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October 10, 2017

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Emerging Markets

October 10, 2017

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Emerging Markets

October 10, 2017

Global accommodative monetary policies have helped sustain the expansion across equity markets all over the world. The low inflation pressures were helped by the lower energy prices. US broad indexes continue to trend upwards and volatility has been kept within a tight range between 9 and 11 over the last month. We have witnessed this development since May of this year, of course with minor interruptions which are suspiciously happening each and every month. Yet, markets continue to form new highs, and the S&P 500 recently hit record values.

 

Looking at global markets and drawing comparisons, non-US stocks have led the rally since the beginning of 2017, supported by a weaker dollar and reduced concerns over the overheating of global markets. As part of this broader class, the emerging markets are very well positioned at the moment, and provide numerous portfolio diversification benefits.

 

 

 

Due to a combination of fundamental factors and recent market developments, emerging markets represent an attractive investment opportunity at the moment:

  • Consistently stronger GDP growth: Emerging economies continue to grow faster than the developed world – 4.1% as per the April 2017 IMF economic outlook, versus 1.7% for developed economies. The champions are in Asia, with a growth rate of 6.4%. With continued population growth, the expectation is for a shift in global economic power to key emerging economies during the next 20 to 30 years, as shown in a 2017 study by PWC. The projection for GDP ranking in PPP terms by 2050 is that US will be far behind China and India. The countries that will follow include Indonesia, Brazil, Russia and Mexico, with Turkey gaining a higher ranking as well.
     

  • Accommodating global economy fundamentals: A low-interest rate environment is not only favorable for the US market, but non-US stocks as well. Many emerging countries also hold US dollar-denominated debt, and a weaker dollar will make it easier for them to pay it down.
     

  • Improving corporate fundamentals: In September 2017, the corporate confidence index in Turkey hit a 4-year record high. China’s economy is also stabilizing and returning to high growth, supported in large part by a strong IT sector.
     

  • Attractive valuations and positive sentiment: Despite recent growth, emerging market stocks currently have lower valuations as compared to the US. According to MSCI data, the P/E for the EM index was 15.65 as of August 2017, while the S&P was 24.2. The iShares MSCI Emerging Markets ETF broke its 2-year downtrend in Q2 2017, when the index surpassed the level of just above 43 from September 2014, and the 50-day moving average crossed the 200-day moving average. Since the middle of 2016, the growth in EM stock prices has been accompanied by rising cumulative emerging market net fund flows – analysts see this as a sign that confidence is coming back to this asset category.
     

  • Potentially lower correlations: The trend of rising globalization seems to be diminishing. In the long run, this should drive correlations between US and non-US stocks down. During the last seven years, the correlation has been around 0.75, which is still attractive.

Of course, investing in emerging market stocks comes with a lot of risk, which must be managed. EM stocks tend to exhibit higher volatility than their counterparts in developed markets, and changes in currency rates, as well as trade and policy changes, may result in sharp drop in values and persistently lower returns. Even more relevant is the risk that the Fed may start raising interest rates more frequently than expected, which should also be taken into consideration for overall equity exposure.

 

In my opinion, the sustained expansion and accommodative monetary policies in the developed world will drive returns in emerging markets even higher in the coming months. The recent uptrend shows that investors are already moving in this direction, attracted by improving corporate earnings and generally positive economic fundamentals.

 

 

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

 

References:

https://www.cnbc.com/2017/08/17/emerging-market-stocks-may-be-set-to-break-out-after-years-of-struggle.html

www.stockcharts.com

http://www.institutionalinvestor.com/article/3724693/banking-and-capital-markets-emerging-markets/emerging-markets-investing-for-wimps.html#.WdKFDrIjHX4

http://www.tcmb.gov.tr/wps/wcm/connect/TCMB+EN/TCMB+EN/Main+Menu/STATISTICS/Chart+Gallery/Tendency+Surveys/Real+Sector+Confidence

https://www.fidelity.com/viewpoints/market-and-economic-insights/quarterly-market-update

https://www.pwc.com/jp/en/japan-press-room/press-release/2017/world-in-2050-170213.html

https://www.msci.com/documents/10199/c0db0a48-01f2-4ba9-ad01-226fd5678111


 


 

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