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FRANKLIN TEMPLETON EMERGING MARKETS EQUITY

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Three Things We're Thinking About Today

  1. For the first time in more than a decade, the US Federal Reserve (Fed) cut the policy interest rate by 25 basis points. While the cut was widely expected, the market was disappointed by the reference to the rate as a “mid-cycle adjustment” and not likely the beginning of a prolonged easing cycle easing cycle. However, the Fed did concede that uncertainties remain, leaving the door open to rate cuts in the future. We believe the Fed’s rate cut will likely help extend US growth longer and will likely be positive for emerging markets (EMs) overall, given the importance of the US economy as a growth driver. The rate cut also alleviates upward pressure on the US dollar, helping EM currencies, while also facilitating greater flexibility in EM monetary policy (e.g. rate cuts in South Korea, Indonesia and Thailand). History over the last four Fed rate cycles has shown that the MSCI Emerging Markets Index tend to outperform the US market in the 2-3 year period following the first rate cut.1 The only exception to this was in the run up to the Asian financial crisis in the late 1990’s.
     
  2. Brazil’s lower house of Congress overwhelmingly approved a landmark pension reform bill in July, a positive step in a process that should substantially shore up the country’s fiscal situation. While it still needs a full congressional vote, we think this is a positive development. Savings from the reform are expected to reach US$235 billion over the next 10 years. After the approval of the pension system reform, we expect tax reform to come next, along with privatizations and more microeconomic reforms aimed at improving Brazil’s regulatory environment. Therefore, from an investment standpoint, we expect a recovery could be felt first in state-owned enterprises, along with infrastructure plays, capital markets platforms (e.g. stock exchanges), and other capital-intensive industries. Despite the strong market performance this year, we remain constructive on the outlook for Brazil’s market and believe industries with higher exposure to the domestic economy could benefit from further progress.
     
  3. India’s budget for fiscal year 2019/20, which aims to give the economy a boost via tax cuts and other measures to stimulate foreign investment, was released in July. We believe the government is moving in the right direction by focusing on improving the investment climate and diversifying the source of government funding, which should lower the cost of capital in the long run. However, clarity is still required in some areas. With the elections behind us, we expect market focus to shift to the fundamentals, such as earnings growth, inflation and fiscal prudence. The risks we currently see are related to global factors, such as trade tensions, US monetary policy and rising oil prices. However, rising domestic consumption has tilted India’s economy to be less reliant on the export sector, which makes India less vulnerableto adverse global factors, in our view. As a result, we retain our positive outlook for India’s equities in the medium to long term.

ENDNOTES

  1. Source: MSCI. The MSCI Emerging Markets Index captures large- and mid-cap representation across 24 emerging-market countries. Past performance is not an indicator or guarantee of future performance. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

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