Nobody is going to blame you if you’re a bit hesitant to go “bottom” fishing in emerging market assets right about now.
After all, trade tensions look set to escalate materially going forward, raising the specter of slower global growth.
Zooming in on China, policymakers’ tight rope walk (i.e., the effort to squeeze speculation out of the labyrinthine shadow banking complex and orchestrate a broad-based deleveraging without accidentally choking off credit growth to the real economy) has been complicated immeasurably by trade frictions.
Oh, and there’s always country-specific, idiosyncratic risk. That’s part of investing in emerging markets and it’s manifested itself this year in the collapse of the Argentine peso and the currency crisis in Turkey.
While the situation in Argentina has improved thanks in part to the IMF, news that Erdogan has put his son-in-law in charge of the Turkish economy seems to suggest the lira will continue to be an issue going forward. Meanwhile, there are problems in Brazil and Indonesia, where policymakers have been at pains to prevent currency weakness from spiraling out of control amid external pressure from an unapologetic Fed.
So yes, there are reasons to believe that any respite EM assets enjoy will be fleeting.
On Monday, the MSCI EM FX index had its best day since May 10, rising for a third consecutive session. The gauge fell on Tuesday, but the recent bounce off the lowest levels since October is giving some folks hope that perhaps the worst is over.
Here’s a snapshot of the underperformance in EM equities as a group:
You might recall that Q2 was the worst quarter for EM FX and equities since 2015 or, more to the point, since the last time Chinese stocks were crashing and the yuan was depreciating rapidly against the dollar.
So who’s buying the dip? Well, for their part, Goldman is constructive but warns that as has been the case historically, growth is moderating alongside the decline in EM equities, perhaps suggesting investors are focusing too much on external factors and not enough on the EM growth narrative. To wit, from a note dated Monday:
Putting the current EM correction in a historical context, we find it quite easy to link the driver of the sell-off to softening growth data. In order to do so, we employ our EM Growth Factor (which is comprised of cyclical vs. defensive equities, the local 2s-10s yield curve, and trade-weighted FX across 19 EMs) as well as our Current Activity Indicator (a measure of underlying EM activity growth). As shown below in Exhibit 1, the co-movement of the market and macro indices is straightforward, with almost all significant market corrections over the past decade being mirrored by a slowing growth profile. Even during sell-offs such as the Taper Tantrum of 2013, which have often been referred to as a ‘policy shock’, we note that EM growth was weakening, providing fuel to the market correction. This year, we see a similar dynamic forming, as the market has been heavily focused on rising US rates and perhaps not as much attention on the softening patch of EM growth data.
Still, Goldman sees “relative value” in emerging markets and that aligns with Citi, who this week described EM equities as “a favorite value trade with expectations of 17% EPS growth this year.”
That said, Citi cautions that “pressures associated with growth headwinds, a strengthening dollar, high commodity prices and narrowing DM vs EM rates differentials [increase] the potential for stagflation.”
For their part, Morgan Stanley thinks any near-term bounces can be written off as “head fakes”. To wit, from a note out Monday:
We don’t believe this is the start of a sustained recovery. Trade tariffs are going higher, a supply side-led rise in oil prices is under way, the U.S. yield curve is close to flat while QE is in reverse.
Just to give you some perspective on the scope of the malaise, EM equities have fallen for five months in a row, the worst streak since September of 2015:
So who you gonna believe?
Me or your lyin’ bulge bracket?