David Semple, Portfolio Manager, Emerging Markets Equity Strategy
April 10, 2019
MSCI Emerging Markets Index rose 9.67% during the first quarter of 2019, staging an impressive comeback following a lackluster 2018. Although the asset class has lagged behind the S&P 500® Index in 2019, over the past five months (or since the trough on November 1, 2018), emerging markets have outperformed the S&P 500 by approximately 6%. While they did both decline into the end of last year, emerging markets did not decline as much as the developed markets, and have been relatively strong performers in 2019.
The prize for top performance in 2019 goes to (drum roll) China—particularly the A share market, but also, the offshore market. The whole Chinese market has done well. Clearly this has been a reaction to more stimulus taking place and signs of improvement in trade negotiations between the U.S. and China. On a sector level, 2018’s laggards become 2019’s outperformers. The consumer discretionary and real estate sectors1 performed best in 2019, rising 20.1% and 15.6% respectively, while utilities and healthcare lagged, but also rose 3.64% and 4.23% respectively. Finally, growth stocks1 have outperformed value stocks1 so far this year. Conversely, small caps1 continued to underperform.
We believe any signs of improvement in China are tentative at this stage. The usual tools will not be as effective and will take a little bit longer to work. But that is not to say they will not be effective in our opinion. We do believe, however, that the economic data should get better in the second quarter of the year. The mood domestically has certainly turned around on the basis of what the country is doing itself in terms of the provision and transmission of liquidity, and regulatory and fiscal moves. The fourth quarter earnings’ cycle for Chinese companies is well under way (58% of the MSCI China Index have reported), and so far, on average, more earnings and revenue “beats” than “misses” have been reported. On average, the largest surprises have come in aggregate from sectors that performed poorly last year, such as communications services, consumer, and real estate. It has also become relatively clear that there is likely to be some kind of deal in the country’s trade dispute with the U.S., although it might be a “deal lite”.
All this is in the background of central banks blinking, which one by one they have done. The People’s Bank of China (PBOC) was first to move in terms of creating more accommodation. The U.S. Federal Reserve has recently completed its full turn on its monetary policy stance. Not only has it taken away any expectation of interest rates hikes in 2019, but also chatter about rates being cut has appeared. It took the European Central Bank (ECB) a while to recognize the weakness in the eurozone, but it finally did and adjusted its monetary stance accordingly. Overall, we are not facing a tighter monetary environment around the globe, which is good for emerging markets. If anything, the environment may even be looser.
At the margin, the gloss is coming off in Brazil. Finding solutions to long standing problems, especially social reforms, is proving not quite as easy as anticipated. President Jair Bolsonaro’s reform attempts are becoming a bit “untidy.” The situation makes people very cynical and the corporates that had been cautiously optimistic are now erring on the cautious rather than the optimistic. In addition, while not terrible, the economic numbers have not been as good as one might have hoped. Meanwhile, up in Mexico, the markets have clearly sold off and the cost of capital has gone up. The key questions are political: Is AMLO (Andrés Manuel López Obrador, President of Mexico) all bark? Or is there really some bite? This actually matters, though, much more on the fiscal side, because to the extent that there is money being “given away”, then consumer confidence soars. And consumer confidence is currently pretty high in Mexico. But macro worries outweigh in our opinion.
India last year saw some pretty bad earnings revisions, and the premium it trades on, versus the rest of the emerging markets, is still high. In our opinion, India deserves to trade at a premium, but not one as high as it is. Foreign investors have not recently put money to work in the country, net of re-investment of dividends. As for the forthcoming elections, we have heard many conflicting signals and can draw no firm conclusions as to results from any of them!
Emerging Markets Outlook
We see the outlook as being constructive. We do think that, although some kind of a deal will be reached between China and the U.S. over trade, the more worrying thing is the gravitation towards bilateralism and the continuing attrition that is going to take place between the two “empires.” A turnaround in China due to stimulus can be positive for Asia and emerging markets in general. Earnings in China have not been nearly as bad as they were last year, but in an environment where liquidity is made available, earnings revisions tend to follow rather than presage it.
Loose monetary policy talk has sparked fears regarding global growth and an inverted yield curve in the U.S. This does not necessarily preclude emerging markets’ outperformance, in our opinion, but it certainly remains something to watch. One thing seems to be evident, the case for a strong U.S. dollar in 2019 continues to weaken.
There are going to continue to be issues. But many emerging markets countries had raised rates as a precaution in the face of tightening by developed markets central banks. This provides them with the scope to bring rates down without having too much of an impact on their currencies. We also have the singular positive of corporates continuing to generate record high free cash flow.
The asset class may not be quite as under-owned as it has been. Valuations remain at long-term historical averages. We do, though, think there is still scope for increased weightings. Now that the U.S. has less of an outstanding economic development rate, and a stock market that reflects it, it is a much more even playing field for everybody else. Emerging markets ought to get its fair share.
1Based on the MSCI EM sub-indices such as the MSCI EM Growth Index, MSCI EM Value Index, MSCI EM Consumer Discretionary Index, MSCI EM Utilities Index, MSCI EM Healthcare Index, MSCI EM Real Estate Index, MSCI EM China Index, and the MSCI EM Small Cap Index.
All indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. Certain indices may take into account withholding taxes. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.
The Morgan Stanley Capital International (MSCI) Emerging Markets Index captures large- and mid-cap representation across 24 Emerging Markets (EM) countries. With 836 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. The MSCI Emerging Markets Investable Market Index (IMI) captures large, mid and small cap representation across 24 Emerging Markets (EM) countries. With 2,628 constituents, the index covers approximately 99% of the free float-adjusted market capitalization in each country. MSCI All Country World Index (ACWI) captures large- and mid-cap representation across 23 Developed Markets (DM) and 24 Emerging Markets (EM) countries. With 2,483 constituents, the index covers approximately 85% of the global investable equity opportunity set.
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Portfolio Manager, Emerging Markets Equity Strategy
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