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MARKETINSIGHTSQuarterly PerspectivesCheaper oil: Friend or foe?We see a drop in oil prices to be a net positive for emerging markets, especially in Asia.Obviously oil-producing countries would experience lower oil receipts, which can be asignificant source of fiscal revenue either directly via state-owned companies or indirectlyvia taxes. Lower oil revenues could also undermine the ability to service debt by energycompanies, which could in turn seek financial support from the government or put stresson the domestic banking sector.However, for those emerging markets that are net oil importers, as shown on page 64 ofthe Guide to the Markets-Asia, cheaper oil prices can deliver a number of benefits. Theyhelp to reduce total import bills and hence reduce current account deficits, or boostsurpluses. This is crucial for countries like India and Indonesia, that suffer from currentaccount deficits and downward pressures on their currencies. On the fiscal account, lowercrude oil prices can also reduce government spending on fuel subsidies, for example, inIndonesia, Malaysia and Thailand. This allows these governments to divert more of theirresources to other productive uses, such as infrastructure or social programs. Somecountries can also use this as an opportunity to reform their fuel subsidy programs, suchas Indonesia.Cheaper oil prices also help to keep inflation low. This is particularly apparent in low-tomidincome emerging markets where a large proportion of household income is spent onfuel. Poor infrastructure logistics also magnifies the inflationary impact of higher energyprices. More benign inflation in turn gives emerging market central banks more flexibilityover monetary policy. Instead of being forced to raise interest rates in response to fuelprice-induced inflation, they can maintain an appropriate interest rate policy to supportgrowth. For consumption, cheaper energy prices also improve household disposableincome as less money is spent on fuel as a necessity. They can either save more or spendit on other discretionary items.Other Assets andnvestor Beha viorCommodities: Oil Price’s Impact on Emerging MarketsOil ImportsNet imports (imports minus exports) as % of GDP, 2014 IMF EstimatesThailandKoreaSingaporeTurkeyTaiwanHong KongHungaryPhilippinesIndiaSouth AfricaJapanIndonesiaNew ZealandChinaBrazilAustraliaMexicoMalaysiaVietnamIranRussiaUAEAsia PacificEmerging Markets-27.1%-11.0%-12.9%-4.4%-0.6%-0.9% 09%14.0%7.3%7.2%6.9%6.6%6.4%57% 5.7%5.2%5.0%4.7%4.2%3.3%2.2%2.2%1.6%0.6%Brent Crude Oil Price and ClickEM CPI InflationYear-over-year % change160%120%80%40%0%Brent CrudeOil PriceEM CPI InflationEM Asia CPI Inflation64GTM - AsiaSaudi Arabia -39.7%I0%-80%-50% -40% -30% -20% -10% 0% 10% 20%'04 '06 '08 '10 '12 '14-40%10%8%6%4%2%We see lower energy pricesto be a net positive for manyemerging markets.Source: IMF, FactSet, J.P. Morgan Asset Management “Guide to the Markets – Asia 1Q 2015.”Data reflect most recently available as of 31/12/14.Source: Guide to the Markets - Asia, page 648 | Quarterly Perspectives: 1Q 2015
Differentiation among emerging marketsIn sum, we believe that investors should take sustained USD strength more seriously thanbefore, especially as the Federal Reserve embarks on its next phase of policynormalization. Currencies with strong external positions and ample foreign exchangereserves are likely to be more resilient in a strong USD investment landscape. Many Asianmarkets, such as China, Hong Kong and Taiwan, fit these criteria. We believe thatemerging markets as a whole are now in a better position to avoid currency and financialcrises as seen in the 1990s. However, this does not mean that emerging marketcurrencies won’t depreciate. Currency hedging and overlays when investing in emergingmarkets could become more important in the next five years than the last five years.Beyond a strong USD and weak oil price environment, we believe there are other factorsthat will continue to influence emerging markets and Asia. The recovery of the U.S.economy and consolidation of Chinese economic growth would create a change in theexport dynamics for emerging markets. Markets such as Taiwan, South Korea and Mexicoare in a good spot to benefit from a steady rebound of the U.S. This also implies thatmarkets that are strong in exporting manufactured goods should perform better thancommodity exporters. In referring to the right-hand chart on page 23 of the Guide to theMarkets-Asia, markets that are on the top left-hand quadrant of the chart (highmanufactured goods, low commodities) should enjoy a more positive outlook than thosein the bottom right-hand quadrant (low manufactured goods, high commodities).INVESTMENT IMPLICATIONSDecisions on investing in emergingmarkets is likely to be dominated bycurrency outlook and exposure tocommodities in the next 6-9 months.While we believe fundamentals arenow stronger than in the 1990s,some countries are still vulnerable topotential currency depreciation due tolarge current account deficits and highexternal debt.Differentiation amongst emergingmarkets to identify strengths andweaknesses in a strong USD and weakcommodity price environment will becrucial to generate returns.conomyGlobal EcU.S.DM Trade Connections to EMExports as a % of GDP - 2013Goods exportsJapan9.4%14.5%EU 19.8%BrazilIndiaChina10.9%16.8%24.0%U.S.EUJapanChinaOthersEM Exports Breakdown100%China% of merchandise ex xports - 2013Click23GTM - Asia90% CzechAsian countriesKoreaOther EM countriesTaiwanHungary80% Hong Kong PolandTurkey MexicoThailandPhilippines70%VietnamSingaporeMalaysia60%IndiaUkraine50%Exporters of manufactured goodsshould enjoy better performancethan commodity exporters in2015.Russia*AustraliaKoreaASEANTaiwan16.8%26.0%45.7%54.6%62.5%0% 10% 20% 30% 40% 50% 60% 70%Manu ufactured exports asSouth Africa40%IndonesiaBrazilArgentina30%Russia20%ColombiaSaudi ArabiaChilePeru10%VenezuelaNigeria0%0% 20% 40% 60% 80% 100%Commodity exports as % of merchandise exports – 2013Source: World Trade Organization (WTO), World Bank, IMF, CEIC, J.P. Morgan Asset Management “Guide to the Markets – Asia 1Q 2015.”* 2012 figure due to data availability.(Left) EU exports as a % of GDP excludes intra EU-trade as the European Union is considered as one regional economy. (Right) EM exports breakdown based on WTO classifications, which arebroken down into 3 components including: 1. Manufactured goods, 2. Commodities (Agricultural) and 3. Commodities (Fuel and Mining). Total may not sum to 100% due to miscellaneous items notcovered by WTO. Data reflect most recently available as of 31/12/14.Source: Guide to the Markets - Asia, page 23J.P. Morgan Asset Management | 9
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