Trip Report: Cairo, Egypt, October / November 2016

In my research and investing I stress three things: people, structure and value.  I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests and trade at valuations that are below fair value if not outright cheap.  This post is about a recent trip to Cairo, Egypt and touches on people, structure and value – as well as lots more - in that country. 

The purpose of the trip was to generate a short list of quality companies I’d like to own stock in if/when the currency is revalued.  Egyptian equities appeared on my value screens back in March, but corporate responsibilities kept me tied to home.  

I was also concerned that Egypt’s currency was going to be devalued.  There was a large and growing gap between the official and black market rate.  Russian stocks popped higher soon after their currency was floated in early December 2014, and I wanted to get my ducks in line in case the same thing happened in Egypt. 

Readers are advised to note that it was my first time in Egypt as well as my first time in the Middle East.  Most of what’s not referenced below comes from on-the-ground meetings rather than from verified sources.  The people I met were mostly financial and corporate professionals, who are generally more conservative, educated and less willing to rock the boat.

Meet the New Boss. Same as the Old Boss?

One of my first impressions of Cairo was the heavy security presence on the way from the airport to my hotel.  There were suited ‘undercover’ security men standing every 400 meters or so on the access road’s median strip and straight through the tony Heliopolis neighborhood.  Toward the end of my trip I was politely told not to take pictures at a major intersection near my hotel by a serious, well-dressed man with a walkie-talkie.

Despite having one the world’s oldest continuous parliaments, the country has been basically under military control since the 1950s.  Nasser, Sadat, Mubarak and now Sisi all come from the military.  And this doesn’t seem likely to change.  Nobody I talked to had anything positive to say about Morsi’s and the Muslim Brotherhood’s short stay, and there does not seem to be any other decent sized and well organized opposition.  I was told that most Egyptians feel that the military provides welcomed stability in volatile region.

While nobody I met had anything good to say about Morsi and the Muslim Brotherhood’s brief government, I’m sure this view is not shared by all.  Members of Hasm, reportedly a new group aligned with the Muslim Brotherhood, certainly don’t feel this way.  They recently took time and effort away from more productive activities to bomb and kill six police who were stationed on the road leading to the pyramids (see here).

Much of the outward appearance of stability could be due to suppression of the press and dissidents.  The government is not shy about keeping the press under control by jailing journalists, and some reports note that the present government is more repressive than previous ones (see here, here and here).

Foreign Exchange Nirvana

Virtually all discussions on the economy focused on the currency.  Egypt imports a lot and virtually all trade is done in USD (United States Dollars).  It’s one of the world’s largest wheat importers for instance.

Virtually every meeting with corporate executives began with a discussion of the currency - how they are sourcing dollars from the ‘parallel’ market, how much of the higher costs they can pass onto customers, and how and when the situation will end.  All were adamant that the situation was unsustainable and had to change.  None thought the change would come so quickly. 

It happened when I was there which, for an emerging markets geek like me, made it a super exciting week!!  So please forgive me if this section is a bit long-winded.

When I arrived on Sunday USD1 bought EGP8.88 at the official rate (EGP stands for Egyptian Pounds). However, the black market rate was EGP15, up from about EGP12 just a few months ago.  This means that people who exchanged their USD to EGP on the black market could buy twice as much as if they exchanged their currency at the official rate. 

It also means that companies that import raw materials, equipment and finished products needed twice as many EGP to buy the same thing when using the black market rate.  Few non-government companies could get enough USD at the official exchange rate so they relied on the parallel market.

By Tuesday – just two days after I arrived - the black market rate shot up 20% to EGP18, before falling by 33% to EGP12 the next day (Wednesday).  The dramatic one day fall foreshadowed the next day’s news that the currency was going to be set free (Thursday).  It fell to EGP15 by the time I left (Saturday).  It has declined further and, as this is being written, is trading a little over EGP18.

To put this in perspective, my daily breakfast at the Hilton cost EGP205.  At the old official rate of EGP8.88 to one USD, my breakfast cost USD23.08.  By the time I left it cost USD13.53, and at the current rate it cost USD11.39, or 50% less than it did at the old exchange rate.  Not as cheap as I’d like, but certainly not as expensive as before. 

Second cheapest Big N' Tasty meal in the world?
USD3.20, Cairo, 5 November 2016

After the change, prices in Egypt are not very expensive.  In fact, after Ukraine it has the least expensive Big Macs in the world.  At the hotel across the road from my hotel it cost EGP26, or about USD1.50 at current exchange rates.  (Link to The Economist's Big Mac index is here).

A quick stop at Carrefour confirmed this.  A 1kg bag of pasta cost EGP10 (US$0.66), pre-cooked large salami pizza EGP22 (USD1.46), and a French baguette, EGP5.75 (US$0.38).  This was a month ago and right after the devaluation, and with inflation expected at 25-40% next year, it’s unlikely they’ll stay so cheap. 

Stocks on Sale Too

Carrefour's Inexpensive Pasta
Cairo, 5 November 2016

Another way to look at this is that all the stocks were at a 50% sale for USD investors on Thursday as compared to Wednesday.  And who doesn’t like a sale? 

Investors certainly do and have bought heavily with the headline stock index increasing some 30% in the month since the currency was freed.

For foreign investors there is an additional problem of getting your money out and into the currency you want.  It’s easy to transfer USD into Egypt, but it may take a while to get it out as government approves all foreign currency outflows.  There have been signs of this improving, and with the currency now freely exchangeable, theoretically there should not be any problems.  However, governments everywhere are loath to give up power and fiddling with the currency exchange plumbing may be around for a while.  

Other potential inflationary reforms have also been implemented.  In August Egypt’s 150-year old parliament approved a 13% VAT tax, and more recently the government halted many subsidies on food and oil which had been in place for decades. 

In addition to freeing its currency, the central bank raised interest by 300 basis points (i.e. 3 percentage points), and Egypt now has some of the world’s highest interest rates at over 15%.  This was done in a bid to shore up the currency and in an effort to stem inflation.  

Long term these reforms should be good for the Egyptian economy, but there’s going to be a lot of short term pain.

Going Underground

One saving grace may be Egypt’s large underground economy.  It’s believed to be as large or larger than that tracked by official statistics.  Senior bankers note that only about 10% of Egyptians have bank accounts, which means that for the vast majority, Egypt remains a cash based economy.  Except for the minority very few Egyptians had access to the official exchange rate, so one could argue the dramatic fall in Egypt’s currency had already been absorbed by the majority of the population.  The new rate reflects what most Egyptians are already dealing with.

Meeting with consumer goods companies seemed to confirm this.  They have been steadily raising prices to cover USD purchases of raw materials like sugar and wheat.  Several noted that there was little decrease in demand despite higher prices.  Perhaps the economy is more resilient than the official figures suggest. Hope springs eternal.

Crowded House

One big problem could be crowding out by Egypt’s state and military owned companies.  Egypt's largest fertilizer producers, telecommunications company, and its tobacco monopoly are government owned.

I’ve not come across any credible figures but it’s speculated that the military and the companies they control account for 5-40% of the economy and that they crowd out private enterprise (see here). 

This is not unusual in developing countries.  China’s PLA and Indonesia’s ABRI were also heavily involved in business not that long ago.  Troops need to be paid and if the government doesn’t have the budget, smart generals do what smart people all over the world do – make do.

  

An example of this is the military backed cement plant that’s being built by a subsidiary of China government owned Sinoma (see here).  According to meetings with cement company executives, Egypt’s cement supply is already in surplus and a new plant that doubles capacity is not needed. Governments and state-owned-companies are typically bad at allocating capital and I doubt that two together will be any better.

In addition to curtailing the government and military’s business ambitions, Egypt can do a lot more to level the playing field for entrepreneurs and business people.  It’s ranked 122 out of 190 countries in the World Bank’s “2016 Doing Business Report”, which looks at the factors that impede or assist in business formation, construction permits, etc.  Big macro reforms like those written about above make the headlines, but making it easier to do business by cutting down on the time and costs of starting and running a business is just as much if not more important.

The Only Thing to Fear is Fear Itself

Egypt’s reputation is not very good these days.  Before my trip literally everybody said I should be very careful there.  Between the bombing of a Russian plane last October, continued problems in the Sinai, and fighting in nearby Syria, Iraq and Yemen one will naturally feel nervous.  The recent bombings near the pyramids and a Coptic church certainly won't help (see here).

Selfie With the Locals,
Giza Pyramids, 4 November 2016

Tourism is way down and I was told it’s not just the Russians and Europeans who are staying away. Regional visitors have curtailed trips for the same reasons.  According to the locals, Cairo was a fun destination where Arabs from stricter countries used to go to let their hair down.  Alcohol is available, there are no dress restrictions, and the Internet is free and open from what I can tell.

So my guard was up when walking around Cairo and visiting the pyramids. But I encountered no problems besides the usual pesky salesmen. The only people who approached me were overly friendly teenagers wanting to practice English and take selfies with a foreigner.  This reminded me of traveling in China some 30-years ago when foreigners were a rare sight and nervous kids yelled a friendly hello to the passing ‘laowai’.   

My fears seem to have been misplaced.  Egypt was recently taken off the US State Department’s travel warning list.  According to their ranking, traveling in Egypt is safer than anyplace in Europe, if recent reports are accurate (see here).

Investing

For US investors Egyptian stocks are not very expensive.  Measured in USD, its headline index, the EGX30, is bumping along close to the 10-year low levels it reached in 2009 and 2011.  However, when measured in EGP the index is at a 10-year high.

Egypt reminds me a lot of Indonesia, a country I’ve written about before (see here, here, here, and here).  Like Indonesia its demographics are very young with about 30% of its population below 14.  Both are the most populous countries in their respective regions.  Egypt is the largest in the Middle East and third-most populous in Africa.

Both are overwhelmingly Muslim – about 90% in Egypt.  Both are moderate Islamic countries.  An example of this is its current domination of women’s squash where all three top spots are held by Egyptians (see here). 

While parts of society seem modern, one is also reminded that Egypt has one of the world’s highest rates of FGM – female genital mutilation.  Despite laws against it, many websites report that it’s still widely practiced (see here).

While Egyptian stocks are now close to the cheapest they’ve ever been for USD investors, it does not feel like the fat pitch of Indonesia in Sep 1998. This is when the Indonesian index reached its lowest point ever in USD terms.  It fell a stunning 93% from July 1997 when the Thai Baht and Indonesian Rupiah collapsed.  The low point coincided with widespread riots in Jakarta and other cities, and the stepping-down of then long-term president and military strong man Suharto.  One should note here that there were 14 months between the initial currency fall and when the market and currency hit bottom.  It’s only been one month since Egypt changed its exchange rate, and instead of the market falling, it’s increased.  With more inflation to come to an already frustrated and increasingly poor population, political and societal uncertainty are still high and may not be fully reflected in the market.

A big difference is that Indonesia’s depreciation was unplanned.  All the business people I met in Cairo were anxiously waiting for the currency change so they could get back to business instead of spending time skirting the law in a search for USD.

The change can also help Egypt to become more competitive.  I was impressed with the managers I met at one of the world’s largest carpet manufacturers, and the lower and free currency means that they can compete very favorably with their biggest competitors in Turkey.

Wrapping Up

I was impressed by the people I met in Cairo as well as the numerous Egyptians I met during a short stay in Dubai.  The country has a lot of educated and switched-on people.  It should be to Egypt's benefit if their government and military is there to support rather than compete with them.

I don’t envy the changes, struggles and hardships that my Egyptian brothers and sisters will likely go through in the next few years.  Saying that short term pain leads to long term gain rings hollow when parents have to tell their children they can't afford meat, or to attend the university they expected to go to, or even delaying marriage because there’s not enough money.

But as we’ve seen before, economic reforms can and do work.  Indonesia’s per capita income fell from USD1,100 to US$560 between 1997 and 2000, and its poverty rate increased from 17% to 23% over roughly the same time according to the World Bank.  Now at USD3,440, Indonesia’s per capita income is more than 5 times higher and its poverty rate at 11% has never been lower (see here).

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Postscript
For a very good discussion of the recent currency change, other reforms, and Egypt's economic and political structure, readers are encouraged to watch/listen to the very good Al Jazeera episode, "Can Egypt's currency devaluation boost its economy" (see here).

Book Review: Clara Ho Tung : A Hong Kong Lady, Her Family and Her Times

In my research and investing I stress three things: people, structure and value.  I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests and trade at valuations that are below fair value if not outright cheap.

This post is about people, and specifically about one of Hong Kong’s most prominent and oldest family, the Hotungs. People are the most important aspect in business and I enjoy reading business biographies to better understand what characteristics successful leaders have that may help me evaluate today’s CEOs and controlling shareholders.

I bought the book to gain insight into Sir Robert Hotung Bosman, one of the wealthiest people in Hong Kong if not all of China before its 1949 liberation.  I’ve heard a lot about him over the years, but never really knew the source of his wealth, family dynamics, etc.  Despite his notoriety, I never found a good book about him or his family.  “Clara Ho Tung: A Hong Kong Lady, Her Family and Her Times”, written by his daughter Irene Cheng was the closest I could find.  Clara Hotung was Robert Hotung’s second wife.

Unfortunately, there isn't much information on Robert Hotung’s business dealings and how he became so rich.  

Between the book and Internet searches, he seems to have made most, if not all, of his money as a comprador for the Jardine group.  

The following paragraphs from another book provide a good background to the comprador system and Robert Hotung’s role in it.

'…the comprador systems was crucial to the rise of Sino-foreign commerce in modern China.  Named after the Portuguese word for "buyer", the comprador system originated in the late Ming dynasty but came to prominence in the early 1800s'. 

'Some Western company officials became so dependent on their compradors that they were hardly aware of how their businesses in China functioned below the highest levels of operation.  By the end of the nineteenth century, compradors were among the richest men in China – not just in the treaty ports but in all of China.  Two compradors would become especially famous for their great wealth.  One was the comprador for Jardine’s in Shanghai in the 1890s, one of the richest men in China. The other was Robert Ho Tung, the Eurasian comprador for Jardine’s in Hong Kong from 1883 to 1900, and the wealthiest man in the colony.'  (From: Edge of Empires: Chinese Elites and British Colonials in Hong Kong, John M. Caroll, 2005)

The late 1800s was perhaps the height of China’s opium epidemic, and Jardine’s is widely believed to have its biggest dealer.  Although I’ve not seen any source directly linking the Hotung's wealth to the opium trade, it’s pretty clear that a large part, if not the vast majority, of the family’s wealth originated in some form from the drug trade. (Link to my blog post comparing William Jardine to the main character in the TV show Breaking Bad is here).

This is likely true for many of Hong Kong’s old prominent families and companies. Hong Kong was founded in the 1840s as a legal place to store opium that was destined for China, where it was illegal (at least on paper).  At one point opium contributed 22% of the Hong Kong government’s budget (see here).

From the book and additional sources I got the impression that he invested most of what he made into property in Hong Kong, Macau and other places in China.  Hong Kong continues to be very property focused.

While there isn't much here for the investor or business reader, the book is nevertheless an interesting read.  It describes growing up in a traditional household when China was undergoing tremendous change. Although mixed, the Hotongs considered themselves Chinese and provided lots of funds and support to Sun Yat San and modern China.

Many of Hong Kong’s oldest schools and institutions were started or initially funded by the Hotungs.  Amongst their many charity works are the Lady Hotung Hall at Hong Kong University, the Hotung Secondary School, the King George V School and the Tung Lin Kok-yuen Buddhist temple in Happy Valley.  The website of the Robert H.N. Ho Family Foundation, run by Robert and Lady Clara Hotung’s grandson can be linked to here.  

Wealthy and powerful, the family’s disputes and internal squabbles are often public and they are they favourites of Hong Kong's paparazzi.   The latest has the patriarch's oldest son, Eric Hotung, disputing a deal that was made some 50 years ago with his cousin (link here).

Like other book reviews I’ve written, I’ve cut and pasted portions from the book that I think are especially interesting.  

The Hotungs were very, very rich.  Located on Hong Kong’s expensive Peak neighbourhood, their compound,‘Idlewood was a large, well-known house, with an excellent view of the harbour and with gardens on several levels linked to each other by flights of stairs and pathways, two cement tennis courts and a large vegetable patch on the highest level.'  

‘The houses Father bought on Victoria Peak in 1906 were named “The Chalet”, “The Dunford”, and “The Neuk”.  Each house had five main rooms - three bedrooms (with two or three bathrooms), a living room and a dining room. "The Chalet’"and "Dunford’"were joined to each other by two tennis courts, one of which was never used.'

'In addition to the Idlewood and Peak houses, Father also had residences outside Hong Kong.  In Macao, he owned No.25, Praya Grande, which immediately faced the Pacific Ocean.'

'He also bought a house in Shanghai during the 1920s.  There was a large lawn and vegetables patches at the back.' ‘...Father also bought a house in the beach resort of Tsingtao (Qingdao)’.  ‘Lastly, there was a house in England at 18, Mortlake Road, Kew Gardens.  The house stood in large grounds which included a lawn in the front, with roses, a mulberry tree and flower-beds; and a tennis court, garage, vegetable gardens….’.  ‘Father acquired several boats’.

“There was no motor road which went up to the Peak until the early 1920s.  The only way to go other than walking was the Peak Tram.  The Tram station on the Peak itself was reached by sedan chair, by rickshaw or by walking.’ ‘...for convenience, our family had several chairs and rickshaws of its own and men to handle them.’ 

'When my parents travelled, they took along...everything they might need'.  'We even took an upright piano with us, because Mamma did not want us to neglect our musical education during the holiday.' 

Other family members worked for Jardine's.  ‘After Father retired, because of poor health, from the compradoreship of Messrs. Jardine, Matheson and Company, Uncle Ho Fook was appointed to the position…’. ‘Our Fifth Uncle, Mr. Ho Kom Tong...also worked for Messrs. Jardine Matheson…’  

But lived simply. ‘Mamma always encouraged us to have simple tastes, and brought us up frugally.  She explained that if some day we were not able to live affluently, we would not feel the difference so much if we had not become accustomed to luxuries.’

They were generous.  '...in 1930 she established the first Po Kok Free School in Macao, and a second one, with the same name, in Hong Kong.  In 1932 she established the Po Kok Buddhist Seminary at Castle Peak, in the New Territories.'  'She named the temple, “Tung Lin Kok Yuen", the first word being Father’s first name and the second and third her own Buddhist names.'  

Tung Lin Kok Yuen

Changing times.  'I have often felt that among the Chinese, Mamma’s generation and mine have been hardest hit by the rapid social changes that took place during our lifetimes’.

‘She had come from a refined family and so had bound feet’.

‘When Eva and I graduated from D.G.S. (Diocesan Girl’s School), there was no higher education open to girls in Hong Kong.' ‘In September 1921, the University of Hong Kong admitted girls for the first time, and I was one of the first three to enter.  During the academic years 1921 to 1922, there were only three, and later four or five lady undergraduates, as we were then politely called, among more than three hundred male students…'  ‘But we endeavoured to keep up with the men in our academic pursuits, so as to overcome any impression that girls would not be able to hold their own in an institution of higher learning.  It was pioneering work and Mamma encouraged us as always.'  

Changing race relations.  'In the late nineteenth century and on into the twentieth, there was considerable social prejudice against Eurasians from both European and Chinese.  This prejudice made many of them the more determined to "make good"....Their best course was to make a lot of money, for with wealth came power and prestige.'    'They were also determined that after they had attained this objective they would contribute generously to local charities and to worthy causes in both countries of their heritage'.

'Except to conservative Chinese or Europeans it simply is not important anymore'.  'Their numbers have grown considerably by intermarriage and it is well recognised that many of the most successful people in Hong Kong are Eurasian, so it is no longer felt to be a handicap to belong to this group, even though it remains a small minority.

Good descriptions of family life.   'For many westerners it may not be easy to imagine a situation in which a man had two wives and a concubine alive at the same time, all getting on amicably with one another, including the children born of different mothers.  Yet to us this seemed quite natural.  Mamma brought us up to have great respect for our elders…’  

'We had three parents: my father, Sir Robert Ho Tung, my mother, "Lady Clara Ho Tung", and Father’s first wife, "Lady Ho Tung", or "Lady Margaret", who was childless.  In accordance to Chinese tradition, she herself arranged for my mother to be also married to Father, as a "ping tsai" or "equal wife".  We children were taught to call our mother, ‘Mamma’ and Father’s first wife, "Mother".  

Opium was legal. ‘I must, however, add a final touch to the account of our acquaintance with the theatrical couple. They were opium addicts, and in those days opium smoking was still legal.  So every time they came to our house to teach us Chinese opera, we had to supply them with opium and the necessary smoking equipment.’

Sisters Are Doing It For Themselves...And Others

In my research and investing I stress three things: people, structure and value.  I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests and trade at valuations that are below fair value if not outright cheap. This post is about people and how women are making big strides in developing countries.

One of the most important steps in my research process is checking the background and reputation of corporate leaders, politicians and policy makers. Basically anyone that may influence equity valuations. Over the past several years I seem to be spending more time researching and evaluating female leaders.

The increase in the number of women leaders in ‘emerging’ and ‘frontier’ markets is particularly noticeable. I've been spending a lot of time looking at companies in these markets as for the last few years as they've been trading at valuations significantly less expensive than their counterparts in the ‘developed’ markets.

This is a large and long-term positive development.  Theoretically a larger pool of candidates should lead to better leaders. This should ultimately benefit companies and countries that make full use of their resources.  I read years ago in The Economist that educating girls and young women was almost a sure-fire way to increase a country’s living standards.

The increase in female executives was most noticeable on a research trip to Romania last year. As I've written before, stocks traded in Bucharest were some of the world’s least expensive and I went to see if they were merely cheap or had value (see here). 

On the last day I realized that at least half of my meetings were with women.  This was especially surprising considering that most of them are leaders in the traditionally male-dominated energy companies, the largest sector by far on the Bucharest Stock Exchange.

In fact, three of Romania’s largest listed companies are led by women.  OMV Petrom – the country’s largest private oil and gas company is headed by Mariana Gheorghe.  Transelectra – the country’s largest electricity transmitter is headed by Carmen-Georgeta Neagu, and Nuclearelectrica – the country’s largest electricity generator and sole nuclear generation company, is headed by Daniela Lulache.

At my last meeting – with two women executives – I asked what policies Romania had enacted that led to such a large proportion of female executives.  The response was pretty blasé.  They couldn’t think of any, but suspect it had to do with Romania’s communist past.

This could be true.  Eastern Europe and Russia have a higher percentage of women corporate leaders than any other region in the world if the 2015 Women in Business report by Grant Thorton is accurate (see here).

The report notes that 40% of senior business roles in Russia are held by women, which is significantly higher than Western Europe’s 26%.  The report also notes that seven of the top eight countries with the highest percentage of women in senior roles are in emerging European countries. In addition to Russia, these are Georgia, Poland, Latvia, Estonia, Lithuania, and Armenia.  Another factor could be the high proportion of women to men in the ex-Soviet Union (see here).

Interestingly, one thing that the warring brother countries (sister countries?) of Russia and Ukraine had in common until recently were highly respected female finance ministers. Russia’s Elvira Nabiullina is spoken of as being one of the best in the world and someone who has Putin’s confidence; while Natalie Jaresko is one of the few people in Ukraine’s cabinet who seems competent (see here and here).

The Soviet and communist past likely doesn't explain it all. Half-way around the world there are many women in leadership positions in Jamaica. As I wrote in last year’s post, this includes the mayor of its largest city, the head of its stock exchange, its largest bank as well as its largest electric utility (see here). While the female Prime Minister recently lost to her male rival, a recent article on corporate merry-go-rounds in Jamaica emphasizes the prevalence of women in the country’s private sector (see here).

Further south, trends in Latin America also point to more women in corporate leadership positions.  According to a study by Mercer, by 2025 Latin America should lead the world in the proportion of women in professional jobs.  The report notes that in contrast to the developed markets, where the focus has been on recruiting women for top positions, Latin American companies are adding female workers across the board (see here).

I don't know if female leaders will do any better than their male counterparts over time.  I’ve read articles saying women make better investors, financial consultants and political leaders than males.  This could be true, but I suspect that given all the sexism that exists, the ones that make it to the top faced a much higher barrier to entry so have to be that much better.  As more women enter the workforce and obtain leadership positions, I suspect they will prove no better or worse than men.  Regression towards the mean works in just about every other large sample set, and I suspect it will work here.

Another way to put this: for every Sheila Dikshit (the highly respected Mayor of Delhi), Tri Rismaharini (Surabaya), and Michelle Bachelet (2x President of Chile), there’s a Dilma Rousseff (close to being impeached President of Brazil) and Cristina Kirchner (controversial ex-President of Argentina). 

It’s been over 20 years since I very briefly met Benazir Bhutto on my second investment trip to Karachi in 1992, and over thirty years since Aretha Franklin and the Eurythmics released this blog’s soundtrack (see here). Since then women throughout the developing world have made great progress.  I notice this on an on-going basis as I look for value around the world.

In some countries, the proportion of female corporate leaders has leap-frogged developed markets.  I suspect this trend will continue and if anything provides yet another reason for investors to look at developing countries as a long-term investment just as they do for ‘developed’ countries.

  

Other Influential Women in Emerging Markets (I suspect I just scratched the surface. Please leave additional insight in the comments section below):

• Ellen Johnson-Sirleaf – President of Liberia
• Sheikh Hasina Wajed – Prime Minister of Bangladesh
• Ewa Kopacz – Prime Minister of Poland
• Ngozi Okonjo-Iweala – Economist and ex-Minister of Finance of Nigeria
• Sri Mulyani Indrawati – Managing Director of World Bank Group, ex- Finance Minister of Indonesia
• Nguyen Thi Phuong Thao – CEO of VietJet and Vietnam's first female US$ billionaire 
• Chandra Kochar – CEO of ICICI Bank, India
• Dong Mingzhu – President of Gree Electronic
• He Qiaonu – Founder and Chairperson of Beijing Orient Landscape and China's most generous philanthropist in 2015 
• Valeriya Gontareva, Head of the National Bank of Ukraine

CAPE Strategy Update

In my research and investing I stress three things: people, structure and value.  I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests and trade at valuations that are below fair value if not outright cheap. This post is about value.  

About a year ago I wrote about an investment strategy that returned a little over 14% per annum on average in our backtest.  It achieved this by investing in the five least expensive countries as ranked by CAPE, holding for a calendar year, and then re-balancing (see post here).

As noted in that post, CAPE stands for Cyclically Adjusted Price-to-Earnings ratio.  It is like PE except that it compares the current price of a company to its earnings averaged over a number of years. PE or "Price to Earnings" ratio is a popular way to value companies, particularly those that are listed on stock markets.  

2015 was the first year of tracking this strategy and the results are out. They are more or less in line with the backtest. The ‘cheap’ country basket increased by 12.1% local currency, and 2.7% in US dollars.   The best performing markets were Hungary and Slovakia, whose headline indexes rose 44% and 32%, but only 29% and 18% in USD.  The third best performing market, Czech Republic, was up a mere 1% in Koruna and down 7% in USD. Romania was largely flat and Bahrain fell by 14.8%.

The ‘expensive’ countries did not do as well.  On average they fell by 1% in local currencies, and 5% in USD.  Only Lithuania’s headline index was up in local terms, increasing by 7.4%, but down by 3.1% in USD.  Only Israel was up in USD last year.

What is interesting was the spread between ‘cheap’ and ‘expensive’. The 'cheap' countries outperformed the ‘expensive’ countries by 12.1% in local currency terms and 7.7% in USD. This is close to the 6.7 percentage point difference between ‘cheap’ and ‘expensive’ in our study. 

Taiwanese and Mainland Chinese investors would have done slightly better than USD investors with the ‘cheap’ basket increasing by about 7%. The spread for both was also a tad higher than for USD investors. 

Relative to major indexes, the performance of this strategy in 2015 was not bad. The S&P 500 index was flat, and most markets ended the year down in USD terms.  “Emerging markets”, how most countries in both baskets are classified, fell by 17% last year according to the most followed index. This is a massive 19% out performance (see here).    

Global equity markets generally did not do very well last year.  In addition to Hungary, only a few were up more than 20% in USD.  This included Latvia (up 31%), and Jamaica (up 88%, write-up on Jamaica is here).   Venezuela increased by over 200%, but I think this number is very squishy given the country's uncertain exchange rate.  

Despite its decent relative return, the NAV of the "cheap" strategy is still below its 2007 peak. The last several years have seen a good rebound, but still not enough to break its end 2007 high-water mark. 

What’s Cheap and Expensive in 2016?

Our list of ‘cheap’ countries is almost identical to last year’s.  Four of the five countries are still there. The only addition is Latvia.  It remains inexpensive despite last year’s increase. Hungary is no longer among the five cheapest countries after its solid increase last year.

The list of expensive countries however is completely different.  It includes two very large markets, the US and China, which is a cause for concern. Being so big, they are seen as bellwethers for much of the rest of the world.  Being expensive means that it's more likely they will fail to increase or decrease which could put pressure on other smaller markets. This was and remains my biggest fear going into 2016.  But this was also a fear going into 2015 and China was one of the better performing markets last year despite its dramatic rise and fall.

Part of the reason there are so many new countries in the expensive category is that we have slightly changed our screening methodology.  We removed companies whose primary listing was elsewhere.  This means that companies such as the inexpensive Petrobras, whose primary listing is in Brazil, is no longer classified as a US company in our screen.

If the first eight weeks of 2016 make a good indication of any kind, it could a be a bumpy year for global equity markets.  The US and China are down by 5% and 18% respectively.  

So far, the ‘cheap’ basket is leading so far, but it’s not a pretty race.  In USD ‘cheap’ is down by 2.0% and 'expensive' by 6.4%. Only two in the ‘cheap’ basket have increased. The Slovak Republic’s tiny market is up by 9% and Latvia’s not much bigger one is up by 5%. No 'expensive' market is up so far.  

But it’s a long year and a lot can happen in the next 10+ months.

“Cheap” 5 as of 1 Jan 2016

	Index
Romania	Bucharest Stock Exchange Trading Index
Bahrain	Bahrain Bourse All Share
Czech Republic	Prague Stock Exchange Index
Slovak Republic	Slovak Share Index
Latvia	OMX Riga

“Expensive” 5 as of 1 Jan 2016

	Index
China	China CSI 300
Croatia	Zagreb Stock Exchange Crobex
Denmark	OMX Copenhagen 20
United States	S&P 500
South Africa	FTSE JSE All-Share

CAPEd Crusader

CAPE is a long term metric. It was introduced as a way to smooth out the business cycle.  Studies point to it doing a good job of identifying inexpensive markets that tend to perform well in the long-term.

'Cheap' countries have many problems and tend to be in or close to a crisis.  Big markets that are inexpensive on a CAPE basis include Brazil, Russia, and Greece.  Hardly the places your investment adviser is likely recommending.  

However, as written before, some of the best investments are in ugly markets and sectors when prices are low and virtually no one is expecting things to improve (see here).