“Emerging market equities peaked in early 2011 and have struggled ever since. Many investors will be scratching their heads and wondering why valuations are getting ever cheaper, in a global economic environment that is widely assumed to be solid and improving.”
Becket believes there are a number of issues plaguing EM.
Economic and political turmoil
“In the cases of the Ukraine and Thailand, the issues are mostly political, but those markets are small and inconsequential in the wider scheme of things. In Argentina and Turkey, there have been currency collapses due to the lack of faith in the governments’ policies and corruption. Again, Argentina is ‘small fry’, although Turkey is more important.
“In bigger Brazil, investors have been spooked by increasing social unrest and the government’s unceasing uselessness, with fresh violence breaking out in Sao Paulo in the past few days.”
The overriding problem for EM economies, though, is a slower rate of growth, said Becket.
“Given China’s importance to overall EM growth, both directly and indirectly, we should start there. China is slowing due to targeted reforms aimed at rebalancing their economy away from exports and towards consumption. This will be a long process and investors should expect periods of weaker growth.”
The final issue for many EMs is the retraction and reduction of QE in the US.
“The EM bears roar that the loose money created in the US has flooded in to EM asset markets, driving currencies higher and bond yields lower,” said Becket. “This is true to a certain extent; investors have invested in the EMs to try and achieve a yield and EM debt has been a favoured source of carry, or excess yield. The increase in US bond yields has led to money, although not a huge amount in truth, coming out of EM debt and currencies and returning to the ‘safer’ developed world.”
Things should get better but…
This has been painful for those countries which spend more internally than they make externally, because they are reliant on international debt markets, noted Becket, adding: “The expected issues in raising fresh debt at moderate prices could lead to major economic problems in countries like Turkey and Indonesia.”
While history suggests we are now at both relative and absolute valuation levels that should lead to improved performance from EM equities, experience suggests things are likely to get worse before they get decisively better, and there could be a short-term bounce, in Becket’s view.
“While there has been some marginal selling of EM assets, we are yet to see the cathartic capitulation to extreme oversold levels. We stand poised ready to increase our allocations as and when we get more clarity on the common and individual issues.”
