Investment Strategy:  Fourth Quarter 2019 – Specific Market Reviews: Emerging Markets and Asia

  • The Japanese economy had a stronger than expected first half of the year but the escalation in the trade war, an appreciation in the yen and the uncertainty to be caused by the VAT hike in October do not bode well for the next few quarters. The BoJ as always will step in with ever looser monetary policy if necessary.
  • This year marks the 30th anniversary of the high point of the Nikkei 225 index at a level that is still double that of today, which is astonishing. To put this in context, the Dow Jones index took 25 years after the Wall Street Crash to make a new high and has soared and soared again pretty much ever since. This tells us two things, firstly the extraordinary stock market and real estate bubble valuation in Tokyo back in the late 1980s and secondly that maybe value is finally back in the Japanese market with the aggregate P/E at a 48 year low and a dividend yield of 2.5%. An opportunity, well maybe, but we have been here so many times before and the medium term outlook does not look particularly appealing. Deflationary forces still abound, the global trade war is hurting, and the yen’s appreciation as a ‘safe haven’ currency is a headwind to the large industrial/exporting companies that make up much of the market.
  • The Chinese economy is facing plenty of challenges; the corporate sector is over indebted, the household sector is heavily exposed to the residential property market, and the manufacturing sector is struggling to maintain its past momentum. However, there are always plenty of levers in a central command economy to keep the ship afloat. China will want to keep growth steady but no more as it is mindful of controlling existing credit bubbles and making sure it doesn’t create any more. Of course, those of a logical disposition will appreciate that in any case a continued slowdown in the rate of GDP growth is inevitable as the economy gets ever larger.
  • As major supply chain manufacturers and trading partners of both the US and China, Asian economies and stock markets are in the eye of the trade tariffs storm and along with ‘old economy’ Europe would be a major beneficiary of any settlement. A tailwind though will be the looser US monetary policy, especially if it leads to a weaker dollar.
  • Hong Kong has its own problems as those who follow the news will be well aware. The stock market has underperformed its Asian brethren over the summer amid the continued disruption caused by the protests which have raised concerns about a potential slowdown in residential demand, consumer spending and tourism. The MSCI HK Index has risen only 3% this year.
  • Here’s an interesting stat that rather puts paid to the old notion that emerging markets are a high beta play on developed markets. Over the last 10 years the MSCI World Index has produced a return of around 160% in local currency terms whilst the MSCI EM Index has produced a return of around 80%. Even with my dodgy maths that looks like around a half to me. I’m not necessarily trying to make much of a point here or go into reams of explanation, its just a good myth-buster of a number.
  • Emerging Markets as a bloc have produced decent returns this year with the MSCI EM Index returning 8% in local currency and 10% in GBP, though they are lagging developed market returns, held back by the trade war and a still strong dollar. As usual there has been a wide diversity of return between the individual markets which shouldn’t be viewed as a homogenous bloc with MSCI Russia the standout rising by a whopping 35% in GBP, made up of an 23% local current return and, unusually, an 12% strengthening of the rouble. MSCI China has risen around 8% in local currency but 11% in GBP and Brazil 19% in local currency but 15% in GBP, showing the importance of FX in returns to UK based investors. India was the laggard returning only 5% in local and GBP despite a rally at the end of the quarter after measures to stimulate the economy.
  • The MSCI EM Index is trading on a forward P/E of 12.5x which is about in line with its historic discount to developed markets with the MSCI World index trading on 15.5x forward earnings, a gap which shows little sign of closing.

Summary: Asian and EM stock markets have produced strong returns this year, benefitting from the US led global trend and the tailwind of a more dovish US monetary policy. China and the trade war continue to cast a vast shadow over the region.

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