BUTCHER: If there was one last thought you would leave with investors for 2018, what would that be?
The Emerging Markets “Party” has Years to Run
VAN ECK: Coming into 2017, too many portfolios were underweight international and emerging markets. They have not yet caught up, but are too worried about being late to the party. We think there are years to go. With what is happening in the world, this view is easily justified looking at long-term trends. So many people live in the emerging markets and so much of the growth in the economic activity is going to be there.
Last, the disconnect between commodity prices and corresponding equities of commodity producers has been historic this year, particularly in the energy space. In the U.S. upstream arena we are expecting many years of double digit growth while returns and cash flow begin a dramatic inflection after a decade of significant research and development spending. (Read October 19 blog post for more on commodities: Tighter Fundamentals, Global Growth Lend Support.)
Numerous tailwinds driving emerging markets higher
The rally in emerging markets (VWO) has mainly been driven by higher earnings growth on the back of an improved business environment, rising exports, and strengthening corporate balance sheets. Investors’ rising confidence in the asset class has led to higher flows into EMs. In 3Q17, EMs (EEM) witnessed equity inflows worth $19 billion, taking the YTD inflows to ~$65 billion.
EMs improving fundamentals
Over the next few years, emerging markets (IEMG) are expected to report healthy growth. Corporate debts in EMs are shrinking, while companies become more prudent in choosing projects with a favorable risk-return profile. Capital expenditures have fallen in most of the emerging markets, leading to higher margins. While fundamentals are improving, emerging markets are still trading at over a 25% discount to the developed markets. The valuation gap provides ample opportunities for EMs to post higher growth in the years to come. Moreover, as the commodity sector rebounds further, the rally in EMs will likely expand to other related sectors, thus pushing up the broader markets.
US upstream space looks promising
A combination of higher commodity prices, rising production, and increased drilling activity led to soaring 3Q17 earnings for many oil and gas (USO) (XOP) companies in the US. The trend is expected to strengthen further because crude oil production in the US is likely to rise significantly in the years to come.
According to the US Energy Information Administration, crude oil production in the country will hit a new all-time high in 2018, rising to 9.9 million barrels a day from 9.2 million barrels a day in 2017. On the other hand, the IEA (International Energy Agency) estimates that the US will account for 80% of the incremental global oil supply until 2025. The shale gas producers, who will become more efficient even at lower prices, are likely to contribute substantially to the incremental supply. The IEA’s World Energy Outlook 2017 estimates the US will become a net oil exporter within the next decade, the first time since the 1950s.
As a result, the oil and gas leadership will likely shift from the Middle East to the US, and the country could rule the industry for decades to come. This transformation is expected to considerably benefit US upstream companies.