Four years into the stock market party fueled by a punch bowl overflowing with trillions of dollars of central bank liquidity, you’d think a hangover might be looming.
It’s generally accepted these days that emerging equities are cheap and that value-focused investors should consider buying. But some disagree — analysts at UBS say the alleged cheapness of EM equities rings hollow when you look at the return-on-equity on emerging companies. They don’t dispute that the market has de-rated significantly on price-earnings and price-book metrics (at 10.5 times and 1.5 times respectively, they are well below long-term averages). But they argue that these have not been excessive when compared to the decline in profitability. Emerging return-on-equity pre-crisis was usually higher than developed. Once at a lofty 17 percent, emerging ROE now languishes at 12.7 percent, almost on par with ROE for developed companies. Check out this graphic:
Investors in emerging markets are facing a tough choice. Should one buy cheap shares in the hope that poor corporate governance and profitability will improve some day? Or is it better to close one’s eyes and buy into expensively valued companies that sell mobile telephones, holidays and handbags — all the things high-spending emerging market consumers hanker after?
Emerging stocks, in the doghouse for months and months, haven’t done too badly of late. The main EM index, has rallied more than 11 percent since its end-August troughs, outgunning the S&P 500’s 3 percent rise in this period. Bank of America/Merrill Lynch strategist Michael Hartnett reminds us of the extreme underweight positioning in emerging stocks last month, as revealed by his bank’s monthly investor survey. Anyone putting on a long EM-short UK equities trade back then would have been in the money with returns of 540 basis points, he says.
The Fed’s unexpectedly dovish position last week has sparked a rally in emerging markets — not only did the U.S. central bank’s all-powerful boss Ben Bernanke keep his $85 billion-a-month money printing programme in place, he also mentioned emerging markets in his post-meeting news conference, noting the potential impact of Fed policy on the developing world. All that, along with the likelihood of the dovish Janet Yellen succeeding Bernanke was described by Commerzbank analysts as “a triple whammy for EM.” A positive triple whammy, presumably.
Banks and financials stocks have had a pretty good year. The Thomson Reuters Global Financials index is up by more than 20% in the last 12 months, and although the detritus of the financial crisis still offers the occasional sting, investors are starting to see brighter spots for the industry.
Emerging stocks have rallied 3 percent today after the Fed’s startling decision to leave its $85 billion-a month money-printing in place, and some markets such as Turkey are up more than 7 percent. With the first Fed hike now expected to come in 2015 and tapering starting only from December, emerging markets have effectively received a three month breather. So will the buyers return?
Emerging stocks are not much in favour these days — Bank of America/Merrill Lynch’s survey of global fund managers finds that in August just a net 18 percent of investors were overweight emerging markets, among the lowest since 2001. Within the sector though, there are some outright winners and quite a few losers. Russian stocks are back in favour, the survey found, with a whopping 92 percent of fund managers overweight. Allocations to Russia doubled from last month (possibly at the expense of South African where underweight positions are now at 100 percent, making it the most unloved market of all) See below for graphic:
In the selloff gripping emerging markets, one currency is conspicuous by its absence — the Turkish lira. But this will change unless the central bank adds significantly to its successful lira-defensive measures.
The frontier markets juggernaut continues. Here’s a great graphic from Bank of America/Merrill Lynch showing the diverging fund flow dynamic into frontier and emerging equity markets.