Emerging markets: to buy or not to buy
To buy or not to buy — that’s the question facing emerging market investors.
The sector is undoubtedly cheap – equity valuations are 30-50 percent cheaper than their 10-year average on a price-book basis; currencies have depreciated 15-20 percent in the space of 4 months and local bond yields have surged by an average 150 basis points. As we have pointed out before, cheapness is relative and the slowing economic and credit growth in many countries will undoubtedly manifest itself in falling EPS growth. Companies that cannot pass on high input costs caused by weak currencies, will have to take a further margin squeeze.
But many analysts have in recent days changed their recommendations on the sector. Barclays for instance notes:
Value has been created in EM local (debt) markets and the bulk of the global rates repricing should be behind us.
At Morgan Stanley they write:
Improved valuations and carry as well as signs of positive export growth momentum support emerging currencies near term.
Even the more bearish analysts such as Deutsche Bank’s John-Paul Smith and Societe Generale’s Benoit Anne have been cautiously turning more positive, at least tactically. Of course the signs of recovery in U.S., Chinese, Japanese and euro zone growth have helped. An airstrike on Syria does not look imminent. The Fed stimulus rowback could be smaller than expected, many reckon. And emerging markets too are showing marginal improvement.
Brazil and Turkey posted better-than-expected economic growth for the second quarter — Turkey grew 4 percent. India’s huge current account deficit is contracting steadily, data this week showed. And markets have reacted accordingly, with emerging stocks having rallied to three-month highs. The rand and rupee are at the highest levels in three to four weeks, well off recent record highs.
Anne of SocGen is just back from meeting European clients and has this to say:
EM investors are dying to go back to a market that is driven by bottom-up analysis, where some differentiation across countries can define investment themes… Some clients even made it clear that they were no longer bearish and were very close to start building long EM positions again, the reasoning being that the EM rally would probably be as brutal as the sell-off was in June/July, and they did not want to miss it.
But the sector is not out of the woods yet. Fed tapering is yet to start first of all. Most economies still appear reluctant or unable to kick start the structural reform that is essential for faster economic growth. Latest data from Poland, Turkey and South Africa show that current account deficits remain a problem. And finally, there are still plenty of question marks over China’s growth and banking sector.
Morgan Stanley have upped their recommendation on emerging markets to “Accumulate” from “Hold” but they stress this is a short-term trade. Anne of SocGen has this to say:
To those EM investors that captured the full risk-on move in EM, hats off and well done. To those that have missed the rally and are now thinking of jumping on, please don’t.