“Contrarian” Deutsche (a bit) less bearish on emerging stocks

July 2, 2013

For an investor in emerging equities the best strategy in recent years has been to take a contrarian stance, says John-Paul Smith at Deutsche Bank.

Smith, head of emerging equity strategy at Deutsche, has been bearish on emerging stocks since 2010, exactly the time when bucketloads of new cash was being committed to the asset class. Investors who heeded his advice back then would have been in the money — since end-2010 emerging equities have underperformed U.S. equities by almost 40 percent, Smith pointed out a couple of months ago.

Things have worsened since then and MSCI’s emerging equity index is down around 12 percent year-to-date, almost the level of loss that Deutsche had predicted for the whole of 2013. June outflows from emerging stock funds, according to EPFR Global last week, were the largest on record. But true to form, Smith says he is no longer totally bearish on emerging equities.  Maybe the presence or absence of those he calls “marginal international investors” — people who joined the EM party too late and are quick to take fright — is key. Many of these positions appear to have been cleaned out. Short positions or high cash balances dominate the books of dedicated players,  Smith writes:

However bad the underlying fundamentals appear to be,the best approach, following the end of the acute phase of the global financial crisis in early 2009 with regard to emerging market equities, has been to follow a contrarian strategy. We have attributed this to the greater influence of marginal international investors and in particular the rising influence of the sort of momentum – or trend-following investors whose strategies have become largely self-defeating, because they are devoid of the broader context  of sovereign and corporate governance, which is the true driver of longer term investment performance.

He adds wryly:

Also our own services are in fairly high demand which is usually a sign of a short term bottom in EM

The graphics below shows how in EM neither growth-oriented nor value (cheap) stocks have done well while in the developed world, the growth index has provided stellar returns.

Smith is now overweight  equities from select countries such as Poland, Taiwan, Turkey and Mexico which are less exposed to China and will benefit from an oil price fall. But he is by no means positive on the sector as a whole. The reason is his doggedly negative view on China, the biggest emerging market and the second biggest economy in the world. Smith again:

It is obviously impossible to have a bearish fundamental view towards the Chinese economy and equity market, with all the negative implications for trading partners and commodity producers and not to remain underweight in GEM versus DM.


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