decade of reasonable tranquility — and disappointment — global equity markets
have hit another “black swan,” and trust me I use that word with fearful
caution. The coronavirus is truly a black swan in the sense of being both
unpredictable and an event of massive consequence. I believe it is also likely
going to significantly change behavior and approaches at fractal levels across
society and culture, including demand for greater state capacity and
governance. As Nassim Taleb explained to us in his book The Black Swan,
history is seemingly smooth and linear, until it is not. And when it is not — black
swans are responsible for much of what we call history, those large disconnects
where big change happens.
stressors are vital for developing less fragility (or anti-fragility). The
suppression of these stresses has been occurring for decades, since the tenure
of “The Greenspan Put,”1 by trying to avoid healthy recession. This has
been further amplified in the aftermath of the Global Financial Crisis (GFC),
with central banks around the world suppressing natural interest rates levels
along with other fiscal stimulus in the big economies such as the US and China.
This has created fragility by constraining volatility against nature, depriving
markets and corporations of the ability to be stronger and more vigilant. It
also has encouraged complacency, buybacks by professional CEOs and leverage.
One can easily find the analog in public health care — where efficiency has
trumped preparation for pandemics and now, we are witnessing the dire
Although I am
an investor, I can also be a speculator about the broader world. Beyond
elections and markets, I imagine that many, many things may change in response
to this Black Swan event. At the level of global relations, we can hope for
greater collaboration and understanding. Perhaps a renewal of the Pax-Americana
era, which followed the demise of the Soviet Empire, an era of globalization
and liberalization, with more equitable and tolerant leadership in an
increasingly multi-polar world. My bet, however, would be the opposite, and
that the endogenous forces of national chauvinism and parochial interest we
have witnessed over the past decade will get further reinforced. But outside of
obvious triage improvements in public health, I suspect the most profound
changes at the abstract level are likely going to be about a big shift in the
orientation of capitalism. I see a few potential developments:
- The pursuit of shareholder capitalism will come under greater attack. A milder form of capitalism, with less pronounced focus on meritocracy (a “winner take-all” approach), and a greater focus on fairness: re-establishing an ethos of equality of opportunity (which is not the same thing as equality of outcome). After the second massive economic crisis in a decade, the pendulum will shift in the ongoing balance between the state and the market. I also suspect that social demands for greater accountability of governance will grow as state capacity expands. I believe we are moving towards a better world, where redundancy will be more appreciated vs the MBA-orientation of efficiency at all costs.
- Oligopolies will be under pressure. This implies not just technology, which has some level of meritocracy associated with it, but also politically prominent oligopolies which under-deliver innovation and unfairly tax society.
- Corporate empires will face internal pressures to find focus. The behemoths will struggle to overcome the inevitable diseconomies of scale that lodge in as corporate complexity overwhelms efficiency gains. Bureaucracy and process at extreme scale overwhelm competitiveness as these behemoths get disrupted. Leverage is often a catalyst and a bane amongst such companies. Glencore, HSBC, and Anheuser Busch are not in many ways different than Citi and GE at the turn of the century.
Beyond speculation about the world, I have some thoughts on some likely proximate consequences for emerging market equity investors.
1. Contrary to conventional wisdom, Russia may just be one of the great places to invest now.
Russia is the strongest of any major oil economies with a
fortress balance sheet, strong fiscal position and a flexible currency (and
Exhibit 1: Russia is better positioned to cope with US$30/bbl oil price
While oil at $30 will be uncomfortable for Russia, where inflation
is estimated to rise to around 4% resulting in lower real incomes, it will be
devastating for the Gulf economies. Saudi in particularly could run double
digit deficits and see its net debt to GDP soaring to 53% in 3 years.
ultimate losers of this price war will likely be the biggest recent growth
producers – the US shale firms, whose breakeven price lies between $48 and $54,
according to a Dallas Federal Energy survey. By taking advantage of all major OPEC
price stabilization while sitting on a mountain of debt, the shale oil industry
has lost its ability to weather the black swan moment. As the capital market is
turning off its tap on the US shale producers, the number of bankruptcies rose
50% to 42 in 2019, from 28 in 2018. At $30 oil, there will likely be a lot more
US shale producers going belly up this year.
Exhibit 5: Average Breakeven Prices in U.S. Range from $48 to $54 per Barrel
2. China will be reasonably fine.
While the coronavirus has hammered China’s economy, which grounded to a near standstill in February, it has a strong and pragmatic state that acted fast and decisively to contain the spread of the virus.
In response to the outbreak, China has spent roughly 1.2%
of GDP ($150B) — excluding infrastructure investment – on a myriad of targeted
support, including granting waivers and reduction of social charges, lowering value-added
taxes (VAT) for some enterprises, and electricity and gas fees for corporate
Structurally, China has a lot more ammunition in its monetary
policy. It has developed its antifragility out of a host of inherent stressors
in the system – including its skimpy pensions and health insurance system –
which have reinforced its high levels of domestic savings. The culturally
rooted fiscal conservatism has harnessed China for it to emerge stronger from
Exhibits 8-9: Rates table (China vs. US): China was in no rush to follow aggressive global interest rate cuts
3. Latin America will continue the funk.
The economic history of Latin
America involved cycles of high expectations followed by disappointment. The
region’s volatile and uninspiring growth path has been marked by financial
crises and contractions caused by repeated debt defaults and hyperinflation. While
Latin America rode out the previous black swan crisis of 2008 with only a brief
economic dip and little damage to its banks, the region has been in low-growth
doldrums since 2013, with GDP growth averaging 0.8%.
The epidemic is casting fresh light on the region divided by cruel inequalities of wealth and political clout. But beyond aspirations for overarching reforms, Latin American countries like Brazil have never moved upstream to tackle the structural vulnerabilities perpetuating the cycle – including low levels of savings, clumsy states and the prohibitive cost of capital that has been crowding out private investment for years. At 38% of GDP, Brazil’s fiscal expenditures topped all major EM countries in 2019, while its private capital investment has been steadily falling in the last decade – now hovering around 15% of GDP1.
Exhibit 10: Major Latin American economies have lagged behind their EM peers in the last decade
4. The strong — not the oligopolies — will survive and thrive.
The unprecedented non-wartime economic disruption of
social distancing this virus has thrust on us will be painful to all competitors
in multiple industries, and not all will survive. Many marginal players will
face bankruptcy. Others will have to make fateful decisions to reduce
investment in capacity, product development, brands, and talent. Either way,
the strong will emerge even more competitive, gathering market share and likely
gaining higher profitability against more anemic competition.
The old adage “cash is king” is more applicable now than
ever. Companies that have been relying on cheap funding – consequences of central
banks’ excessive monetary interventions – to expand their balance sheets will
likely crumble under liquidity pressure. And a few privileged companies with strong
balance sheets will be able to capitalize on real non-organic opportunities,
which occur when prices are cheap.
In the consumer discretionary space, luxury powerhouse
Kering, restaurant operator Yum China and lodging innovator Huazhu are cases in
luxury goods industry is in for enormous cyclical stress as travel restrictions
and a collapse in wealth hit near term earnings. This – alongside major
structural forces of new consumers, new communications, new channels and new
technologies – will further separate competitively advantages players from the
long tail of struggling and under scaled brands. Kering has demonstrated its ability to
revive a dynamic suite of iconic brands, including Gucci, Saint Laurent,
Balenciaga and Bottega Veneta. In addition to in-house brands, Kering can also
benefit from M&A at attractive valuations.
Similarly, despite concerns over the high operating leverage inherent in the restaurant and hotel businesses, the market has failed to appreciate how resilient leading players like Huazhu and Yum China may emerge even more competitively advantaged out of this black swan moment. As stand-alone hotels close in droves amid China’s national lockdown, the survivors will place even greater value on the risk mitigation benefit of joining large brands than before. Yum China will also be able to garner space and “stomach share” after this current emergency subsides.
5. Irrational competition — particularly in “disruptive’ technology” — will likely become far more rational.
Cheap capital and unbounded ambitions have created unsustainable
business models within the technology sector. If the WeWork debacle was a
warning sign, the upcoming displacement in the real economy, as well as in
financial markets, should end the tech world’s obsession with often spurious numbers
(such as Total Addressable Market, or TAM)2, many of which are used to
justify ever higher valuations. Of late, we have seen the unique spectacle of
businesses in the “sharing economy,” where growth is clearly slowing, but
profitability remains stubbornly out of reach. Such excesses are likely to face
a reckoning, as will reckless capital allocators, such as Softbank, who have
been harbingers of capital and governance related malfeasance, in our view. We
believe that more moderately behaved competitive behavior in China will emerge
and could benefit companies like Alibaba, Tencent and Meituan Dianping. More
rational competition in the Brazil fintech space could benefit companies like
Pagseguro Digital, Mercadolibre and Stone. And we can imagine a possible merger
between Grab and Go-Jek, which could help to reshape ridesharing and” super-app”
platforms in South East Asia.
Our investment philosophy is driven by a long-term
orientation and focus on differentiated research. We are deliberately not
tactical as we attempt to restrain the team from decision fatigue, and
hopefully poor decision making. In times like this we are reassured by our
North Star compass, which guides us in an environment as turbulent and
devastating as markets are today. We have been through a fair number of black
swan events over the decades investing in emerging markets. And we trust that
our focus on high quality companies with low capital intensity, resilient
balance sheets and sustainable advantage will lead us in navigating this one
Despite the near-team challenges that all of us are facing, we remain excited about the opportunity that emerging market equities can provide for investors. We believe the most compelling opportunity for investors is to avoid short-term tactical positions and macroeconomic calls and instead focus on companies that have the potential to deliver strong, long-term financial performance. Investors should focus on sustainable competitive advantages and real options that can manifest over time. We look for companies that have innovative products or unique assets that capture demand domestically and/or outside their home economies and real options that can manifest over time. We look to avoid mean reversion/pattern recognition; capital-intensive, cyclical industries; companies without sustainable advantages; firms whose fortunes depend on product cycles or gadgets; state-owned businesses or companies with other governance conflicts. We believe these types of opportunities offer investors the greatest potential for compelling results over time.
1. Source: World Bank, https://www.theglobaleconomy.com/Brazil/Capital_investment/
December 31, 2019, Invesco Oppenheimer Developing Markets Fund had assets in
the following companies: Glencore
(1.05), HSBC (0.00%), Annheuser Busch (0.00%), Citigroup (0.00%), General
Electric (0.0%%), Huazhu (2.73%), Kering (5.09 %), Yum China (2.57%),
WeWork/The We Company (0.00%), Softbank (0.00%), Alibaba Group Holdings
(6.97%), Tencent Holdings (4.89%), Meituan Dianping (1.03%), Pagseguro Digital
(0.33%), MercadoLibre (0.29%), Stone Co. (0.44%), Grab (1.46%) and Go-Jek
December 31, 2019, Invesco Oppenheimer Emerging Markets Innovators Fund had
assets in the following companies: Glencore (0.00%, HSBC (0.00%), Annheuser Busch
(0.00%), Citigroup (0.00%), General Electric (0.0%%), Huazhu (2.92%), Kering
(0.00%), Yum China (3.25%), /The We Company (0.00%), Softbank (0.00%), Alibaba
(0.00%), Tencent Holdings (0.00%), Meituan Dianping (0.00%), Pagseguro Digital
(2.46%), MercadoLibre (0.00%), Stone Co. (0.00%), Grab (0.00%) and Go-Jek
- The Greenspan put was
a trading strategy popular during the 1990s and 2000s as a result of certain
policies implemented by Federal Reserve Chairman Alan
Greenspan during that time.
Greenspan was chairman from 1987 to 2006. Throughout his reign he attempted to
help support the U.S. economy by actively using the federal funds rate as a
lever for change which many believed encouraged excessive risk taking that led
to profitability in put options.
addressable market, also
called total available market, is a term that is typically used to reference
the revenue opportunity available for a product or service. TAM helps to
prioritize business opportunities by serving as a quick metric of the
underlying potential of a given opportunity.
reversion, sometimes referenced
as reversion to the mean is a finance theory that states asset prices and historical returns
eventually will revert to the long-run mean or average level of the entire
dataset or population.
investments may be volatile and involve additional expenses and special risks,
including currency fluctuations, foreign taxes, regulatory and geopolitical
risks. Investments in securities of growth companies may be volatile. Emerging
and developing market investments may be especially volatile. Eurozone investments
may be subject to volatility and liquidity issues. Investing significantly in a
particular region, industry, sector or issuer may increase volatility and risk.
expressed are those of the author as of March 18, 2020, are based on current
market conditions and are subject to change without notice. These opinions may
differ from those of other Invesco investment professionals.
not constitute a recommendation of any investment strategy or product for a
particular investor. Investors should consult a financial advisor/financial
consultant before making any investment decisions. Invesco does not provide tax
advice. The tax information contained herein is general and is not exhaustive
by nature. Federal and state tax laws are complex and constantly changing.
Investors should always consult their own legal or tax professional for
information concerning their individual situation. The opinions expressed are
those of the authors, are based on current market conditions and are subject to
change without notice. These opinions may differ from those of other Invesco
Holdings are subject to change and are for illustrative purposes only and should not be construed as buy/sell recommendations.