2019 Outlook

glass globe on paper with charts and graphs

Adam Kutas | Portfolio Manager

January 2019

Every year over the end-year holidays, I gather up a mix of research, try to avoid my computer screens and think about an outlook for the next year. Usually the stock markets over the holidays are quiet providing some room for deeper thought. This year was different, though. At the end of 2018, volatility spiked as the markets finally priced-in most of the higher business cost of capital. As well, oil and other commodity prices collapsed sharply given fears of an oversupply by producers, but also weak demand given a growing consensus of recession for many major markets. For many market participants, these movements lent themselves to a generally bearish outlook for 2019.

Yet what may have been missed by some market commentators is this volatility was generally confined to the developed markets, primarily the US. Emerging and frontier markets were relatively stable from their lows reached mid-year. Frontier markets performed quite well in 2016-17 so it’s not much of a surprise to see a re-setting of expectations and a shake-out of marginal investors. In my view, these lows were likely a cyclical downturn in a broader structurally positive outlook for these asset classes. This constructive outlook is based on a blend of bottom-up company fundamentals, investor sentiment and equity valuations as well as a broader, positive outlook for the macro backdrop for the structural winners (such as Vietnam, Bangladesh and Cambodia), but also commodity-oriented, frontier countries (like Colombia, Nigeria and Saudi Arabia).

To start, let’s look at investment returns for 2018. As seen in Chart 1, the MSCI Frontier EM Index was down almost 15% in USD terms last year which hurts any portfolio. Yet this performance is inline relative to other international equity asset classes such as developed and emerging markets. The only market that performed better was the S&P 500 Index which was down almost 5%. Within frontier markets, as seen in Chart 2, the main driver of the weakness was the macro-driven decline in Argentine equities. Conversely, Kuwaiti stocks performed quite well as the market priced-in a potential upgrade to “EM status” by MSCI. 

Chart 1: Equity Market Returns in USD for end-2018
Chart 1, the MSCI Frontier EM Index was down almost 15% in USD terms last year which hurts any portfolio.
Source: FMR

Chart 2: Top 5 and Bottom 5 Countries in 2018 in USD
Chart 2, the main driver of the weakness was the macro-driven decline in Argentine equities.
Source: FMR

So, after that decline, how do fundamentals look going forward? Well, as seen in Chart 3, returns on equity (one measure of profitability) continue to trend-up globally, with FEM companies posting broadly around 13-14% which is above their EM and DM counterparts excluding the US. From an earnings growth perspective, as seen in Chart 4, frontier companies are expected to grow around 11% in 2019 while the bottom line could grow 17%. These growth figures are above both EM and DM which is generally in line with history as frontier countries are earlier in their economic development and hence should grow faster (similar to small cap companies versus large blue-chip corporates).

Chart 3: Returns on Equity
Chart 3, returns on equity (one measure of profitability) continue to trend-up globally, with FEM companies posting broadly around 13-14% which is above their EM and DM counterparts excluding the US.
Source: FactSet, MSCI

 

Chart 4: Revenue and Earnings Growth Expectations
  Revenue % EPS growth (%)
  2017 2018E 2019E 2016 2017 2018E 2019E
DM 9% 9% 4% 5% 26% 27% 10%
EM 13% 9% 7% 17% 26% 17% 12%
FEM 1% 13% 11% -12% 12% 29% 17%

Source: IBES

So, we have companies that are growing at a low double-digit pace and at a profitable level. But what price are we paying for this growth? As seen in Chart 5, using price-to-book valuation measures as our proxy for prices, frontier equities compare quite well. They are a bit more expensive than broader EM and developed markets, though much cheaper than the US. Though the valuation premium is only around 10%, the higher price to book measure for frontier equities is driven by the higher-priced stocks in the Philippines and Kuwait markets (both of which the fund is underweight). But when one merges the growth outlook and prices paid, frontier equities compare quite favourably, as one is paying a decent price for better growth, and investor sentiment is on the beaten down side after a tough 2018.  

Chart 5: Price to Book
using price-to-book valuation measures as our proxy for prices, frontier equities compare quite well.
Source: FactSet, MSCI

So, in conclusion, though the headlines continue to unsettle most investors, stock pickers digging in commodity-based markets should find decent growth for attractive prices, especially relative to most richly-priced developed markets.

 

Thanks for reading

Adam Kutas, CFA


Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus, which contains detailed investment information, before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

Certain statements in this commentary may contain forward-looking statements (“FLS”) that are predictive in nature and may include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates” and similar forward-looking expressions or negative versions thereof. FLS are based on current expectations and projections about future general economic, political and relevant market factors, such as interest and foreign exchange rates, equity and capital markets, and the general business environment, in each case assuming no changes to applicable tax or other laws or government regulation. Expectations and projections about future events are inherently subject to, among other things, risks and uncertainties, some of which may be unforeseeable and, accordingly, may prove to be incorrect at a future date. FLS are not guarantees of future performance, and actual events could differ materially from those expressed or implied in any FLS. A number of important factors can contribute to these digressions, including, but not limited to, general economic, political and market factors in North America and internationally, interest and foreign exchange rates, global equity and capital markets, business competition and catastrophic events. You should avoid placing any undue reliance on FLS. Further, there is no specific intention of updating any FLS, whether as a result of new information, future events or otherwise.

From time to time a manager, analyst or other Fidelity employee may express views regarding a particular company, security, and industry or market sector. The views expressed by any such person are the views of only that individual as of the time expressed and do not necessarily represent the views of Fidelity or any other person in the Fidelity organization. Any such views are subject to change at any time, based upon markets and other conditions, and Fidelity disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for a Fidelity Fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity Fund.

Read a fund’s or pool’s prospectus or offering memorandum and speak to an advisor before investing. Read our privacy policy. By using or logging in to this website, you consent to the use of cookies as described in our privacy policy.

This site is for persons in Canada only. Mutual funds and ETFs sponsored by Fidelity Investments Canada ULC are only qualified for sale in the provinces and territories of Canada.

118567-v2019117

Close Search