And here we go again. Sell-side analysts in 2011 that tirelessly argued for emerging market equity outperformance – only to see the asset class crash and burn – are fighting back.
First, a refresher: emerging market equities were the worst-performing of any mainstream asset class in 2011. The MSCI Emerging Market Index shed 20% last year, massively underperforming developed equity markets – the S&P 500 closed out the year flat, while the FTSE 100 fell 5.5%.
But so far this year, and despite mounting global risks and raft of negative headlines - most recently, a stark warning from the World Bank about the looming threat of a global recession - emerging market equities have significantly outperformed, giving sell-side analysts a spring in their step. The MSCI Emerging Market Index is up 7.7% ytd, compared to a 3.2% bounce in the MSCI World Index.
This week has seen a particularly strong bounce on leading emerging market equity indices. The Shanghai Composite Index, which shed 22% last year, has rebounded by more than 7% since January 6, including a 4% bounce on Tuesday, following the release of above-consensus GDP growth numbers for the final quarter of 2011.
Is this a dead cat bounce? No, according to Philip Poole, global head of macro and investment strategy at HSBC – and a massive EM bull - a litany of bad news has already been factored into asset prices, in particular on equities, so value investors should take note.
From his latest note to clients, published this lunchtime:
| “Things could always get worse than currently expected but the negative tone of recent news suggests that there is a lot of angst already factored into asset prices. In fact, we believe that the correlated 2011 sell-off in most risk assets has also created long-term value in a range of fundamentally attractive investments, given that it was based more on risk aversion than deterioration in underlying fundamentals. ... We see this as an attractive entry point for exposure to powerful long-term investment themes like emerging consumption and infrastructure spending.” |
Here’s the pitch, based on fundamentals: - EM equities are trading cheap to their long-term valuation averages on a forward PE basis despite big downgrades in earnings forecasts
- EM equities look cheap relative to history on a price-to-book and a price-to-book return on equity basis
This is the emerging consensus call. Piero Ghezzi, head of global economics, EM and FX research at Barclays Capital, just last week wrote in his latest Emerging Markets outlook:
| “We would look for opportunities to capitalize on attractive valuations in EM assets removed from the European crisis.” |
But EM equities will be beholden to sentiment-driven trades, and could once again underperform developed markets in a risk-off environment. Here’s a flurry of downside risks, penned by Poole’s colleague and head of EM research, Pablo Goldberg.
From a report published in mid-December:
| “Despite strong fundamentals, emerging assets are likely to remain hostage to the turbulence coming from a very unstable global backdrop. Global investors see emerging assets as a risk-on trade. It has been shown many times that emerging assets are highly sensitive to drops in appetite for risk.” |
And here’s Nomura’s Peter Attard Montalto, as told to Emerging Markets:
| “There is still this long-lying structural asset reallocation into EM, but that clearly is overrun by the short-run risk sentiment. The volatility of that is clearly much larger.” |
With key Asian markets about to enter near-hibernation mode for the Lunar New Year, the positive start to 2012 for EM equities may well be prolonged, by default. More generally, the valuation argument failed to shore up EM equities in 2011. Net-net, who knows?