Now look, I know what you’re thinking.
You’re thinking that, considering the already sizable move (some 60% from the start of 2016), considering the multitude of geopolitical headwinds and idiosyncratic country risks, and considering the distinct possibility that DM central banks are about to try and unwind the policies that have helped create a carry trader’s paradise, it might be time to reduce exposure to emerging market stocks which are sitting near 6-year highs:
But you’d be wrong. Or so says BofAML’s Ajay Singh Kapur who, in a pretty epic new note dated Thursday, reminds you that “EM equities rise 230% on average, in bull markets” and this time shouldn’t be any different. Which means they’re set to double (at least) in the next two years.
There are all manner of amusing tidbits from the note, including the following excerpt which has a distinctly “Chappelle-ish” feel to it. Two wit:
We have found that an over-analysis of geo-politics, central bank zig-zags and trying the search for longer-term earnings visibility were a distraction and impeded making money in these bull markets. We recommend investors to raise exposure if they haven’t already, and sell when valuations reach 3X PB, or when they expect a US/Global/Asian recession. Let the bull market do its job.
“Can’t be distracted with what’s goin’ on with the war, or what’s wrong with the economy – stop worrying about that!”…
Anyway, Kapur offers the following visual retrospective of historical EM equity rallies…
…before noting the following:
The PB normally bottoms around 1.3X. The bull markets usually peak out around 3X PB. We are just at 1.7X PB currently. The only two bulls that did not reach 3X PB were the Sep 1998-Feb 2000 bull market that stopped at 2.2X PB, felled by the oncoming US recession and TMT bust. The March 2009-May 2011 bull just reached 2.1X PB, succumbing to the Chinese nominal growth decline from 17% to less than 1% between 2011 and 2015.
Kapur makes a half dozen or so other points that are duly noted, but as you’re probably aware, one of the linchpins here is a weaker dollar, which is acknowledged in the piece as follows:
It shows that EM bull markets almost always are associated with a weaker US dollar, and bear markets almost always with a strengthening USD. While USD forecasts abound, we note that the USD real effective exchange rate looks high on Figure 20, and that the US runs a current account deficit of 2.4% of GDP. We are skeptical of a strong USD view, from these starting points, and acknowledge that this view is different for most analysts.
Fair enough, but do note that more than a few observers believe the dollar has likely found at least a short-term bottom and don’t forget that it was just 9 short months ago when “long USD” was the most crowded trade on the planet. So when Kapur says that “Figure 20 is important” – it’s an understatement.
You can draw your own conclusions here but this seems like a rather Goldilocks scenario to us.
Oh, and meanwhile, the Bloomberg Barclays EM USD Aggregate spread index closed yesterday at its lowest level since 2007.
“Clearly the EM market isn’t much phased by the latest Korean saber-rattling,” Bloomberg’s Sebastian Boyd dryly notes, before reminding you that “the further down they go before turning, the sharper the turn will eventually be.”