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

  • Slowing global growth momentum, tighter US monetary policy, rising bond yields, a strong dollar and the escalating trade war are very strong headwinds to the emerging markets. Throw in an old school crisis like Turkey and Argentina and it is no surprise that the EMs are the worst performing of the global equity markets with the Investment Association Emerging Market fund sector average down by 7% to the end of Q3.
  • There continues to be a wide divergence in returns from the individual markets, especially when the weakness of some EM currencies is taken into account. The MSCI EM index is down 3% ytd but Russia is bucking the trend rising 22% ytd in local currency whist Brazil and India are both up around 5%, the latter reflecting its relative insulation from a potential trade war as exports comprise only around 20% of GDP. MSCI China is down 9%, Turkey 11% whilst some of the smaller markets like Indonesia and the Philippines have also suffered double digit falls. The weakness of many EM currencies has increased the pain for UK investors with MSCI Turkey down a whopping 42% in sterling terms and India and Brazil seeing their local currency index gains turned into losses of 5% (India) and 9% (Brazil) for the sterling based investor. Gains in MSCI Russia were pared back to 13% when translated back into sterling.
  • Chinese financial markets are in a bit of a tizzy. The yuan has fallen by 10% against the dollar since March, the stock market has been very weak and there has been some flight of capital. Yet again fears are being expressed as to the size of China’s debt mountain, the vertiginous state of the property market and, above all, the trade wars with the US are dominating sentiment. But is this a worry on a ‘global scale’? Probably not, Q2 GDP growth was 6.7% but the authorities are gently tightening credit to slowly deflate the bubble so yes, slower growth ahead. However, as we have always said, China is a central command economy so deleveraging will take a lot longer than in a market economy but in doing so will avoid a hard landing.
  • While the EMs are currently in the eye of the storm the long-term outlook actually looks attractive. Emerging rather than developed economies will increasingly power global growth with most of the individual countries showing a growing resilience to external threats as a result of significant structural improvements since the Asian crisis of 1997. They have a growing independence and have been gradually decoupling from the developed world’s business cycle as their own domestic economies expand, powered by excellent demographics. US dollar denominated debt uncovered by FX reserves is no longer the Achilles heel it was a decade ago and gone are the days when Asian companies were awash with debt.
  • Japan’s economy returned to growth in the second quarter, expanding by a better-than-expected 1.9%, evidence that the decline seen in the first three months of the year was more of a blip than the start of a downturn. The market has struggled this year; trade friction and the perception that Japan will never escape from the deathly grip of deflation haven’t helped and foreign buyers have been deserting the market. Nonetheless, Japan remains the best ‘global value’ play in the eyes of many and corporate Japan certainly seems to have regained its mojo with profit margins and dividend payments increasing. Long-time Japan watchers will be well aware of the 1800 index level ‘iron coffin’ on the Topix Index, the level the index has failed to breach on several occasions since 1989. And guess where Topix finished the quarter, yep, 1800.
  • For the stattos amongst you, Japan has this year retaken the title of ‘second biggest stock market in the world’ from China having being itself overtaken in 2014. With everyone gushing about the emerging world back then no-one would have predicted this reversal of fortune.

Summary: Emerging and Asian Markets have produced disappointing returns this year as they face strong external headwinds, notably tighter US monetary policy, a strengthening US dollar and the tariff war between Trump and China. Distress in Turkey and Argentina are echoes of EM crises of old. These markets remain best suited to higher risk/reward investors with a long term time horizon and acceptance of a high level of volatility.

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