Compelling indicators to support the bull case for emerging markets
Ian Beattie, co-chief investment officer at NS Partners and Portfolio Manager for the Nedgroup Investments Global Emerging Markets Equity Fund, highlights the conditions in play to indicate bullish prospects for emerging markets for the latter part of the year and into 2021.
We have a very simple model that we call an emerging markets (EM) checklist that identifies seven conditions needed for EM equity outperformance and which has been very effective for us over the last three decades that we’ve been using it. Historically it’s given us very clear signals at peaks and troughs and when there’s not much of a signal, it’s very clear that there’s not much of a signal. It’s been a long time since we’ve had such an extreme reading, indicating that emerging markets are a good place to be in the current environment.
The first condition is real money growth and specifically we are looking for the growth of emerging markets, represented by the E7 to be above that of the developed markets, represented by the G7. It currently isn’t, however excess liquidity in the global market is the greatest since the Global Financial Crisis (GFC) with broad money in the G7 economies rising to 13% in April. When real money indicators are as strong as they are, it doesn’t matter too much whether E7 real money growth is above G7. The G7 is growing so fast due to the Fed pumping money into the system, faster than anything we’ve seen in peacetime. China has, on the other hand, not been as aggressive. They’ve loosened monetary policy, but can ensure that narrow money turns into broad money by telling their bankers to lend, which they are doing at a higher rate than they did in 2009. We’re waiting to see if this narrow money leads through to the real economy.
The second condition is lower valuations in emerging markets versus developed markets. At the moment these numbers are low both in absolute terms and relative to developed markets with emerging markets looking especially cheap.
The earnings revisions ratio also needs to look better in emerging markets relative to developed markets and they’re currently showing better signs of recovery, given that Asia and China are ahead of the curve on COVID-19 and on earnings as well.
The global industrial cycle needs to show an upswing and we believe that we’re at or near the bottom and definitely in an upswing. When you stop the economy, as it restarts, the growth rate is going to look phenomenal. All this liquidity is either going into asset prices or into the real economy, or both.
The next point in the checklist is global excess money. Emerging markets like money growth to be growing faster than the economy needs, which means a lot of excess liquidity. The economy is flat on its back and even if it does start to recover, the amount of money that’s been pumped into the system by central banks is enormous and there is no political appetite to claw this money back through taxes or an austerity programme. We’ve got record levels of excess money, banks in better shape and evidence of broad money accelerating to record levels as well. There is US$1.2 trillion sitting in US money markets alone.
Commodity prices need to be in an upswing for EM outperformance. We believe commodity prices are bottoming overall and the data tells us that emerging markets are positively correlated with commodities.
The final point is the US Dollar, which is the swing factor. The US dollar is in many ways a function for all of these conditions. Emerging markets like a weaker US dollar, which is what’s happened over the last few weeks where we saw the US dollar peak as a result of Fed action, but it’s now unwinding more quickly than we’ve seen before. This crisis has been bigger and quicker, as was the response.
Another factor providing support for a positive view is that we’re seeing real narrow money growth in almost all emerging markets at record highs and heading higher, which is unprecedented. My last observation is that US broad money, money that is moving through the system into GDP, is at its highest level since 1860 and grew by 25% in May.
All of these indicators supporting a bullish view on emerging market equities have led us to adjust our portfolio and we will have to start getting more cyclical assets, with more exposure to Russia, Indonesia, Brazil, Korea and Thailand.
The Nedgroup Investments Global Emerging Markets Equity Fund has, since inception, outperformed the MSCI Emerging Markets and the Morningstar European peer group by 6%. Over the longer term, the 25-year history of the NS Partners global emerging market equity strategy, the consistency of outperformance is quite phenomenal. The seven factor checklist has been a constant feature of the investment process during the past three decades.