An investor who shun the US equity market as well as technology companies in 2018 and instead focused on emerging markets, which are more attractively valued, would have found it impossible to out-perform. US technology stocks make up close to 15% of total global market capitalisation and investor positioning in this sector is a much bigger factor than 20 years ago, where it was only a small part of equity markets.
Is the macro environment not supportive of Emerging markets?
In a nutshell, the macro environment is relatively strong and does not on its own explain the under-performance of emerging markets this year. Global growth is tracking at a comfortably above-trend base at +3.2% and it is therefore strange that emerging markets are not doing as well as expected, especially with manufacturing output globally recovering from weakness earlier in the year. Last week’s US employment report suggests the US will get the globe off to a strong start in July and economic momentum will thus be maintained.
On the flip side of strong global growth are two significant short-term concerns
- China & Trade: The US is looking into raising the tariff on the proposed next round of $200bn of imports from China from 10% to 25%. China threatened to retaliate with new tariffs on $60bn of imports from the US.
- The Federal Reserve has raised interest rates over the last 18 months from record low levels causing a rally in bond yields and increasing the cost of capital for all businesses in the process. The markets are concerned that higher US interest rates will ultimately flow through to pressure emerging market equities as investors demand a higher margin of safety (read: lower valuation).
What are the impacts of Western behemoths on emerging market competitors?
This year Tencent, Alibaba and Bidu have had mixed performances, with Tencent down 15%, Alibaba up 5% and Bidu going sideways. Perhaps investors have sensed that these companies will face more competition in their home markets, where they have had a clear path to growth in the past whilst enjoying some protection from foreign competitors. High valuations at the start of the year also meant that a lot of growth was already baked into these companies’ share prices.
Google made an interesting announcement last week that they are initiating an expansion of their services into Asia. Google is in talks with Tencent Holdings Ltd., Inspur Group and other Chinese companies to offer its cloud services in China. It follows the announcement earlier last week that Google is developing a version of its search engine for China that would block information the Beijing government considers sensitive. If implemented, the move would mark a dramatic reversal by the Alphabet unit, which exited the mainland in 2010 after refusing to comply with its censorship practices.
With the arrival of Google as a potential competitor to the big Asian technology companies, we continue to monitor its actions. The US-based company has made it clear that the goal of the cloud initiative is to run Google internet-based services via the domestic data centers and servers of Chinese providers, similar to the way other US cloud companies access that market.
We own a selection of global technology companies where we believe they can compete on a global basis including Google and Tencent.
Recently we have also invested in Facebook as a good example of a US-based company with big ambitions to expand into emerging markets. Facebook comprises of a selection of online and mobile platforms that generate the vast majority of their revenues through advertising. These platforms include Facebook, Instagram, Messenger and WhatsApp.
Facebook exhibits very strong underlying growth in both revenues and free cash flows whilst maintaining significant barriers to entry for new competition. Concerns around heavy capital investment over the next few years along with client confidentially issues are no trivial matters, but as long-term investors we believe these concerns are outweighed by positives, including:
- A large growth runway, starting off with the Facebook platform itself. The company continues to innovate with advertising efficiency, which makes the platform more attractive and will positively impact active engagement on the site.
- Beyond the Facebook platform there is Instagram with over 1 billion active Instagram users on a daily basis. Ads continue to expand strongly on this platform and we believe that ultimately this will become just as financially rewarding as the Facebook site.
- At present monetisation is significantly less as the company continues to experiment with advertising formats. One of the large success stories of Instagram has been Stories, which we believe will continue to drive revenue growth for years to come as advertising methods become more sophisticated.
- Further down the line in terms of monetisation potential, we have Messenger and WhatsApp. Messenger has 1.3 billion monthly actives on the platform with over 8 billion messages now sent between people and businesses per month. WhatsApp has been experimenting with payments in India. Ultimately, these are platforms that can open up revenue avenues for Facebook to drive profits higher.