Yet again the question for emerging markets is whether they offer an incipient disaster or an incipient buying opportunity. The past few months have seen a vintage sell-off, with familiar and easily described causes.
At home, they involve messy politics, leaders who are unpopular abroad and deficits that require borrowing to fill. In the developed world, the catalysts include the slowdown in the eurozone, the growing threat of tariff barriers and, most importantly, the move towards tighter monetary policy, as higher US rates attract funds and weaken emerging currencies against the dollar.
Also, an unplanned consequence of last year’s US reform to encourage companies to repatriate dollars held overseas is that non-US banks now find it harder to get access to dollars.
The same patterns and issues reveal themselves across asset classes. The greatest problem is in currencies, which covers a basket of currencies, has given up 10 per cent in the past two months against the US dollar, and now only needs to drop another 2 per cent to take out the all-time low during the Chinese growth scare of early 2016.
Emerging market inflation is persistently higher than in the developed world, so EM currencies will naturally fall over the longer term. But note that the last low came at a moment of deep alarm over China and its prospects.
This time around, companies deriving most of their revenues from China have been performing well and there has been no sudden and unexpected Chinese devaluation to set nerves on edge. That makes this broad emerging currency sell-off harder to explain.
However, Chinese domestic markets have suffered a sell-off, despite the fillip of impending inclusion in the MSCI emerging markets index (.MXEF), which will, in effect, oblige many portfolio managers to buy so-called “A-shares” for the first time. The CSI 300 index, the main index of A-shares, has underperformed the US S&P 500 (.SPX) by 21 per cent since February, in a move that may have been driven by US announcements of tariffs on Chinese goods.
Within stocks, emerging markets tend to move in long waves of over- and underperformance compared with developed markets. Having underperformed since 2010, many believed that they were in a steady secular upturn after the last China scare dissipated in 2016. That has reversed. MSCI’s emerging markets index has lagged behind developed markets by 11 per cent since March.
Emerging markets: What to watch
But while they look cheap, emerging stocks do not look a compelling buy, and show none of the usual symptoms of revulsion and catharsis. According to Research Affiliates, emerging markets trade at a cyclical earnings multiple (compared with average real profits for the past decade) of 17.7. This is far cheaper than the US (where large-caps trade at a multiple of 30), but not far below the multiple for the “EAFE” non-US developed markets. And while emerging markets do look cheap on this measure, they have looked even cheaper a third of the time over their history.
In fixed income, greatest interest has attached to Argentina’s “century bond”, issued last year in a sign that confidence had been restored. Since peaking last October, its price has fallen some 24 per cent. Mexico’s century bond has shed 12 per cent since a peak last autumn. Wider market indices have also fallen, with the exchange-traded fund that tracks JPMorgan’s EMBI index dropping 10 per cent since last August.
As in stocks, these are significant moves but remain far removed from the extreme prices that were logged during the financial crisis of 2008.
This bout of nerves, like its most recent predecessors, is discriminate. Since the election of President Donald Trump, the MSCI Asia excluding Japan index gained 30.4 per cent, while its Latin America index has fallen 8.1 per cent. This reflects the two regions’ very different economic trajectories.
Also, as I have said before, Turkey and Argentina, the two markets whose currencies are under the greatest pressure, are also the two large emerging markets with a deficit of more than 3 per cent.
Pressure has also been heaviest on countries where investors dislike the political situation, such as Brazil — which has a lame duck government, and a presidential election that looks wide open and chaotic due this year — and Mexico, where the presidential election next month looks very likely to deliver a left-winger to power.
Such factors determine which markets are under most pressure. But it is hard to see revulsion anywhere. Indeed, figures on fund flows from UBS’s Geoff Dennis suggest that investors are already trying to “buy the dip” with Mexico one of the most overcrowded markets, and Turkey seeing sharply increased interest in recent weeks.
This is not yet a crisis. But it is not yet a buying opportunity either.
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