The global macroeconomic backdrop for emerging markets (EM) has improved. Additionally, there is a strengthening case for EM outperformance from the combination of the Fed pausing in the rate hiking cycle, a steady dollar, and de-escalation of trade tensions with China. Moreover, valuations are supportive and fundamentals are stabilizing. Given these positive developments, the MSCI EM Index is up 12% from the market bottom at the end of October, of which 8% came since U.S. Federal Reserve Chairman Powell’s speech in January.1 Even as EM has rebounded, QMA believes there are still sufficient positive catalysts to support a continued rally. In a recent market commentary, QMA’s Global Multi-Asset Solutions team explained its more positive EM stance and detailed how the pre-conditions (summarized below) for the outperformance of EM equities seem to be lining up.
Stabilizing macroeconomic forces
A strong catalyst for outperformance of emerging markets has been a stabilization in macroeconomic forecasts, thanks to tailwinds from low commodity prices, especially oil, that benefit EM commodity-poor nations such as India. Also, the OECD expects global growth to pick up in 2020 to 3.4% from 3.3% expected in 2019.2 Furthermore, many idiosyncratic factors that weighed on markets last year, such as election uncertainty in Mexico and Brazil, are behind us, providing further optimism on the outlook for EM.
A dovish Fed and steady U.S. dollar
After steadily raising rates for three years and spooking markets with hawkish rhetoric in October of last year, the Fed raised interest rates one more time in December. It then surprised markets in January by hinting at a pause in the rate-hiking cycle, and emphasizing both patience and newfound flexibility on the shrinkage of its balance sheet. Given this dovish shift, fed fund futures are now pricing in no rate hikes this year and a cut in 2020.
A lower interest-rate trajectory in the U.S. also translates into a reversal of the financial flows from the U.S. toward higher-yielding EM countries, weakening the U.S. dollar (USD) and propping up EM currencies. A dovish Fed offers support for EM currencies and halts appreciation of the USD. Indeed, this was the case back in 2016 and appears to be the case this year. The J.P. Morgan EM FX Index bottomed in September, but after the speech by Powell at the beginning of January that signaled the start to a more “patient” Fed stance, it increased by about 1.5%.
美国利率下降也意味着资金从美国流向高收益新兴市场国家的趋势逆转，美元走软，新兴市场货币走强。温和的美联储为新兴市场货币提供支持，并阻止美元升值。事实上，2016年的情况就是如此，今年似乎也是如此。摩根大通新兴市场外汇指数(J.P. Morgan EM FX Index)在9月份触底，但在鲍威尔1月初的讲话之后，该指数上涨了约1.5%。鲍威尔的讲话表明美联储开始采取更为“耐心”的立场。
With the economy slowing, business confidence sagging and non-performing loans rising, China initiated a stimulus program in mid-2018 that started with monetary measures such as rate cuts and continued with fiscal policy and credit easing. QMA believes China will do whatever it takes to stimulate its economy and expects the impact will become more evident as we move through 2019.
- The U.S. and China are making progress on a trade deal. Regardless of whether the deal is substantive in addressing underlying structural issues or just a temporary cessation of hostility, it would likely benefit China and the rest of the EM world.
- Despite a still slowing economy, there have recently been “green shoots,” including a large increase in overall social financing growth (which contains shadow lending), rising Caixin/Markit combined PMI composite with the new-orders component moving into expansion territory, and accelerating home price growth for Tier 2-4 cities.
- China is a major destination for many emerging market exports. Once China’s economy stabilizes and/or accelerates, the multiplier impact on EM economies and EM corporate profits could be substantial.
EM equities are inexpensive, trading at a 12-month trailing P/E of 12.8x, which is slightly below the 10-year average. Historically, at this starting level of valuations, EM equities have delivered an average return of 15% over the next 12 months. Not only are EM equities inexpensive relative to their own history, but also relative to developed markets, trading at a roughly 27% discount, which is slightly above its historical average discount.
Meanwhile, earnings expectations for EM have come down from a lofty 15% in the beginning of 2018 to 7%, and show signs of bottoming. Current expectations are also a lower hurdle for upside surprise. With supportive valuations and sensible earnings expectations, EM is looking increasingly more attractive.
MSCI EM P/E vs. average return over the next 12 months
Source: QMA, MSCI, FactSet. Data from 1/1/99 to 2/28/19 for MSCI EM Index.
资料来源:QMA, MSCI, FactSet。MSCI新兴市场指数由1/1/99至2/28/19的数据。
Positive macroeconomic developments underpinned by attractive valuations of EM equities and a stabilization in GDP growth forecasts make a compelling case for emerging markets. However, risks remain, including a much deeper slowdown in global growth, a breakdown in trade talks, or the Fed pivoting to a more aggressive stance in response to more positive U.S. growth or an inflation surprise. Yet, on balance, QMA believes that the risks are skewed to the upside and EM equities are an attractive value proposition, offering an ample risk premium.