Emerging markets always find themselves on the receiving end of geopolitical and economic tensions and May was no exception, with stock markets giving up most of the gains achieved this year on broadening trade war tensions. The MSCI Emerging Markets Index slumped almost 8% during May in the face of investors disinvesting a massive $14.6-billion from emerging market equities, the largest monthly foreign investment outflow since June 2016.
The last week of May was undoubtedly an eventful one for emerging markets. Brazil came in with first-quarter growth numbers that put it on a path to imminent recession again and India heard that it was no longer considered a developing economy by the US, striking 2,000 products off the US’s preferential trade list. Then Saudi Arabia entered the MSCI Emerging Market Index to South Africa’s short-term detriment, and US President Donald Trump made the surprise announcement that Mexico would have total tariffs of 25% imposed over the course of the next five months if they did not deal with “the immigration problem”. Some 70% of Mexico’s exports go to the US, according to Investec Wealth & Investment investment strategist Chris Holdsworth
China also struck back at the US, releasing a white paper on Friday in which it blamed the US for the failed trade talks and demanded respect from the US. Earlier in the week, it threatened to restrict rare earth exports to the US. China is the world’s largest producer of rare earth metals, which are used in a broad range of items including cellular phones, rechargeable batteries and military weapons.
But do emerging markets deserve to be subject to blanket sell-offs like these when risk-off sentiment takes hold? Or are there any countries in this universe that deserve different treatment?
Emerging market stock market assets have been trading at reasonable valuations for some time, with forward price-earnings ratios, as measured by Ed Yardeni from Yardeni Research, at lower levels than the key developed markets. Last week’s forward P/E of the MSCI Emerging Market Index was 11.5 versus the US’s 16.7, Europe’s 12.9 and Japan’s 12.4. Emerging markets trade in a wide range given their diverse nature, with India the most expensive at 18.2, South Africa at 13.3 and Russia showing the most value at 5.2.
Notwithstanding recent events, Blackrock is overweight on emerging market equities. On equities, it says, “Economic reforms and policy stimulus support EM stocks. Improved consumption and economic activity from the Chinese stimulus could help offset any trade-related weakness. We see the greatest opportunities in EM Asia”.
It is neutral on emerging market bonds, saying prospects for a Chinese growth turnaround and a pause in US dollar strength support both local- and hard-currency markets.
“Valuations are attractive despite the recent rally, with limited issuance adding to positives. Risks include worsening US-China relations and slower global growth.”
South Africa has always been at the receiving end of any emerging market sell-off because it has such liquid financial markets. This enables investors to get in and out quickly and efficiently and has sent the rand reeling in the past. This was evident last week when South Africa felt the greatest impact of investor rebalancing as Saudi Arabia entered the MSCI Emerging Markets Index, comprising 2.6% of the Index. It was the biggest daily outflow on record, with foreigners pulling R13.3-billion from our equity market. The rand depreciated to about R14.70 to the dollar but managed to retrace its step, ending the week closer to R14.50.
Our fortunes looked up a day later when President Cyril Ramaphosa revealed his generally well-received Cabinet line-up on Wednesday evening. He maintained continuity in the all-important economic management posts, namely National Treasury, Public Services and Trade and Industry. He also got the thumbs up for reducing the size of the Cabinet and achieving a 50:50 male/female ratio for the first time.
But what about economic fundamentals? Bloomberg recently published an emerging market scorecard that ranks each emerging market on a combination of factors. These include GDP, trade war vulnerability, safety and valuations. The ranking gives insight into how different emerging markets stack up against each other.
The trade war impact measure is taken as “a weighted average of each economy’s exports to the US and China relative to nominal gross domestic product”. Safety includes emerging market countries’ current-account positions, sovereign credit ratings and foreign exchange reserves. Reserves are scored on the basis of whether a country meets the International Monetary Fund’s adequacy ratio or not.
Valuations include MSCI price-to-earnings ratios, inflation-adjusted bond yields and real effective exchange rates.
For the BRICS countries, India heads up the rankings at a total score of 2.03, while South Africa is the laggard, scoring -2.97 on the basis of negative GDP, Trade War and Safety measures. Others rank as follows: China (4), Russia (9) and Brazil (15).
Although India ranks highly in the Bloomberg analysis, first quarter growth came in at a five-year low last week, a lower than expected 5.8% year on year growth in the gross domestic product (GDP). ING points out that this is the weakest economic performance since the Modi government came to power five years ago. The lower investment was the main culprit, while private consumption and trade also weakened. The Reserve Bank of India is widely expected to cut rates this week for the third time this week.
China is publishing mixed economic numbers and its economic outlook is largely dependent on the outcome of the trade negotiations, which are not looking likely to be resolved anytime soon. In the absence of a resolution, the Chinese government is expected to provide further stimulus to the economy.
Some investors are eyeing out Russia, given its attractive stock market valuation. However, its economic performance has been underwhelming, with latest growth numbers disappointing, and the Russian government’s much vaunted multi-trillion ruble infrastructure investment plan to 2024 has been slow to take off.
Brazil’s medium-term economic outlook is arguably the least promising of the BRICS, with first-quarter growth falling into negative territory for the first time since the 2014/2015 recession and there’s a good chance that the next quarter’s growth will be in the red too – officially putting the Brazilian economy in recession again. The country is still working on implementing pension reform, which would relieve pressure on the significant government debt burden weighing the economy down.
If you look past the trade furores buffeting financial markets currently, what stands in favour of South Africa or other emerging markets for investors in the medium term? There is no doubt valuations are generally more compelling and the interest rate differential is enticing for investors and perhaps becoming more so if the US Federal Reserve reduces rates against this year, in line with market expectations.
When gauging where South Africa fits into this universe, particularly against its BRICS counterparts, the country’s medium-term outlook looks tentatively more promising than some of its other fellow emerging markets and any upside surprises will push the country even higher up the rankings.
As always, it is the fundamentals rather than the vagaries of market sentiment that position investors best for making money over the medium- to longer-term – and that’s particularly true when it comes to emerging markets. It’s a broad, diverse universe offering a wide range of opportunities and risks and those who do their homework and see through the noise will be the winners. DM