About the expert
Jurrien Timmer is the director of global macro in Fidelity's Global Asset Allocation Division, specializing in global macro strategy and active asset allocation. He joined Fidelity in 1995 as a technical research analyst.
In recent weeks I have laid out the case that in 2021 we should see more relative strength coming from cyclicals and value and small caps and non-US stocks, and that this cyclical backdrop is aided by a formidable secular setup in the form of a 10-year compound annual growth rate (CAGR) in stocks that is far below its mean and ripe for a reversal.
Today I would like to highlight emerging market equities, which in my view could take center stage in 2021 and beyond. Witness the chart below. I can’t speak for my fellow chartists but to me this is a dream chart: a well-established long-term uptrend interrupted by a long trading range that now appears to be ready to break out to the upside. The series below consists of the MSCI EM Index since the 1990s, and Global Financial Data (GFD)’s Emerging Markets (EM) Index prior to that.
Let me walk you through the chart. In the top panel is the total return series (dotted line) and the price index (which does not include dividends and therefore has less of an upward slope). You can see the long uptrend interrupted by long periods of “sideways.” Those are called continuation patterns and they often resolve themselves in the direction of the prevailing trend (which in this case is up).
The bottom panel shows the return of EM stocks relative to the US, and also the 10-year CAGR (compound annual growth rate) of that relative return. The CAGR is useful because it lets us identify the cycle if there is one. In this case there is a clear cycle that spans around 20 years from low to low or high to high. You can see the pendulum swinging back and forth.
So what we have here is an index which after 11 years of trading sideways is trying to “break out” to new highs, while the relative return cycle is poised to reverse higher. A pretty good chart setup if you ask me.
What could drive a newfound bullish case for EM?
An essential part of that potential mean-reversion, I believe, is the US dollar. For EM to outperform both cyclically and secularly we will need to see the dollar head lower. After all, for a US-based investor, currency risk is an important part of the mix if you’re invested in non-US markets.
With the US embarking on what might potentially become a long period of fiscal/monetary coordination (some might say MMT-lite*), it is possible we will see the dollar head lower in the months and years ahead.
And if the dollar heads down (as it has been consistently doing since March), emerging market currencies (below) should be on the other side, as indeed they have been.
So, the dollar seems to be doing its part, but EM earnings will need to do some heavy lifting as well. Indeed, both the global and EM earnings cycle have clearly bottomed, aided in part by China’s credit impulse (as defined by credit growth as a percentage of economic growth).
And the EM squiggles chart (showing the earnings estimate progression over time), I think, suggests that we are in a new earnings up-cycle for EM and the world.
With EM being a high-beta (more volatile than the stock market as a whole) play on the global earnings cycle, and with the global cycle now in an early expansion, we should be able to see good earnings growth out of EM. Juxtaposed against a large valuation discount, this bodes well for EM relative to developed markets.
The MSCI EM Index sports a forward P/E of 14.8x while the S&P 500 is at 22.5x. On a relative basis, EM trades at 0.61x the P/E of the US, the lowest in almost 20 years. Yet both regions are up the same 45% since the March low. More room for outperformance, I think.
EM equities are also a play on improving financial conditions. With both the Treasury and Fed likely embarking on a policy that targets unemployment for all segments of the US population, both fiscal and monetary policy are likely to remain quite stimulative. This bodes well for financial conditions and therefore, I believe, EM.
All in all, in my view EM equities may well be a high conviction “outperform” for 2021 and beyond.