What were the major recent events and impacts on your asset class?
Emerging market equities have had a reasonable year to date up to just before the half year end, 27th of June, 4% up in dollars. That's nothing to write home about, but it's with the drag of China, which is 30% of the index, down 5% in that period. So there's, as always, a heterogeneous and a multifaceted answer to emerging markets. Has it been a good year? Well, compared to the Dow up in the same period 2%, yes. Compared to Nasdaq up 29% in the same period, no. Have there been parts of emerging markets which have kept up with the more AI momentum growth at a reasonable price (GARP) component of developed world? Yes, there have been. If you're looking at as an example, Taiwan up 19% or Korea up 16%, there's large parts of those markets which are being very influenced by the AI momentum that has caught fire on Nasdaq and dragged the S&P up. So, yes, it's all about alpha. It's all about stock selection. It's all about asset allocation. In terms of sectors, it's even more apparent that where IT is up 19%, but the value side of the market, such as an example, the energy up 7% or indeed some of the industrials up 3% or the financials on the steeper yield curve up 7%, lagged that IT component. But they were still better than the expensive defensive areas such as your utilities, healthcare or staples, which are actively down in that period. So a large discounting, if you like, of global growth coming back at some juncture after the pivot, the peak of interest rates and some sectors discounting that too far too fast, others consolidating their gains from last year and giving back some in absolute terms and some which are moved materially so by this AI momentum.
What can your asset class offer in the current environment?
I think for investors looking at frontier market exposure or secondary stocks, there's a lot of opportunity. Vietnam, Argentina, Romania or indeed some of the onshoring, reshoring opportunities in northern Mexico are all very much in that group. Secondary opportunities in the better governance plays of India, the more liquid secondaries, again, excellent hunting opportunities to go after. I think the bifurcation of world supply chains, the bifurcation of people's mindsets between Western liberal democracies and that of command economies is not necessarily a plus or a minus, but it's very much there. And as such, I think supply chains are hedging the bets and reshoring / onshoring / nearshoring is very much a theme which will capture the imagination, I think, of Western allocators for the next 5 to 10 years.
What is your outlook in the near and medium term?
I think emerging markets overall are, as always, under-loved, under-owned and undervalued and no more so now than ever. The portfolio itself that we're running is cheaper now than it was in 2004, before the massive rerating that it achieved between 2004 and 2008, which was the last meaningful outperformance of emerging markets (EM) versus developed markets (DM) on the books. We've had 15 years of choppy sideways and de-rating since then, which is illogical in some respects because you've had the earnings continue to grow and prospective earnings 16% to 18% for emerging markets is not shoddy and would justify a rerating from a portfolio valuation of 9.5 price/earnings ratio (PER) or indeed an index one of around 11. With returns on equity (ROE) of above 15% and a dividend yield well covered of 3.5 on a group of countries where the top eight out of the top 10 are investment grade now, unlike 2004, where only six were or even five in those days. It's a different offering. The earnings themselves are more resilient, modern facing, much more in the AI, robotics or indeed cyber area or consultancy, a much higher value add chain contributions, much more consistent, much more able to be a centre of excellence and compete with DM and much more integrated to DM supply chains. So in that sense, why would an asset class go sideways for 15 years when they were rewarded for that in the DM but not in the EM? I think there'll be a rerating and a material one at that, like it was in 2004 and it went on for four years and it was a monstrous outperformance to DM. So with that backdrop on the secular, what's the catalyst? It's normally liquidity related. Why would people go into a perceived, and perception is nine tenths of reality, a perceived higher risk asset class? The answer is if indeed the reality is one which is easily intangibly certifiably illustratively shown to be good on its earnings, cheap on its valuations and under owned, then that passive money and indeed that active money will come flying back in and that de-rating will evaporate. So in that sense the catalyst would be a peak in in the dollar, a peak in obviously the interest rate cycle and the recognition of the investment grade, the cross asset class attraction, the value, the growth, the yield attraction domestically and the domestic demand angle, which people are totally ignoring, i.e. the birth of a lot of pension funds and a lot of these emerging markets which themselves will stabilise and then inculcate a degree of a buffer, if you like, for foreigners leaving, it will be the slack will be picked up by domestics. And so liquidity and not being so prone to passive international hot money, but much more domestic, longer term institutional money. And that's happening in a lot of these markets. And so a buffer on liquidity, a secular and a cyclical confluence of activity, of valuation. And in sum put all that together and I think you've got an incredibly good longer term story.
Is there one chart you’re currently monitoring closely?
I think when a lot of emerging market real rates start to roll over and come back down as their domestic inflation rates fall faster than we're seeing in a more sticky world of inflation in the developed world, I think that would be a tremendously positive sign. Brazil's one of those where inflation has come down much quicker. It went up, the SELIC (Brazilian federal funds) rate went up, the domestic discount rate went up much higher and faster than the developed world initially. Perhaps a lesson and a guide for developed world central banks. But they never went into negative real rate territory, never went into quantitative easing (QE) territory, so they were more orthodox in nature. But as you see there, domestic inflation and core inflation fall faster. That's a tremendously positive sign for a crossover between allocations domestically from Brazilian pension funds in fixed, back into equity. And that will catalyse a rerating, whether it's that market or Mexico, it's a very similar story. So yes, I think that's one that I would look at core domestic inflation, real rates coming down, continuity of credit being solid on its transition to being ever higher investment grade and real effective exchange rates continuing to be very attractive. I mean, they are egregiously cheap in some of these countries after the geopolitical knock ons that you've had. So I think if you see global growth even begin to level off at the lows, if you see passive flows come back in and you see the cross asset class attraction for emerging markets, they're the kind of things that I would be looking at very closely and monitoring on a chart by chart basis daily.
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Christian Munafo of Liberty Street Advisors notes an improvement in market conditions for investors in late-stage private companies; many of these companies are similar to what public market investors used to seek in small to mid-cap growth stocks. He also stresses that many of them are not just high growth, they are also at or approaching profitability.
Goro Takahashi describes the key factors that influenced the Japanese market over the third quarter, particularly the main stock exchange’s ongoing initiative to improve listed companies’ financial indicators, and the areas he thinks investors should focus on into the turn of the year.
Julian Howard reflects on the combination of stretched valuation and a tight equity risk premium that has made equities less attractive in the short term. However, it does not undermine the very long-term case for equities, in his view. He also notes the long-term structural case for China.
GAM Systematic’s Dr Chris Longworth and Guglielmo Mazzola highlight bond sell offs and a commodities rally as significant market events, and note that systematic investment approaches can help provide investors with much-needed diversification for their portfolios.
Atlanti’s Gregoire Mivelaz highlights the three major events of Q3 that impacted his investment universe: earnings, bond call dates and the reopening of primary markets. He believes given we are now in a late credit cycle, credit quality matters for investors. And he notes that market mispricing is continuing to lead to opportunities.
Jian Shi Cortesi notes that weak sentiment in China is keeping Chinese equities at very low valuations, due to the soft economic growth, real estate drag and the ongoing China-US rivalry. However, she is optimistic about long-term prospects, with the conviction that in the long term earnings growth will drive stock prices.
Niall Gallagher shares his views on the implications of rising real bond yields and why he thinks central banks will continue to have to fight inflation rather than deflation. Niall also discusses the sheer scale of capital required to enable the energy transition, and some of the companies he believes stand to capitalise.
Tim Love, Joaquim Nogueira and Rachit Chirania of GAM Investments’ Emerging Markets Equity team believe India could lead emerging market outperformance over the course of this decade. They outline seven reasons why they think the country presents a rare secular and cyclical growth story at a time when major economies are struggling.
Given an improving risk/return backdrop for emerging markets (EM), Tim Love, believes now is a good time to revisit a grouping he coined in November 2020 called “START” (Samsung Electronics, Tencent, Alibaba, Reliance and TSMC) which represent well the cyclical and secular opportunities for the EM region.