Talk Your Book: Emerging Markets Are Back

0:00Today's Animal Spirits Talk Your Book is brought to you by Schaefer Cullen. Go to CullenFunds.com to learn more about the Cullen Emerging Markets High Dividend Fund. That's ticker CEMFX. Again, that's CullenFunds.com to learn more.

0:16Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:46Welcome to Animal Spirits with Michael and Ben. Michael, insert the Al Pacino from Godfather 3 just when I was out. They pull me back in. That's got to be one of the only good parts about Godfather 3. Never saw it, never will. All right, don't. Emerging markets, I looked on a total return basis, are up over 32 % this year. We're recording this on October 20th. I'll do you one better. Okay. Or no need to one up. I'll do you one also. Okay. This is surprising. Since the beginning of January, 2024, almost a full two years. And think about all of the dominant financial headlines, MAG7, US stocks, American exceptionalism.

1:32Open AI. Yeah. All that. Industrial revolution. Since January 2024, emerging market stocks and US stocks are even-steven. That's kind of hard to believe. That is surprising with how well the US stock market did in 2024. Now, a very easy counterpoint, which doesn't negate what I said, but is, all right, well, how about 23 and 22 and 21 and 20 and 19? Like, US stocks have been in a bull market for a long time. EM hasn't. Nevertheless, it's just I was surprised to see that it's neck and neck for the last almost two years. Right. And I guess if you were going to make a claim, you'd say, well, listen, things have changed, right?

2:15The dollar is down a lot. It's possible the U.S. will continue to pursue a weak dollar strategy, and that would be good for emerging markets. It's really good for international stocks. I think it's really, really good for emerging markets if we can quantify that. And so a weak dollar, which we haven't had in a while, a sustained period of it, makes a lot of sense. Yeah, I definitely wouldn't have said it. Yeah, sure, emerging markets is going to be the outperformer this year. But I guess that's how this thing works. So on today's show, we talked to Raul Sharma, who is a portfolio manager at Schaefer Cullen Capital Management.

2:48We've had Raul on the show before. He has a real boots-on-the-ground approach. He tells us about his trip to China, which after we read Dan Wang's book, Michael, I almost feel like I have to see it now. Well, I also read China and Apple. Or no, I'm sorry. Jeez. Apple and China. Apple and China. So I've read 100 % more books than you have been about China. So catch up. I think the actual growth there is 50 % more books than me. Well, either way.

3:18Yeah. No, no, no, no, no. You've graduated from tourists. Excuse me. I've read twice as many books as you have. Okay. So yeah, you've graduated from tourists to actual expert, and I'm still a tourist. China and Apple. Nailed it. Anyway, we talked with Raul about a bunch of different stuff. We talked about the dollar and China and dividends in emerging markets, which still matter a lot. And then their EM strategy, which is the Cullen Emerging Markets High Dividend Fund. So here's all that and more with Raul Sharma from Schaefer Cullen Capital Management.

3:55Raul, welcome back to the show. Thanks, Mike. Thanks for having me again. All right. So Ben and I recently read a book called Breakneck by Dan Wang, China's Quest to Engineer the Future, which makes us pretty much experts on China. And he wrote something that was obvious after reading it, but Ben and I are tourists here. So he basically, the premise of the book is that China is run and built by engineers and the United States is built and run by lawyers. And so the way that things get done, the way that things are built, very different incentives, very different structures, obviously. China is a third of the benchmark, give or take.

4:42How do you think about, maybe since you had first hand experience, how do you think about how the different cultures trickle into equity markets, how they think about shareholders and how that impacts how you build a portfolio? Yeah, Michael, that's a good question in terms of the engineering talent from China and kind of what we're seeing there. And I had just gotten back from China and we spent a lot of time looking at kind of some of their newer technologies, whether it be what they're doing with AI, autonomous driving, robotics, humanoids, all those sorts of things. And they're just very, very good.

5:15They have a lot of engineering talent, more engineers probably than any other country in the world. And they're just very creative of how to build things in a less costly way and in a more constrained way. So if they can't get NVIDIA's best chips, that's not really holding them back as much as maybe the US thought it would when they put those kind of restrictions on them. And, you know, if you just look at their large language models, you know, their leading models are maybe only 5 % to 6 % behind, say, a chat GPT, which is kind of the industry standard. But I've heard estimates of the cost being about 90 % less expensive to build.

5:51So when you think about the cost efficiency of what they're building, it's really quite impressive. And, you know, being 5 % or 6 % behind is really, you know, you got to really think about who actually needs that 5 % or 6%. I mean, the models are so advanced as they are. So I was very impressed with that. And if you just look at other areas, particularly newer technologies like, say, electric vehicles, robotics, humanoids, battery storage, they clearly have a global lead. There's a lot of ways to point to this. You can look at the number of patents filed, the number of scientific papers that have come out.

6:24They're still behind in older areas like, say, semiconductors or software or maybe space and defense technology. But even there, they're definitely catching up. And I think it is a tribute to the engineering talent they have and just how hard they work. I mean, these people are working very, very hard. And so I'm impressed with that. In terms of the second part of your question, in terms of governance, that's something that's definitely sweeping Asia this year, that you're seeing a massive wave of governance reforms. It kind of started a couple of years ago in Japan. Now, this year, it's really South Korea is probably in the forefront.

6:56But I would say almost every country, even places like Thailand, Indonesia, they're doing things also to try to improve corporate governance and improve valuations. And China has also been doing the same. In fact, I would say that China has probably been the global leader in terms of the percentage of share buybacks and dividend increases that the companies have made over the last five to seven years. And they're not calling these reforms kind of any program. Like in Korea, they call it the value up program. They're not calling it anything, but it's essentially the same thing where the government is telling companies to have better corporate governance, to do more buybacks, and just to be better companies.

7:33And I think that that is making a difference, and it's one of the catalysts for that market this year. So there's the old saying that the U.S. innovates and China imitates, right? Do you think that a lot of people who have that mindset are totally underestimating what they can do in China? because it's not just like they're taking our plans and building out the hardware and software that we tell them to. You're right, they're actually engineering things on their own now. Do you think a lot of people underestimate what China can do on the tech front these days? Definitely, for sure. And like I said, especially with regards to the leading and emerging technologies where there's really nothing to imitate because they already kind of have the lead in so many of these areas.

8:10So I think that was more of a model of the past. I mean, I'm sure there's still a lot of that kind of going on, but I think it's a lot less. And, you know, when you sit down with some of these companies, they're just very impressive, you know, across the board, not just, you know, AI companies or tech companies, but a lot of their electric vehicle companies are really kind of trendsetters in what they're doing. If you look at some of the new EVs that they're producing, these are just really beautiful cars. I mean, I think the Ford CEO was on record of pointing out how good these cars are. He actually used one for several months to just kind of get a sense of, how capable they are.

8:46And I know he came away quite impressed. So there's a kind of a US industry insider kind of pointing to the same thing. Well, I know we've had you on before, but for listeners that might be new to Schaefer Cullen, let's zoom out before we zoom back in. How do you all think about running a portfolio? What's different about what you do versus some of the traditional ways that advisors might get access to emerging market exposure? Well, first of all, we're active. And, you know, I think that's a big difference. You know, we use a Benjamin Graham style value investment discipline, which, you know, basically means two things is that we're trying not to pay up.

9:22We don't pay up in terms of the multiples that we pay for stocks. And then we're very long term investors and we don't stray from our discipline. So I think that that's pretty unique. But then we do a lot of other unique things with this strategy, which I think are particularly important to emerging markets. We do a lot of country research to manage country-related risks because they matter just that much more in emerging markets. So if you look at our alpha generation over time, I think you see a healthy split between stock selection and country selection. And I think that's a function of the Ben Graham-style process, but then also that kind of top-down, kind of more risk management work that we do as well.

9:55Do you find – because a lot of people have decided, like, I'm abandoning the Ben Graham framework in the U.S. It doesn't work anymore. These big tech stocks, growth just seems to always beat value. Do you find that there's a difference between the growth and the value parameters overseas, and especially in emerging markets where that stuff still works much better than it does in the U.S.? Yeah, definitely. I mean, I think there's, well, for one, there's a lot less of a distinction between growth and value in emerging markets. Now, it's starting to grow again as growth outperforms value in the year to date.

10:23But because some of the former darlings, particularly some of the Chinese companies, some of the Chinese internet companies, corrected so much in recent years, these growth stocks essentially became value stocks and we pounced on them we bought them too because they were finally in our range and they were paying dividends and increasing dividends like i mentioned so there's a there's a bit of a less disparity uh i would say in emerging markets and there's certain kind of growth themes like ai that i just think are much better play better ways to play it than in the u.s or in emerging markets just because the stocks are you know so much cheaper i was looking at a group of like ai suppliers like semiconductor companies server companies, companies making cooling systems that we own in our portfolio and comparing them to the U.S.

11:04counterparts. And they're 50 % cheaper with a yield that's still over 3%. And if you look at some of the AI enablers called companies like Alibaba or Tencent, they're still about a third cheaper than the U.S. counterparts. So it's a cheaper way to play, I think, megatech growth themes and not just AI, but really across the board because a lot of technology supply chains run through emerging markets. And those stocks are still trading at attractive valuations. One of the big headwinds for US investors anyway has been the dollar. Talk about how that impacts both international flows and maybe more importantly, how it impacts investors.

11:47Well, a declining dollar has always been a huge catalyst for emerging market stocks. I think we've shown that if you look at the 10 periods where the dollar declined by more than 10 percent before this current period emerging market stocks were up on average by about 45 percent and there was a 90 percent hit rate it happened nine out of 10 periods and so it should be no surprise that in the current year when the dollar has gone down by over 10 percent emerging markets are up over 25 percent it's it's it's it's quite typical and there's reasons for it that um it really kind of relieves emerging market countries particularly those that have a lot of debt or u.s dollar denominated debt or depend a lot on U.S.

12:21imports, which is a lot of countries. All of that gets better for those sorts of countries. So it really is a big thing. And we tend to think it's probably going to continue to happen. And we can talk about why that might be, if you'd like. So I was looking at this today, and I was looking at the emerging markets versus foreign developed stocks versus the S &P and the NASDAQ and the Russell 2000. And emerging markets have the lead over all of them. And I'm not sure many people would have predicted that coming into the year. How much of this is because of the dollar falling double digits? And how much of this is other fundamental factors at play?

12:56I think the big thing is the dollar, no doubt. But then, you know, I think it's also those reforms I mentioned that these are very positive things, these corporate governance reforms, like I said, particularly in markets like South Korea, which had really been a dead market for the last, you know, 10 years, all of a sudden, and it might even be the single best performing emerging markets country. And that's all in the back of these reforms that they're doing. I mentioned that's also happening in China. Certainly, you're seeing very strong earnings growth coming out of particularly the technology side of EM, which we were talking about, for the same reasons you're seeing it in the U.S.

13:29I mean, they're essentially benefiting from the very same demand drivers as the MAG-7 is because they're supplying the MAG-7. So those are some of the things that are really helping emerging markets. And yeah, I think that the fact that foreign investors are losing money on U.S. stocks or not making much because the dollar has gone down so much, all of a sudden they're looking for other places. And that's a good thing for fund flows. When you think about value within your mandate, is that at the country level, the company level, the sector level? Because a lot of these names and a lot of these countries tend to trade cheap to the U.S.

14:02for reasons that you can get into if you'd like. So how do you think about that and how do you incorporate that into your framework? I mean, first and foremost, it's on a company level more than anything else. But yeah, I mean, you are going to see us where you see kind of P's lower and dividend yields higher and also not overhangs in terms of kind of country factors to create overhangs, whether it be the external position of a country or poor corporate governance. That's where you're going to see more of our exposures. But, you know, I like to think that there's good ideas kind of, you know, everywhere in terms of how we think about value.

14:35I tend to think of that as we're kind of more of a core value manager. I mean, we like deep value stocks, but with deep value stocks, you tend to get kind of a lot more hair on those stocks in terms, especially in emerging markets, with things like poor corporate governance or with things like balance sheet risks. So while we're always looking for those kinds of ideas, it tends to kind of be more core value in each year. But then, as I mentioned, I think the distinction between value and growth is that much less in emerging markets. You mentioned before the thinking through the country selection, how that's a big part of trying to find alpha in emerging markets.

15:08I'm curious how you try to balance that out when thinking through a valuation framework. Because obviously there's plenty of emerging market countries that could have like single digit PEs, right? But it's for a reason because they're not shareholder friendly. So how do you balance out that desire for value with the fact that you need to make sure the country is high quality enough where they're going to take care of shareholders? Yeah, I mean, we try to use it more as a risk management tool or a country research. And we try to kind of limit exposures to countries that might be cheap, but might have a lot of other problems.

15:38Now, the best example of that over the last 10 or 15 years would be Russia. Because if I just looked at low PE and high dividend yield and even dividend growth, I would have probably had a third of my portfolio in Russia. But because Russia has a lot of other problems from an investment perspective, we always had a lot less. And I think it's just important to understand when discounts to the historical valuations of countries grow. So I think that's another thing that's supporting the Chinese equity market versus, say, three to four years ago. Three to four years ago, I'd say there was a discount that was due to three reasons.

16:10One was, you know, first, how poorly the domestic economy was doing. Second, there was a huge regulatory crackdown on the internet companies, the leading companies there. And then third, there's really, you could say, four reasons. Transparency and corporate governance was just kind of okay. And then fourth, you always have this risk of a war with Taiwan. So if you fast forward to today, I'd say that two of those factors have gone away. All of a sudden, the government's kind of supporting the technology companies. and I mentioned all the reforms that they're doing to improve corporate governance.

16:41So then you could see how a discount that, you know, might have been a lot larger in the past should be a lot smaller. And, you know, we could kind of talk about this all day, depending on the countries where discounts are growing and where they're not. Certainly the external position of a country is very, very important. There are, you see countries like say Turkey or Egypt, I think they're very cheap just because they have such a weak combination of twin deficits, low levels of reserves, lots of debt. That's another thing that tends to weigh down the country valuations in those sorts of countries.

17:12One of the things that makes our capital markets different is not just we have the best companies in the world, biggest earnings, highest growth, all that sort of stuff, but it's the investor appetite for risk. How does that compare to other countries around the globe, specifically the ones that you're covering? And is that a permanent headwind for investors or are they getting wise to the fact that they need to do something more similar to what we're doing? And does that potentially unlock value going forward? Yeah, I think the countries are realizing that we need to do things more like us in terms of some of the governance.

17:49Although it's very interesting because what's happening out in the US, I would argue we're going the other direction all of a sudden. And because all of a sudden we're having SOEs, state-owned enterprises being created in the US with the government taking big stakes in companies. We're having these cross-shareholdings emerge, which we never had before with companies taking big stakes in one another. And then I think there's no doubt that there's a lot more companies that are kind of trying to please the administration by some of the investments they're making. And all that reminds me of what happened in markets like China, to be completely honest with you.

18:18Now, it's very, very small. What I'm saying is, I think it's important that there's a shift because then as I described in places like Asia, you're seeing the opposite happen where they're trying to be like, we've always been in the past and improve that governance, get rid of those cross-shareholders. That was probably the biggest driver of the Japanese market. Cancel treasury shares, improve corporate governance. So I think it's interesting to see which way the tide is turning in emerging markets compared to the U.S. So Michael started talking about China, and that, again, I think it's a third or so of the EM index.

18:50Do you believe that they'll start caring about shareholders? Because I think that, I mean, a lot of people have talked about this, the fact that the economy is growing at like 10 % a year, but the stock market went essentially nowhere since like 1990. Like, are they actually going to be willing to accept that as part of their culture? Because that does seem like it's a cultural thing where they haven't been as reliant on the stock market as we have for household wealth. Well, yeah, that's become much more important for them. In fact, the stock market is the key tool now for them to kind of, I would say, get the domestic economy going, which is what they really want to do.

19:22They can't really rely on the property market because that's just, too far, just has a lot of problems. There's still high youth unemployment. That's not so easy to fix either. So the thing that they can do to make people feel better about spending more is to have the stock market do better. And I think that's one of the reasons why you've seen them be quite supportive of the stock market and want to put in those governance reforms so that the multiples of your average stock can go up. And it's not that Chinese people do not have a lot of money. They have a lot of money. They just don't want to spend it right now.

19:51So there's a lot of speculation and another potential catalyst for emerging market is that you're going to see a lot of that money coming into the market. And I think you definitely have. You're especially seeing it coming. If you look at some of the H-share, these new listings in the H-share market of leading Chinese companies, these IPOs are doing very, very well. I mean, the Hong Kong market's having a banner here for IPOs, and a lot of that money is coming from local and domestic investors. International equities. I assume that the drivers of returns are the same as here. I mean, over the long term, its earnings?

20:23Or is there anything different about the way that their stocks behave relative to fundamentals and ours? I mean, the big difference is that here we've benefited from a lot more from multiple expansion. You've seen a lot less of that in virtually all markets. Maybe you're starting to see some of it now. But generally speaking, yeah, it's very similar in the sense that earnings growth drives stock prices. And there's a very good correlation between long-term earnings growth and stock prices. And that's another thing that is good for emerging markets is that if you look at, say, Bloomberg consensus, which in Italy, that's usually wrong.

21:01But still, if you're looking at three years, the EN index actually has the best average annual earnings growth than any major index, including the S &P 500. And then the stocks are, of course, about 40 % cheaper. How much of an overhang do you think the potential conflict between China and Taiwan is having over the index? I know it's been like something that people have talked about for years now. And part two of that question is, is it possible that there is like some sort of, I don't know, positive announcement that might re-rate these stocks higher? Well, I think that is a new discount on Chinese stocks that started to exist a few years ago that didn't exist prior to that.

21:42I think it's being offset right now by some other positive emerging factors that I alluded to. But yeah, it definitely has an impact, even on us. I mean, we have made one change in the way we invest in that region is that we really don't do small to mid caps, which we tend to like in really either market, just because we want to be in a position where if there was a war that we could be out of that market quite quickly. Now, I don't think that's going to happen anytime soon, but it's something that we have to be aware of. I think, you know, other investors have even gone, you know, one or two steps further and said, well, that makes, you know, investing in these stocks completely uninvestable.

22:18You know, I wouldn't go that far, but it's definitely something that you always have to be mindful of. You mentioned your trip to China earlier talk. Any other countries that you go to that you that you think people in the U.S. would be surprised how far advanced they are and some of the investment opportunities that are available there? Well, there's been a lot of change in India, for sure. if you go and like visit Indian airports these days. In fact, the newest airport, which is slated to be the most efficient airport in the world is opening up very, very soon outside of Mumbai. But that's a place where you've just seen dramatic change across the board.