Morgan Stanley has shifted from negative to neutral on global emerging markets. Goldman Sachs says, "Recent price action has likely helped buoy sentiment." The painstaking language reflects widespread uncertainty about what comes next.
Emerging markets assets have firmed after the panic selling of late August and early September. The Vanguard FTSE Emerging Markets exchange-traded fund (VWO) is up 3% since Sept. 10, and the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB), 2.5%.
But caution prevails on expecting a larger rally. "I would like to be on the fence about the market, but I guess I have to decide," says Anders Faergemann, an emerging markets portfolio manager for fixed-income specialist PineBridge Investments.
Emerging market valuations have sunk to theoretically attractive levels. Stocks are 30% cheaper on aggregate than those in the developed world, while the historical average is 20% to 25%, says Jorge Mariscal, chief investment officer for emerging markets at UBS Wealth Management. Currencies are 15% to 25% undervalued, he figures. "The bias is a little more to look for an entry point than an exit point," he concludes.
The gaping-wound countries that spread fear of global contagion are also stanching their wounds. Turkish stocks have rebounded by some 15% over the past three weeks as the central bank belatedly hiked interest rates and speculation spread that the government would release imprisoned U.S. pastor Andrew Brunson, easing tensions with Washington. "I was in Turkey last week, and there's definitely a sense there that things could turn more positive," says Brett Diment, head of emerging market debt at Aberdeen Standard Investments. Stocks in Argentina, the other crisis epicenter, are up more than 10% from their recent low.
But valuations do not magically revert to historical means without some catalyst, and it's hard to see where game-changing good news could come from on a global scale.
The key to emerging markets equities is China, which is beset with a range of well-publicized problems. The immediate threat is further Chinese currency devaluation to offset U.S. tariffs, which could trigger a beggar-thy-neighbor chain reaction, Faergemann says. "A renminbi below seven to the dollar seems to be a line in the sand," he says. The current exchange rate of 6.89 does not leave much leeway.
Since China has limited foreign debt, the bellwether fixed-income country may be Brazil. There's little cause for ebullience there, either. Reformist candidates in the Oct. 7 presidential election have faded, leaving investors in the awkward position of rooting for volatile neomilitarist Jair Bolsonaro over surging leftist Fernando Haddad.
With trouble in the dominant markets, investors are nibbling at more peripheral opportunities. James Donald, head of emerging markets at Lazard Asset Management, is high on Russia. "Russia is the most unbelievably attractive market to look at," he says. "You have asset-rich, very profitable companies that are extraordinarily cheap."
Others take the long view on China, which seems to have made progress on yesterday's problem—excessive leverage—while steering through the current storm on trade. "In China, supply-side reforms and deleveraging could help ease structural risks, while a shift toward innovation and consumption supports improved earnings sustainability," says Chetan Sehgal, director of emerging markets equities at Franklin Templeton.
But those who don't have to invest in emerging markets can probably stand to wait and watch a while. "If you miss the first 10%, you can still catch the next 20% or 30%," UBS' Mariscal says.
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