Stéphane Monier is backing the long-term growth story for EM though he warns that the factors that support growth, such as cheap valuations and easy global financial conditions, are being whittled away and could cause volatility later this year.
He noted that all four Brics, Brazil, Russia, India and China, are growing for the first time in many years and that though Brazilian political crisis continues, it may actually be undergoing a “democratic revolution in transparency” which should give investors optimism for the future.
In a note, Monier added: “We believe in a long-term EM growth story based on favourable demographics and the early stage in their recovery. EM manufacturing purchasing managers indices are in expansionary territory, and the Citi EM surprise index is near multi-year highs. EM companies’ earnings growth has largely delivered on analysts’ high expectations this year– with titans Baidu, Tencent, Alibaba and Samsung seeing impressive share price gains.”
He added that EM local currency debt currently offers spreads of around 400 basis points over US sovereign debt; more than twice the yield differential available 10 years ago and after sharp falls for EM currencies in recent years.
Monier estimates that on average, they are 20% undervalued versus their fair value on a purchasing-power parity basis.
However in the short term, he believes there are challenges.
“EM equities now trade at 13.4 times estimated 2017 earnings – up from 10 times in the early years of the decade – one corollary of money flowing back into EM funds,” he said. “Central bank crisis measures are ending, with rate rises on the cards in much of the world.”
“In the last week of June, global bond yields and currencies reacted sharply to speeches from US, European and UK central bankers hinting at tighter policy ahead. We predict balance sheet shrinkage and a further rate hike from the US Federal Reserve (Fed) this year; and an announcement by the European Central Bank on reduced asset purchases in late 2017. This could create some temporary volatility for EMs.”
However, Monier said that the impact of rate rises particularly from the Federal Reserve may be contained.
The dollar rose sharply ahead of 2016’s rate rises but EM bonds and equities have still gained ground. Yet the fact that many EMs now have floating exchange rates should prevent the kind of currency/debt crises seen in previous decades.
“To varying degrees, EMs import Fed tightening via their exchange rates, potentially damaging growth. But we have reason to believe the wider economic impact will be contained.
“The US dollar (USD) rose sharply well ahead of the Fed raising rates in late 2016– which it has already done three times since December of that year – yet EM equities and bonds have gained ground.
“From here, we see gradual US balance sheet shrinkage and rates topping out between 1.5-2.0% (from today’s 1.25%8) next year. Furthermore, many EMs now have floating exchange rates, preventing the kind of currency/debt crises seen in previous decades.”
