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EM Equities: Why now? It is darkest before the dawn

GAM Investments’ Tim Love provides eight reasons why EM equities look appealing and explains why he believes the asset class offers multiple offsetting positives to the post Covid-19 lockdown world.

09 June 2020

With a backdrop of increasing geopolitical risk, nationalism and state aid, plus a re-evaluation of long supply chains and globalisation, people should find it refreshing, in our view, to identify an asset class with a clear set of offsetting positives to the post Covid-19 lockdown world with its associated problems. Below, we have outlined eight reasons why we believe the EM equities asset class is an attractive destination for investors. Ultimately, it is a case of looking at the basics: five tactical factors and three secular factors. We believe it is important to recognise that in the medium term, liquidity trumps fundamentals and valuations, despite health trumping the economy.


Conservative investor positioning and cash levels are too high, in our view. Central bank injections and fiscal stimulus swamp the market capitalisation of EM equities (USD 3.8 trillion total market capitalisation). Investor positioning is still underweight EM equities; with excess cash positions now looking for a place to capture relative or even basic absolute return, we believe EM equities are an attractive opportunity to exploit. With the Federal Reserve (Fed) balance sheet growth and the additional asset purchases by the US government, the combined response of each is now close to or over USD 2.6 trillion, more in aggregate than the real term equivalent of the World War Two cost of circa USD 4 trillion.

Granted, there are risks of further escalation of the China-US trade conflict (but these are certainly not in the same league as the 1930s Smoot-Hawley Tariff Act). With global central banks acting as a lender of last resort (“doing what it takes”), joined up with the pro-cyclical supportive loose fiscal policy, this has all underwritten an enormously positive support for risk assets. We believe the liquidity should prevent a systemic risk such as the 2008 “Lehman” moment, with all the unintended consequences emanating from that point forward. In short, it is also the largest, swiftest and most combined post World War Two policy response ever. 

Chart 1: Largest bailouts in history in 2020 USD on a log scale (USD billion versus G7 debt to GDP)

Source: Deutsche Bank, Haver Analytics, IMF, as at 2 June 2020

Chart 2: Rapid response: Fed asset holdings have grown sharply during the Covid-19 crisis compared to past QE periods

Source: Federal Reserve Bank of St Louis, as at 2 June 2020

We believe the size of the US stimulus in historical context should turn investors from a fear of deflation to a fear of inflation. With a diversified asset base to exploit, EM equities could be well placed to absorb a modest continuous level of consumer price inflation (CPI) growth. Total leverage, composition of FX debt profile, debt maturities and FX reserves all support the bulk of core EM markets, especially China, Korea, Taiwan, India and Russia. With eight out of 10 of the top EM markets at investment grade, that materially widens the cross-asset class investor base that can exploit these above merits for EM equities.

Chart 3: While the 37% drop in MSCI EM up to 23 March was accompanied by USD 55 billion of foreign outflows, foreign participation in the subsequent 32% recovery has been absent, with a further net USD 15 billion of outflows

Source: Bloomberg, UBS estimates, as at 9 June 2020.

Index change

EM equities are not what they seem. The MSCI EMF Index has materially migrated from being a commodity and US dollar sensitivity play; instead, the index is now dominated by command economy plays with domestic demand drivers and ever increasing environmental, social and governance (ESG), liquidity and credit dynamics. The top 10 index stocks are the top three players in each of their respective industries in market capitalisation and revenue terms. We believe the relatively new and greater resiliency of EM earnings per share (EPS) is misunderstood, as is the new weight of its new world economy sectors (versus commodities). This new weighting is a key driver to an increasingly domestic demand-driven EM EPS-led recovery.

With finance (eBanking, fintech) and EM information technology / EM communication services in combination accounting for 50.6% of EM EPS MSCI weight, there is a clear case to be made for a fundamental change to the resiliency and to the new world economy bias of the EM EPS stream. Before the 2008 global financial crisis, EM energy and materials were close to 35% of the same index versus their circa 12.5% today.

Chart 4: MSCI Emerging Markets Index sector weightings - commodities have given way to the technology and consumer discretionary sectors in EMs

Source: Bloomberg, as at 2 June 2020


Prior to this crisis, EM equities were already presenting themselves as the final liquid and investment grade laggard appealing to value, growth and yield investors. Global demand for yield has further been enhanced by the Covid-19 and oil crises, as dividends have been cut and fear of capital loss has driven demand for fixed assets.


  • The real effective exchange rate of major EM currencies are at historic lows compared to the US dollar despite better balance of payment and current accounts, especially Brazil.
  • In a world of negative real rates, lower for longer weighted average cost of capital and very low equity risk premiums, the risk of a bubble valuation (akin to the Nifty Fifty premium in the past) is very real. New world economy valuations could easily overshoot given the attraction of search for yield and premium for growth drivers.

EM re-rating

After 12 years of de-rating versus developed market (DM) equities and relative to their own valuation histories, EM equities were primed to enter a material re-rating phase, similar to 2004-2007, and were ripe for a re-rating. Combining EPS 2021 / 2020, dividend yields and price-to-earnings re-ratings, we believe this asset class will make a difficult opportunity cost for other asset classes to beat in the next three years. This is primarily due its starting point on a relative, absolute and cross-asset class perspective. As an example, the price-to-book value on the HSI Index is at relative lows to its 25 year history, see Chart 4.

Chart 5: Price-to-book value on the HSI Index is at historic lows 

Source: Bloomberg. Data as at 29 May 2020. Past performance is not an indicator of future performance and current or future trends.

Risk return

EM equities fell less than most DM equities during the February / March Covid-19 sell off. The asset class has proved a point on the downside, but EM equities have yet to prove this point on the upside in the medium / long term. In our view, their attractive relative valuation and fundamental factors versus DM will drive a re-rating as they did in the 2004-2007 period (post EM de-rating in the Asian crises). With the present market focus now on the speed of economies reopening, it is also critical that fresh surges of Covid-19 do not re-emerge and force strong counter measures. As Asia is in the vanguard of experimenting with these opening procedures, we believe they may well have an advantage over DM coming out of this pandemic. EM equities are no longer a high beta play on DM; they are a domestic-demand led, investment grade set of opportunities with ever greater new world economy components, with increasing ESG credentials and resilience.

Chart 6: In the last 30 years, the average MSCI EM price return in the 12 months after the market trough was 45%. Compared to DM equities, EM outperformed by 18% on average 

Source: MSCI, Datastream, UBS. Note. X axis represents trough date for that bear market. The average returns are calculated excl. the current period. * EM average return is the average 12m return since trough for all the bear markets previous to the current one. ** Relative return calculated as average MSCI EM return relative to MSCI World in 12 months since MSCI EM’s trough for the mentioned bear markets. The price return for the current period is until 13 April 2020. Past performance is not an indicator of future performance and current or future trends.

Structural investment themes

Secular logic for EM equities further underpins the longer-term valuation models. Urbanisation, percentage of women in the workplace, younger demographics, reform programmes in China and India, and adoption of digital technologies (artificial intelligence and robotics, cloud-based working) are all increasing as the migration to more productive, inclusive, higher value economies continues.

Chart 7: S&P 500 now more concentrated in the five largest stocks than ever before. We expect the same from Alibaba, Tencent, and Meituan Dianping over time

Source: Bank of America, Bloomberg, as at 2 June 2020. Past performance is not an indicator of future performance and current or future trends.

Investment grade

With eight of the top 10 EM equity markets now investment grade and seven of those eight with a positive carry trade; they should command an attraction towards EM, as has recently been seen in the Indonesian rupiah appreciation.

Chart 8: EM Asia has abnormally high cash on balance sheet when we look at the percentage of companies with net cash

Source: Refinitiv, Credit Suisse, as at 2 June 2020.

Reform programmes and command economies: A free local put option from five-year plans

China, as an example, is expecting over the next five years to top more than CNY 27.1 trillion (USD 3.78 trillion) in new infrastructure construction and related investments, according to Haitong Securities. The intention is to heavily invest in the digitalisation of its infrastructure. In sum, although new tech infrastructure figures are quite vague, Haitong Securities estimates RMB 3 trillion for 2020 and RMB 17 trillion over next 10 years.

At the National People’s Congress (NPC) and Chinese People’s Political Consultative Conference, held between 22 and 28 May 2020, Ma Huateng, Tencent’s founder and NPC deputy, stated that the industrial internet should be planned in the historical new round of scientific and technological revolution and industrial transformation, and promoted from the height of national strategy to continuously strengthen China’s digital economy. He continued to say that China needs to strengthen the top-level design, formulate a national strategy to systematically promote the development of the industrial internet and focus on the research and promotion of new infrastructure, digital transformation in all walks of life, smart cities, scientific research and innovation, and network information security. He also proposed to accelerate the advancement of new infrastructure such as cloud computing and the digital economy, data centres, digital governance and artificial intelligence. 

In our view, investing alongside this reform programme can only help an investor’s risk / return profile. Similarly this would apply to material reform programmes in Brazil, India and Saudi Arabia.

Important legal information
Source: GAM unless otherwise stated. The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. Reference to a security is not a recommendation to buy or sell that security. The companies listed were selected from the universe of companies covered by the portfolio managers to assist the reader in better understanding the themes presented. The companies included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. June 2020
Tim Love

Tim Love

Investment Director

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