Investment Strategy:  Second Quarter – Specific Market Reviews: Emerging Markets and Asia

  • Some of last years headwinds have abated, though probably not yet turned into tailwinds, for the emerging market stock markets. Rising US interest rates and a strong dollar have been a poisonous double act for traditionally risky assets like the EMs but this year’s more dovish Fed and stalling US dollar are more supportive. Consequently, in line with other global markets, the EM markets produced strong returns in the last quarter. Hopes of a China/US rapprochement on trade are also helping.
  • China’s growth rate of 6.6% in 2019 was the weakest since 1990 but this is not necessarily as problematic as many consider. China actually generated a record amount of GDP last year but the growth rate is naturally falling because it is from a much larger base. The nature of China’s growth is also changing with exports less important than previously and domestic consumption now accounting for three quarters of GDP. China is also making some modest progress in cleaning up its financial system, reining in the debt somewhat and if not deleveraging then at least achieving some stabilisation.
  • What is problematic though is whether we can believe the official numbers at all and whether the economy is in fact much weaker. There are plenty of worrying signs with sales of cars and mobile phones sluggish and earnings growth in general slow. China is a central command economy so a sharp slowdown will likely see monetary policy eased and some fiscal packages introduced. China would undoubtedly like an end to the trade wars, but it is not desperate, and as arch players of the long game will be prepared if necessary to sit it out for longer, not least to see if the US economy itself (and the stock market!) starts to suffer which may lead to a more conciliatory approach from Trump.
  • Japanese GDP growth rebounded with an annualised growth rate of 1.4% in Q4 2018 following a nasty 2.6% contraction in the previous quarter. A slowdown in China is a concern for this year’s growth though, contrary to popular perception, exports make up less than a fifth of Japanese GDP. The stock market though is over-representative of manufacturing and export companies and is still regarded as a ‘global cyclical’. Nevertheless, it is one of the few global market that looks cheap, trading on a forward P/E of only 12x, a six year low, cheaper than other developed world stock markets bar the Brexit benighted UK.
  • Emerging Markets as a bloc have produced strong returns this year with the MSCI EM Index returning 9% (5% in GBP). As usual there has been a wide diversity of return between the individual markets which shouldn’t be viewed as a homogenous bloc. There has been somewhat of a ‘flip flop’ effect with last years biggest losers being this years biggest winners with MSCI China rising 16% (13% GBP). Interestingly, MSCI Russia also rose by 10% in GBP though this was made up of an 8% local current return and, unusually, a 3% strengthening of the rouble. Brazil suffered from a weakening of the real, a 7% local return dwindling to just 2% for sterling based investors.
  • The MSCI EM Index is trading on a forward P/E of 12x which is about in line with its historic discount to developed markets with the MSCI World index trading on 15x forward earnings.

Summary: Markets bounced strongly in line with the global trends, benefitting in particular from a stalled US dollar and a more dovish US monetary policy. China though is looking more problematic, both politically and economically, and continues to cast a vast shadow over these markets.

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