Global Investing

Emerging stocks: when will there be gain after pain?

Emerging equities’ amazing  first quarter rally now seems a distant memory. In fact MSCI’s main emerging markets index recently spent 11 straight weeks in the red, the longest lossmaking stretch in the history of the index.  The reasons are clear — the euro zone is in danger of breakup, growth is dire in the West and stuttering in the East. Weaker oil and metals prices are hitting commodity exporting countries.

But there may be grounds for optimism. According to this graphic from HSBC analyst John Lomax, sharp falls in emerging equity valuations have always in the past been followed by a robust market bounce.

What might swing things? First, the valuation. The  2008 crisis took emerging  equity prices to an average of 8 times forward earnings for the MSCI index, down from almost 14 times before the Lehman crisis. The subsequent rebound from April 2009 saw the MSCI emerging index jump 90 percent. Emerging equities are not quite so cheap today, trading at around 9 times forward 12-month earnings but that is still well below developed peers and their own long-term average.

Lomax says:

Macro headwinds are strong but emerging markets are looking very cheap. On a price/earnings basis they are 15 percent below historical lows which guards against further falls. In the past, whenever you bought emerging markets at such levels, you made money.

Crucially however, that bounce back in 2009 came after a March G20 leaders’ meeting announced a massive stimulus package estimated at around $1 trillion to prevent a global economic and banking collapse. Investors are betting that global central banks will react to the current financial market distress via more money-printing or cheap loans to banks. According to Bank of America/Merrill Lynch’s monthly fund manager survey, investors are firm in their belief  that global central banks, led by the euro zone and the Fed, will soon embark on stimulus.

Central banks and the next bubble (3)

Expectations are running high ahead of next week’s LTRO 2.0 (expected take-up is somewhat smaller than the first time and the previous estimate though, with Reuters poll predicting banks to grab c492 bln euros).

The ECB’s three-year loan operation, along with the BOJ’s unexpected easing, BoE’s QE and commitment from the Fed to keep rates on hold until at least end-2014 may constitute competitive monetary easing, Goldman Sachs argues.

As the moves to ease have been rolled out, we increasingly encounter the argument that such ‘competitive’ (non-coordinated) monetary expansions by developed market central banks are at best ineffective and at worst a zero-sum game at the global level—and perhaps a precursor of something worse, such as a slide towards protectionism.