2017 promises to be a volatile year given the crowded political agenda ahead. However, with EM equities currently under-owned and looking reasonably valued vis-à-vis their developed market equity counterparts, the asset class is likely to prove a popular investment option this year.
Following the election of President Trump, a new world order emerged – investors were forced to grapple with the prospects of stronger inflation, which potentially would mark the end of a multi-year (2010-16) backdrop of deflation, secular stagnation and negative real rate distortions. With developed economies recovering at differing paces, EM assets have been often caught in a cross fire of divergent G3 monetary policies.
In this highly uncertain environment, it’s important to remain focused on the domestic drivers of the EM economies which will ultimately determine this new order.
As such, we have aligned our portfolio positioning in order to remain pro-growth and benefit from the rewards of the immense reform agendas taking place in both China and India.
Looking ahead, we expect that Chinese economic momentum will build in a robust manner. The risks to the current bullish scenario are largely external as the Chinese government is in a year of important political transition and would therefore aim to maintain economic, political and social stability especially ahead of 19th National Congress of the Communist Party this autumn.
We also maintain a positioning bias towards the frontier markets of Vietnam, Argentina, Romania and Pakistan (VARP) – all of these economies boast strong economic growth with a young cash-laden population keen to spend money. VARP equity markets are becoming increasingly more open to investors – Argentina is reaping the benefits of a tax amnesty on capital repatriation and has moved towards eliminating capital controls. Similarly, Vietnam, Romania and Pakistan are reasonably straightforward in terms of accessing locally via cash or derivatives.
We also topped up Mexican exposure recently, as we believed that too much negative sentiment had been priced into the currency and equity markets post the Trump election.
In terms of sector positioning, our preference is for IT – as the demand for technology and new e-commerce platforms soars – financials, consumer cyclicals and industrials, over the expensive bond proxies, such as telecommunications and utilities.
We believe that we are well positioned to take advantage of any market turbulence. Looking at previous Fed rate hike cycles, EM stocks have typically rebounded once the first rise was completed. Earnings growth is also anticipated to be more buoyant in 2017 after a plethora of subdued years.
We maintain our positive outlook towards EM equities for a number of reasons: the relative risk / return profile of EM versus that of developed markets (DM) is favourable on the basis of the former’s positive currency-adjusted returns. Another factor is that EM equity valuations are well below those of the S&P 500 index constituents from a current and historic perspective.
In terms of risks to our positive outlook, the biggest concern is a widespread health pandemic (such as disease outbreak), which, in our opinion, trumps terrorism and geopolitical concerns. During the 2003 SARS crises, Asian markets were truly under pressure in both the financial and real economy terms.
Nevertheless, we believe investors are not yet up to their full weightings in EM, so significant asset inflows are not only merited, but also likely ahead.