I have to say that I have in recent weeks slightly lost contact with what was happening in the world of emerging market stocks. Largely because I have become more and more convinced that developed world investors had taken leave of their senses, that’s meant that I have been slightly ignorant of just how strong the EM rebound has become. Also, I suppose I’m still deeply anxious about the first wave of infections in places like Brazil and now India, which has in turn made me ever so slightly cautious.
Anyway, a note last week from Daniel Salter, Head of Equity Strategy/Head of Eurasia Research, at Renaissance Capital entitled Where are we in the global/EM/FM equity rebound? Should help put some numbers around that EM rebound. According to Daniel at the end of last week the EM rally was “the strongest of any of the big-5 EM sell-off rebounds (1998, 2001, 2008, 2016, 2020)”. So, what have eleven weeks of a rebound brought us to so far? Salter maps out the recovery step by step:
- Global equities bottomed eleven weeks ago, on 23 March.
- As we expected, the rally since then has been led by DM first, then EM with Frontier lagging.
- From the lows, the US (S&P 500) is up 43%, DM equities are up 41%, EM is up 32%, and Frontier up 16%.
- Until mid-May, the EM rally was dominated by ‘self-help’ countries, the relatively safe names with low bond yields and manageable budget deficits (or those exiting the virus earlier) – so Korea, Taiwan and Thailand in Asia, Russia in EMEA and Chile in Latin America.
- But a shift started within EM on 13 May, when EM currencies started to rebound and with it more ‘risky’ EMs started to outperform, such as Brazil and Colombia in Latin America, Indonesia and the Philippines in Asia and Turkey in EMEA. And since 28 May, EM itself has started to outperform DM as confidence builds that Coronavirus is under control in DM and much of EM (China, Korea, Taiwan and Thailand are essentially virus free and make up two-thirds of EM) while several of the poorer EM/FM countries are seem as more likely to ease restrictions given relatively youthful (and less vulnerable) populations vs the costs of keeping lockdowns in place.
Index performance (US$) for MSCI EM countries – fall from high, rebound from low and round-trip
What’s been powering this astonishing rebound in EM equities? My suspicion is that there is probably an amazingly simple explanation, which also applies to developed world markets – follow the money and look at global liquidity flows which have mushroomed over the last few months. At which point we can go to researchers at London firm Cross Border Capital.
The big chart below shows the astonishing rebound in their key global liquidity index. According to Michael Howell from Cross Border this EM version of the liquidity index “rebounded in May back to an EML index of 58.4 (‘normal’ range 0-100). Put into context, this is the highest reading since mid-2016 and a sharp acceleration from the 22.4 index lows of September 2019. The rise proved general, with positive contributions from Central Banks, private businesses and foreign investors….Set into context, net outflows totalled 1.2% of EM liquidity over the past three months, with a peak outflow hitting 9.9% of EM liquidity at an annualised rate: compare this to the 2008-09 GFC where outflows totalled 3.8% of liquidity or roughly three times bigger and suffered a peak drain of 23.8% annualised. “
I think Cross Border makes the very valid point that currency stability really matters for emerging markets. The rebound in recent weeks shows that unlike “the 2008-09 GFC, cross-border financing lines remain open, helped we feel sure by the sudden and sizeable provision of US dollar swap-lines by the US Federal Reserve. The robustness of recent data, reinforced by our previous observations about capital flows, suggests that EM forex markets should regain their recent losses.”
Another factor worth considering is QE, or at least local EM variants on QE. According to Cross Border “Poland is in the forefront of these QE initiatives; Latin America is generally picking up and, even though India and China trail in the rankings, their actions are still positive.”
Looking at emerging markets through the prism of currencies, Cross Border traffic light risk system shows that Brazil, Korea, Thailand, Poland and South Africa are top ranked whereas India and China are less favoured because of concerns, respectively, over the Rupee and still tight Chinese liquidity. Our models do not like Russia, nor the other smaller Asian markets.
And EM equities? Back to Renaissance. First off earnings still look depressed “making 12M FWD earnings multiples high, but nevertheless, MSCI EM is trading on a 12M FWD PER of 14.3x vs MSCI World on 20.9x, with MSCI FM on 12.5x. Given the depressed earnings numbers, EM, DM and FM are all trading at a significant premium to 10 year average 12M FWD PERs. EM is trading at a 28% premium to its 10 year average 12M FWD PER of 11.2x; DM is at a 44% premium to its 14.5x average; and FM is at a 21% premium to its 10.4x average.
Price to book value multiples suggest value in EM, trading on 1.4x trailing PBV versus 2.5x for DM (FM is on 1.5x) but who wants cheap EM companies, when you can have Zoom on 38x Price to Book? Still EM is trading well below its 10 year average of 1.6x, DM well above is ten year average of 2.1x and Frontier just slightly below its ten year average of 1.6x. EM’s discount to DM of 46% is well above the ten year average of 22%, while FM’s premium to EM of 10.9% compares with a ten year average premium of 1.6%.”
Renaissance’s preferred markets are “Russia and Central Europe within EMEA. Vietnam and Kazakhstan in Frontier. For those sure of a V-shape recovery, add more South Africa (and Brazil/Latam/Indonesia) to the mix.” In terms of cheap markets look at the Philippines, Mexico, Greece, South Africa, Colombia, Egypt, Turkey and Pakistan.