Emerging market equities are very attractively valued
Dr. René Dubacher
Financial Markets
The dollar's rally, which began in February 2018 and accelerated in April, has been a wrecking ball through emerging markets in 2018, leaving a picture of destruction in its wake. The crises in Argentina and Turkey were triggered by this and many foreign investors took flight.
The dollar's rally, which began in February 2018 and accelerated in April, has been a wrecking ball through emerging markets in 2018, leaving a picture of destruction in its wake. The crises in Argentina and Turkey were triggered by this and many foreign investors took flight.
Shanghai
The dollar's rally, which began in February 2018 and accelerated in April, has been a wrecking ball through emerging markets in 2018, leaving a picture of destruction in its wake. It triggered the crises in Argentina and Turkey, and many foreign investors took flight.
Downward pressure increased further when the Chinese yuan depreciated, which subsequently led to weak equity markets in Asia. Economies such as India and Indonesia suffered doubly from higher global oil prices and the USD.
Much depends on the future development of the US dollar. The economy in America is showing signs of slowing and comments from the Fed suggest that the cycle of rate hikes could come to an end after another 25 or 50 basis points. It is easy to imagine that if market participants' fears flare up again, the Fed will pause on further rate hikes.
The immediate concern for emerging markets, which tend to be more export-dependent than developed nations, is the consequences of a trade war.
The Chinese, after initially responding conciliatory, have hardened their stance in the face of Trump's aggressive rhetoric. They have decided to dig in and prepare for a long positional war. Here, from the Chinese perspective, it may seem very positive that President Xi Jinping need not fear elections. The Chinese government can insist that the people make sacrifices.
The trade war has taken a serious toll on stock market sentiment, but the actual economic impact has been small. U.S. tariffs on Chinese goods have been offset by a controlled depreciation of the Chinese renminbi against the USD dollar. This means that Chinese goods have not actually become more expensive for U.S. consumers.
Emerging markets have lost most of their outperformance since January 2017. In the last 3 months, relative performance has turned around and emerging markets have been able to outperform.
EMMA vs World
One of the main arguments for investing in emerging markets is always the argument of favorable valuation. Table 1 shows the relative valuation of emerging market equities to developed market equities and their performance over the last 5 years using various metrics. Emerging market stocks are much cheaper and generally trade at a valuation discount of 20%-25%. This discount has widened in recent months.
Valuations: EMMA vs Welt
As we have shown in a longer article, growth per se is not sufficient to assess the attractiveness of emerging markets. Only the combination of above-average growth, clearly below-average valuation and cautious (growth) expectations form the recipe for above-average performance.
The entry point is ideal
Emerging Asia is now the growth driver for the entire world, with China's consumption growth in 2018 measured in US dollars 50% higher than that of the US. In 2019, consumer spending in emerging Asian markets is expected to be higher than that of America. This means that the driving force for future emerging market investment intentions will be domestic demand - not the need to cater to the needs of U.S. consumers. So if emerging Asia, and China in particular, can keep their own consumption going, they will no longer need to worry about the U.S. interest rate cycle.
The unwarranted panic about the economic health of emerging markets presents a wonderful new buying opportunity for long-term investors - especially as these countries have become so economically powerful that their business cycles are less and less dependent on the developed world.