Carmignac Emergents: Letter from the Fund Managers

After a surprising rebound in Q2, Chinese stocks changed course this summer and resumed their downward trend, undermined by the effects of Beijing’s zero-Covid policy. This policy is standing in the way of any real economic recovery because it’s sapping consumer and business confidence and preventing the stimulus to have the intended effect on the economy. The government could start to ease this policy after the Communist Party Congress in mid-October, but we doubt it will be revoked before winter is over. Our Chinese holdings (37% of the Fund’s assets at 30 Sept. 2022) are oriented mainly towards non-cyclical sectors and long-term growth themes. The performance of Chinese stocks in the coming months will be shaped largely by the outcome of negotiations under way in Hong Kong between the US Securities and Exchange Commission (SEC) and the Chinese market regulator, which has been asked to provide the SEC with access to Chinese companies’ audit papers. A preliminary agreement was reached in August – rather unexpectedly, since analysts still believed New York-listed Chinese companies would have to start delisting in 2023. We think a final agreement could be announced in December, which would restore investor confidence in Chinese equities after two bleak years for this asset class. Barring such an agreement, Chinese stocks will probably remain under pressure until next June, when Alibaba is expected to join the Stock Connect programme, enabling investors in mainland China to buy its shares listed in Hong Kong. Chinese households have built up considerably more savings than those in the United States, which will provide new investor base for the Chinese companies listed in Hong Kong.

A positive surprise in the third quarter came from Latin America. Our Brazilian holdings (13% of the Fund’s assets) scored early gains ahead of the first round of presidential elections, with most polls pointing to a Lula victory. Investors seemed happy with this expected result, given that his choice for vice president, Geraldo Alckmin coming from a centrist party. But what really helped investors sentiment is the expectations regarding the regional elections, that pointed the likelihood of a right-wing majority in the Congress. The Congress is a powerful institution in Brazil and will likely block any attempt by the new elected President to walk back the privatisation of Eletrobras – a key reform of the Bolsonaro government. Our Mexican investments (5% of the Fund’s assets) also contributed to our outperformance in Q3. Mexican companies are benefitting from a structural trend towards nearshoring. With geopolitical tensions high between the US and China, and with firms around the world reconfiguring their global supply chains, Mexico is the country that stands to see the biggest increase in exports to regional markets. The International Bank for Reconstruction and Development estimates that Mexican exports could swell by $35.3 billion over the next three years. We hold Banorte in our portfolio; the rising interest rates are a boon to this Mexican bank since most of its loan book consists of variable-rate issues, and it’s in talks to acquire Citigroup’s Banamex subsidiary at a low valuation.

We stepped up our exposure to South Korea (16% of the Fund’s assets) in the third quarter, now that valuations (measured by Price/Earnings ratios) in the country have become very attractive after an abysmal 18 months. South Korean stocks were the first to price in a sharp global recession – and we believe they’ll be the first to bounce back. We also increased our exposure to Brazil by buying stock in Eletrobras, Latin America’s biggest power utility company. 98% of the electricity it produces comes from renewable sources – specifically hydro, solar, and wind power – making it one of the world’s leading renewable energy suppliers and helping to give Brazil the second-highest country rating for its energy mix. What’s more, corporate governance at Eletrobras is now excellent thanks to changes made when it was privatised. Our analyses and the company’s most recent earnings releases show that it’s priced very attractively, offering a return of 13% (after inflation), or some 18% nominally, over the lifetime of its concessions.

We’re still cautious on India since valuations in the country appear stretched and its economy is highly vulnerable to rising energy prices. Both its stock market and its currency could fall – but that would give us attractive entry points for shoring up our Indian holdings.