We’ve been expressing our positive view about Vietnam as a favored investment destination in emerging markets since last June. Since then, the Ho Chi Minh Index has appreciated more than 50% in U.S. dollar terms.
Source: Bloomberg
Stock market rallies require a combination of economic and financial fundamentals followed by demand from investors. Both precursors have been present in Vietnam over the past year, and the momentum appears to be sustainable. (Of course, we caution readers that any market which has moved as far and as fast as Vietnam’s is vulnerable to a normal, healthy correction, and there is no lack of potential catalysts.)
Economic Fundamentals
In the big picture, Vietnam is the beneficiary of a key China-related trend. The growth of China’s middle class and the movement of China towards a more consumer-focused economy have meant rising wages for Chinese factory workers. And as China’s economy has developed to provide a greater mix of services and of higher-end manufacturing, lower-end manufacturing has increasingly moved out of China and into new Asian destinations.
The biggest beneficiaries of this movement have been three countries: Vietnam, Cambodia, and Bangladesh, the so-called “new Asian tigers.” There are other contenders — for example, India, Indonesia, former Soviet bloc economies, parts of Africa. But those other contenders have not succeeded in taking up the Chinese mantle.
The Key to Long-Term Development Success: Manufacturing Exports
Speaking very simply, to rise dependably on the economic ladder, developing countries need sustainable export growth. And that really needs to be a growth in export volumes, not just in export revenues. In other words, it needs to be manufacturing exports, not commodity exports. Commodity-exporting emerging-market economies can have their cyclical periods of outperformance when the global economy is cooperative… But they tend to be hamstrung by the “resource curse,” and often never really move up the development ladder.
In order to achieve that growth in manufacturing exports, there are two basic ingredients a country needs:
• The rule of law and property rights; and
• Geographic proximity to its end markets.
What typically happens is that there is a once-in-a-generation shift, and a few countries that have those two necessary ingredients seize the role of the new cheap manufacturers.
Why the Emerging-Market Laggards Fall Behind
This is one reason why much of Africa and Latin America have not been able to step in and take the opportunity offered by China’s move up the development ladder. Most of Africa, for example, lacks the rule of law, nor is it on a trajectory towards political reform and the establishment of the rule of law. It also lacks geographic proximity to end markets. The same is true for much of Latin America.
So while wages may be very competitive in Congo or Bolivia, multinationals are not breaking down the doors to import capital equipment and set up manufacturing enterprises. During high points of the global economic cycle when commodities become more expensive, commodity exporters can do well.
In cases where that turn up in commodity prices is met with local politics that support the rule of law and property rights, local equity markets can rise — especially when a country is turning the page on a period during which property rights and the rule of law were challenged by a populist government. Currently, Chile is an example of this, which we’ll discuss below.
The Winners From China’s Rise
China’s success created an opportunity. Rising wages meant that manufacturers would start looking for the next countries that could offer lower wages together with the rule of law, property rights, and proximity to end markets. Over the past 15 years, this process got underway and accelerated after taking a break following the Great Recession. The clear winners have been Vietnam, Cambodia, and Bangladesh.
As we’ve pointed out before, the rule of law and property rights do not necessarily require Western-style liberal democracies. China’s model is highly centralized government control of the economy combined with a wild-west capitalism underneath. This model is attempting to harness the dynamic nature of capitalism while keeping the Communist Party in power and in charge of the pace and course of development. So there is enough rule of law to keep competition functioning and to reward investors. Whether this hybrid of capitalism and a command economy can thrive in the long term is an open question, but in terms of economic results, it has worked well over the past 20 years, and other countries are taking up the model.
Vietnam is one of these. It inaugurated a turn to what it describes as a “socialist-oriented market economy” in 1986. Like China, over the decades since, it has reaped economic benefits, advancing to the level of a “middle income” country. China’s share of low-end manufacturing began to roll over in 2010…
Source: Emerging Advisors Group
At the same time, Vietnam, already well-positioned geographically and ready to deepen reforms by selling off more stakes in state-owned enterprises, rocketed past other emerging-market countries in export growth.
Source: Emerging Advisors Group
China is still in the early stages of handing off low-end manufacturing… and as long as Vietnam remains friendly to foreign investment, it will likely continue to benefit from the trend. (Should the political climate in Vietnam change decisively to favor a shift back towards more state dominance, that would change our positive view on the Vietnamese stock market.)
Vietnam has also taken steps to ease foreign investment, over the past few years lowering barriers to foreign ownership of many Vietnamese firms. The relative depth, development, and openness of Vietnam’s market means that more foreign investors who want exposure to Vietnamese equities can get it — and have the ease of liquid exchange-traded funds with which to do so.
So to summarize, in Vietnam we have:
• An emerging market with acceptable and improving property rights and the rule of law,
• Situated near end-markets,
• Taking on the mantle of low-end manufacturing as China advances up the development ladder,
• Open, and increasingly open, to foreign investment,
• With accessible equity markets for foreigners
In short, all the ingredients for sustainable appreciation in equity values. The Vietnamese market has risen dramatically, and we believe that as long as the supporting themes remain in place, it can continue to rise (though of course with corrections along the way) as long as the global economy remains in gear.
What About Latin America?
We mentioned briefly above that commodity-oriented emerging economies can also have their day in the sun when the global economic cycle is supportive. In the case of two Latin American economies, Chile and Argentina, the supportive global environment is coupled with a local political turn towards more market-friendly leadership. The turn is deeper and more difficult in the case of Argentina, where President Mauricio Macri is attempting to undo many decades of destruction wrought by Peronism, Argentina’s home-grown populist movement. We like Chile on this basis for the duration of the current global expansion.
Investment implications: Vietnam, Cambodia, and Bangladesh have been the clear winners in capturing the low-cost manufacturing that is moving out of China as Chinese wages rise and China moves up the development ladder. Vietnam has the best combination of the rule of law, proximity to export markets, and a developed equities market that’s accessible to foreign investors. We like Vietnam on this basis for the duration of the current global expansion. Similarly, although they are not manufacturing powerhouses but are more commodity-driven, we like Chile, which is in the early stages of rule by market-friendly politicians after periods of populist mismanagement. Among Latin American emerging markets, we continue to like prospects for Chile, although its performance will be more influenced by the current cycle than by long-term trends.
