What now for EM equities? Why a reversal of fortunes signals opportunity
22 April 2014 | Investments | Equities | Archie Hart, Investec Asset Management
Emerging markets rallied during March – the first month of meaningful outperformance of developed markets since December 2012, with the MSCI Emerging Markets NDR Index up 3.1% compared with the MSCI ACWI NDR Index which rose just 0.4% during the month. This reflected rising local markets and a recovery in hitherto weak emerging market currencies.
In particular, the so-called ‘fragile five’ markets (Brazil, India, Indonesia, Turkey and South Africa – countries with current account deficits, reliant on foreign funding and thus perceived to be more exposed to the US taper) put in a strong performance in March, up between 5.5% and 16.8%. It is worth pointing out that before the March rally, four out of these five countries were down for the year, and are now all in positive territory and outperforming the broader emerging market indices. In absolute terms, all regions posted positive returns on the month. Latin America and Africa led the broader emerging market rally, up 8.8% and 6.3%, respectively. Within Latin America, Brazil was the star performer, up 11%. At the other end of the spectrum, Asia, up 1.4% (even with China down 1.7% – one of the worst performers aside from Russia), and Eastern Europe up 0.8%, were relative laggards. Russia, while benefiting from a late bounce in the month, was down 2.5%.
The most interesting aspect of the strength in emerging markets last month was the intra-market reversal of fortunes.
Formerly unloved Turkish financials (21.7%), Indian energy (18.8%) and Brazilian energy (17.7%) stocks topped the performance tables, while former market favourites Indian IT (-7.5%) and Chinese IT (-10.4%) rested at the bottom of the performance list. In other words, there was a sharp rally in unloved value stocks, while the so-called ‘GULP’ (growth at unlimited price) stocks succumbed to profit-taking.
It will be interesting to see if this trend persists, and we will certainly keep a close eye on it. Normally, for value to begin to work, the markets would require an economic and market recovery to begin. It is possible that the ‘value rally’ of March presages just such an outcome. Or, alternatively, it could just be noise. March was the best month for value (as we define it) in our process since January 2013.
More fundamentally, the fourth-quarter 2013 results season is now most of the way through, with over
80% of companies by market capitalisation having reported. Of those, 56% have reported either above or in line with expectations and 44% have reported below expectations. The environment remains difficult, but it is far from calamitous.
The emerging market equity asset class is cheap, in our view
What it badly needs is some good news. Perhaps March’s rally in the ‘fragile five’ countries indicates that the market is beginning to see some signs of positive change, such as Indonesia’s economy adjusting and its economic imbalances reducing, Turkey’s electorate supporting the incumbent government (which for all its faults has delivered 10 years of economic growth) and the prospect of a potential change in government in India. If such change happens, we are likely to see it manifest itself in a crop of new ideas for the portfolio – an exciting thought for an investor.
