of redefine what the financial model is, where the banks are afraid to lend to consumers. Or, a lot of them in emerging markets don't know how to lend to consumers, because they'd only lend to big enterprises. And so, these small little financial technology companies are taking significant share. So that's one.
Two, I mentioned automation. Another one 5G, I've also talked about a little bit. But there's also consumption stories, which Danton mentioned. That's a fact. There's a lot of pent up demand, a lot of emerging market consumers have a lot more discretionary income than they did 10, 15, 20 years ago. And so, there are a lot of goods that they don't consume today that they're starting to consume more of.
Defense spending is also going up, so that's another theme that's part of a side effect from trade war that you mentioned before. So, a lot of these countries, which before had relied on the US to provide kind of defense support, are kind of forced to b every kind of on their own. And so, they're forced to allocate more towards defense spending. So those are kind of a taste of them.
Danton Goei: Yeah, I mean just to add, the eCommerce story is a really interesting, long-term global phenomenon; this idea that 75% of the transactions online are actually happening outside the US, the fact that the internet population is growing 10% a year, or that eCommerce is growing 17% a year, or even that the largest eCommerce market in the world is outside our borders; that we've got about 10% of our retail sales online. But a country like China's got 20% of their sales online. It has become the largest eCommerce market.
So, we agree that companies like Alibaba or a JD.com or even like a Naspers, South African company that has a large investment in Tencent, but also has made a number of investments in true delivery and online classifieds is interesting. Or even like if you think about online, overall, and education. For-profit education is growing more and more online. So, a company like New Oriental Education in China, which is sort of one of the leading for-profit education companies over there, is also increasingly investing in online education, which is really, really interesting in a country the size of China.
Another interesting theme, I would say, is global travel. So, it's related to the idea of sort of the rising middle class. But there's not very many large industries that are growing volume 6% to 7% a year, like miles flown are, globally. And that's been happening for several years, and we expect that to continue for a long time. So, if you look through the value chain, there, there's great companies like a Saffron in France, which is a jet engine manufacturer; or in India, Indigo Airlines. Really interesting company that has a 42% market share in one of the largest and fastest growing airline markets in the world. It's amazing that in the entire country of 1.3, 1.4 billion people, there are only a little over 500 commercial aircraft in the whole country. And so understandably so, the market is growing rapidly to sort of catch up to demand. And this one company, Indigo, has got 42% market share and growing, and is also the low-cost operator there. So, there's companies like that; or Azul in Brazil that are also very interesting, in a way, to capture these long-term themes.
Finally, maybe one theme is just the unloved and undervalued part of the market. And we think that financials sort of fit into that bucket, there. And so, if you look at international financials overall, companies like Development Bank of Singapore or DNB in Norway, or even Bank of Butterfield in Bermuda; these are the leading banks in very focused, very strong economies. So, they're not like these mega banks in Europe that are big in investment banking and have a lot of debt, but are the leading banks in some very strong, good economies: Norway, Singapore, Bermuda, that I think are good opportunities, as well, but are in the sort of unloved sector of financials.
Remy Blaire: And Danton, you tied in two key things which is eCommerce as well as consumers. And of course, when we're talking not just about emerging market economies, but even developing economies, we know that more consumers have come to market when it comes to eCommerce. And there are some regions of the world, especially in developing economies where we might see more consumers entering the eCommerce space, whether by shopping online, or even just having access to smartphones or devices to have the power to purchase. So, are there any economies outside of just emerging markets where you might potentially see investing opportunities, since we're talking about international investing?
Danton Goei: You know, I mean in Europe, obviously online has already sort of fully developed. I would say the next ... The area that we focus in emerging markets has been the more developed of the emerging markets. But if you look at the next stage, so the more frontier markets like in Africa, it's interesting there because ... We look at some of the emerging markets like China, they've sort of leapfrogged directly into online. Right? They leapfrogged the physical retail store experience, and just gone straight to Alibaba or JD.com. They leapfrogged the laptop or the PC and gone straight to the phone.
And in Africa, they've also been leapfrogging, basically, and going straight to sort of mobile payments directly, rather than say, credit cards. And so, I think that is an area that's interesting. There are pockets where you wouldn't think, again, that these markets could be innovative and online forward. But because they're starting from scratch and thinking about, "Well how would we develop payment systems with the technology that we have now?" They can go directly into a sortof mobile payment systems in Africa, or in India. Certainly, in China, that's happened.
So, we're following those types of trends, as well, in markets that you might not think are so obvious places.
Remy Blaire: And I think this is a great place to talk about some of the misconceptions we see in international investing. So, gentlemen, let's talk about some of the myths that surround this topic, especially in emerging markets. This does cover a wide range of asset classes, as well as investment options; but can you mention some myths or misconceptions that really irk you?
Sam Polyak: I'll start off. In emerging markets, it's ... First myth is this perception of it being kind of a second-class citizen to IFO is an acronym for international investing excluding emerging markets. And so, as I mentioned before, there's some really good, innovative companies in emerging markets. And the perception is that emerging market is riskier. The perception is emerging market has bad corporate governance. Perception is emerging market is just reliant on macro factors. So, if the economy in, say, Brazil turns down, you don't want to own any Brazilian stocks. And there's some really good companies in Brazil that are growing, despite what's happened with the macro uncertainty. So that would be one big kind of a myth for emerging markets that I think is overplayed a little too much. Do you have anything else?
Danton Goei: Yeah, I mean, I would ... One, just the term emerging markets, in general, is a little bit of sort of a catchall phrase. Right? This idea that Brazil and Russia are the same, or even India and China just because the population sizes are similar, are the same; I think is terribly misconceived. They have very different cultures, governance, governments certainly, and their view of sort of capitalism and for-profit companies are also all very different. So, I think selectivity there, within the emerging market areas is hugely important. Yeah.
Remy Blaire: And so for the viewing audience, if you had some tips when they're discussing emerging markets or even international investing to their clients, how would you advise they approach this wide topic?
Danton Goei: Well, one thing that's I think difficult for financial advisors is to get clients focused away from the headlines and the news cycle and basically this idea that macro is driving everything. Right? And getting them more focused on the companies that you're actually investing. Because you're not investing in China. You're not investing in Brazil. You're investing in SulAmérica, a health insurer in Brazil. Or, you're investing in Tencent in China. And so, getting them focused on those fundamentals, that are doing great, by the way. I mean, for example, if you look at China during this whole trade war, which has been a tough environment certainly the last year. So those are very strong growth rates, even in the face of this trade war that's happening. So, if you can get clients focused, the fact that you are investing in these high-quality durable businesses, trading at attractive valuations, I think that will be key in pulling them away from the headlines out there.
Remy Blaire: Mm-hmm (affirmative). Well I think you both brought up a lot of important points when it comes to misconceptions surrounding this type of investing. So, in terms of closing words, Sam, aside from China, what other countries are you seeing long-term secular growth opportunities, and what do you think is driving them?
Sam Polyak: Yeah, great question. So, places like Brazil, I mentioned the entrepreneurial culture that is changed. Where before, it was basically driven by ... Originally, there were telecom companies and they were poor capital allocators, and they slowly went downhill. Then there was a bunch of commodity companies. So, there's this misperception that Brazil is just driven by what happens to commodities. And they are good companies, low cost producers; but at the same time, they're not what's driving Brazil.
What's driving Brazil today is a lot of these consumer related eCommerce businesses, fintech companies that are just really kind of at their nascent stage, that are starting to take off. And I think, longer term, it's an exciting place to be.
I mentioned China. I think India, longer term, will be just fine, because the reforms that were rolled out; the GST, which is a new tax. India, basically, before, had a tax system where their goods were being taxed at every level; at the local level, at the state level, at the regional level, at the consumer level. So, by the time someone got one of these goods, there were so many layers of tax, it was difficult to figure out whether it was competitive or not. And most of the time, it was not globally competitive.
Now, with this one central ... GST, there's different levels of it. But one layer of tax. The companies can really try to invest for the longer term, and it's bringing a lot of a gray business into the real economy. Similar with demonetization, where a lot of gray businesses are going to be for the real economy, where people aren't going to be working kind of under the table as much as they were before. Granted, the short term effect that eluded to is having very negative short term growth implications. But longer term, coming out of it, it's going to be much healthier growth. And in terms of per capita consumption, on everything from cement to power; it's anywhere between one-eighth and one-twelfth of what China is today, with the same number of people, with less population space, meaning much more dense. So, they can't build out like we do in the US. There's no rows of little pink houses in India. They have to build up. And it's going to be a great opportunity, longer term. But just shorter term, there's some of this uncertainty.
Remy Blaire: And Danton, what long-term investment themes are you focused on?
Danton Goei: Well, we spoke about a few of the themes, in terms of eCommerce or global travel, certainly. One thing that we've been talking about a little bit is just this idea of innovation being present in a lot of these international markets, and especially in some of the emerging markets. And so, I think that can be something that can be interesting. One industry that we haven't really spoken about is healthcare. And so, whether it's because of the aging populations abroad ... now, that's happening ... Most emerging markets are young populations. But China, for example, has already hit its peak in terms of size of labor force. And now, the population is aging. I mean, it's often said that China will probably be the first company that gets old before it gets rich. Usually, it's the other way around, where you get rich and then, so you have less children, and then so the population, as an average, gets older.
So, I think healthcare can be something that's interesting. As the country gets richer, as the population gets older, as innovation and things like AI ...But other areas, too, and biomedical research grows; I think healthcare could be something that could be interesting, long-term in a country like China, and globally, as well. So that's an area that we're looking at, where it's been a big and very profitable industry in the US and in Europe and Japan, and it could, as well, be in a lot of emerging markets where today it's small, it's still sort of mid-single digits as a percentage of GDP; whereas here, it's about 17% of our GDP. And that 5%, in a lot of the emerging markets, is going to grow. So, I think that's an interesting space.
Sam Polyak: Here, it's 17% for the wrong reasons.
Danton Goei: Yeah, unfortunately.
Sam Polyak: We overpay, and we subsidize the rest of the world.
Danton Goei: Yeah. And even in Europe, it's 10% or 11%. So, there's room for some of these emerging markets.
Sam Polyak: Agreed.
Danton Goei: And then on our end, hopefully we can take that 17% down.
Sam Polyak: Yeah.
Danton Goei: And fix it, yeah.
Remy Blaire: And you mentioned healthcare, but are there any other areas that you think you'd like to discuss before we wrap it up? I know that here in the US, there's been a lot of focus on ESG, as well as impact investing, and that's another area that's going to be very interesting as we move forward into the rest of this year as well as 2020. But any other areas?
Sam Polyak: I own some precious metals companies, and so they benefit from a weaker dollar, as well; much like the emerging markets, but with less of a worry on big recession. And so within precious metals, one of the areas where I have some investment that's done all right, and I am still excited for is platinum group metals.
So, there's this big belief that electric vehicles are coming; and they are coming. But the take up is going to be a little slower than a lot of folks expect. And so, we've, in the meantime, because of this concern and because of political worries in places like Russia and South Africa, which are where the majority of platinum group metals are located, there hasn't been a lot of investment in mine development. And so, there's actually a shortage on especially palladium today, where the price has gone from $400 or $500 to $1,600 very quickly. And it's because platinum group metals aren't only used for jewelry, like wedding bands for platinum, but mostly used for catalytic converters. And so those catalytic converters, you need to control smog. If you go to China or go to India, you'll see that there's a lot of smog out there. And pollution is a big concern of the government, so there's a lot more enforcement on cars; that they have proper working catalytic converts. And so, because of that, this demand is actually accelerating. But at the same time, supply has come down and so because of that, the price for the underlying commodity has done well. And so, this is another theme that we have in the fund.
Danton Goei: Yeah, I mean you bring a good point there about sort of pollution and environmental companies, maybe counterintuitively, a lot of them are growing in some of these emerging markets. Environmental technology companies, to deal with this pollution, because it's much more acute than it is here, in the US. And then so electric vehicles are growing even faster than in a lot of the developed world, because of the same issues.
So, I think that's a ... Or, even renewable energy. A lot of renewable energy, whether it's wind or solar, certainly are abroad in countries like China. So those are interesting. If you look at the industry, a lot of the innovation is happening there, as well; outside our borders.
Remy Blaire: Well, gentlemen, thank you so much for joining me today and thank you so much for both of your insights.
Sam Polyak: You bet.
Danton Goei: Yeah, thank you for having us.
Sam Polyak: That's great.
Remy Blaire: And thank you for watching the International Investing Masterclass. I was joined by Sam Polyak of Fidelity Investments and Danton Goei of Davis Advisors. From our studios in New York City, I'm Remy Blaire for Asset TV.