Emerging markets may finally be going from ‘value trap’ to ‘value opportunity’ says George Iwanicki, Emerging markets macro strategist at JP Morgan Asset Management.
Investors judging emerging markets based on their value and momentum characteristics in the last few years would have seen a very cheap asset class with a momentum.
Disappointing economic growth and consistently declining earnings expectations gave investors little reason for optimism. Put another way, emerging markets looked like a value trap. But, for the first time in a long time, that’s starting to change.
Emerging markets are beginning to look like a value opportunity. So far the nascent turnaround is largely concentrated in commodities but that improvement may be broadening. In our view, the asset class has gone from the cheap value with a negative outlook to reasonably cheap value with an improving outlook.
On the macroeconomic front, really for the past five years emerging markets have faced a triumvirate of headwinds – all interrelated. The strength of the US dollar, in secular rally mode, the collapse of the commodity super cycle and the over-indebtedness of EM economies post the financial crisis all played a role. Some of that is starting to neutralise.
The US dollar today looks fairly richly valued, suggesting to us most of the strength may be behind us. Meanwhile, we’ve started to find our footing in commodities. Some of the hardest hit economies including Brazil, Russia, and South Africa are showing signs of bottoming.
Economist expectations that were routinely marked downwards for the past five or so consecutive years are now no longer on a downwards trend. It’s clearly a stabilisation of sorts. The real question for investors is how much of a re-acceleration we can expect from current levels.
The chronic downward pressure may be alleviating, but imminent catalysts for a strong bounce back are less clear. However, that doesn’t mean there aren’t interesting investment opportunities for selective emerging market investors.
Within emerging markets, valuations still look interestingly cheap in Turkey and in China (particularly industrials and banks). Amongst the countries suffering most notably from the commodities downturn, we’ve generally favoured Russia over Brazil. Russian local valuations have remained consistently cheaper than Brazil, with the Brazilian Real having rapidly rallied from its oversold lows of several months ago.
We have been finding interesting opportunities across the banking and retail sectors in Russia. Meanwhile, the rebound in Brazil in USD terms is responsible for a disproportionate share of the overall EM rally so far this year.
When it comes to EM investment opportunities across Asia, an open question mark for investors is India. Momentum achieved on the reform story there is quite good, as evidenced by the recent passage of the Goods and Services Tax Bill, the demographically well-endowed country presents an appealing growth story. The question is whether the significant valuation premium is merited.