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Do Not Bet On A Broad Emerging Markets Recovery - FT
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From today's FT:
Valuations are more attractive but stock picking is important
One striking aspect of last year’s markets is the extent to which emerging market assets underperformed those in advanced economies. As investors search for returns this year among some frothy asset markets, such unusual underperformance attracts even greater attention.
Emerging markets’ underperformance was broad-based, affecting virtually every asset class. EM equities underperformed the aggregate world index by a stunning 29 percentage points as measured by their MSCI index components. In external credit, the return on EM sovereign bonds was a notable 14 percentage points lower than that on high yield bonds (as measured by JPM EMBI Global and ML HY indices, respectively). Local currency EM bonds did even worse, returning minus 9 per cent according to the GBI EM index.
Some “classic” factors contributed to the disappointing performance of emerging markets. Top line revenue suffered on account of more muted growth and lower government stimulus, with related global demand uncertainties compounded by structural changes taking place in China. Profit margins also came under pressure due to inflexible cost structures.
Meanwhile, highly visible company debacles, such as OGX in Brazil, reignited concerns about corporate governance and legal protections; as did political instability in countries such as Turkey and Ukraine. Moreover, and again in contrast to their US counterparts, EM equities did not benefit from the financial engineering that many corporate treasurers pursued as a result of the interest rate policies adopted by G3 central banks. For example, aided by Federal Reserve policy, US company boards authorised as much as $750bn in share buybacks in 2013 (equivalent to almost 6 per cent of the capitalisation of the S&P 500 at the start of 2013).
As significant as these factors are, they do not fully explain the breadth and size of emerging market underperformance in 2013. Also, they are not enough to confidently anchor predictions for 2014. If they were, broad emerging market exposure would probably outperform this year, given the stabilisation in growth rates, higher export receipts, and declining Fed policy support for US corporate buybacks and dividend hikes.
To shed more light on what happened in 2013 and what is likely to occur in 2014, we need to look at three factors that many had assumed were relics of the “old EM”.
First, and after several years of large inflows, emerging markets suffered a dramatic dislocation in technical conditions in the second quarter of 2013. The trigger was Fed talk of “tapering” the unconventional support the US central bank provides to markets. The resulting price and liquidity disruptions were amplified by structural weaknesses associated with a narrow EM dedicated investor base and skittish cross-over investors. Simply put, “tourist dollars” fleeing emerging markets could not be compensated for quickly enough by “locals”.
Second, 2013 saw stumbles on the part of EM corporate leaders and policy makers. Perhaps overconfident due to all the talk of an emerging market age – itself encouraged by the extent to which the emerging world had economically and financially outperformed advanced countries after the 2008 global financial crisis – they underestimated exogenous technical shocks, overestimated their resilience, and under-delivered on the needed responses at both corporate and sovereign levels. Pending elections also damped enthusiasm for policy changes.
Finally, the extent of internal policy incoherence was accentuated by the currency depreciations caused by the sudden midyear reversal in cross-border capital flows. Companies scrambled to deal with their foreign exchange mismatches while central bank interest rate policies were torn between battling currency-induced inflation and countering declining economic growth.
Absent a major hiccup in the global economy – due, for example, to a policy mistake on the part of G3 central banks and/or a market accident as some asset prices are quite disconnected from fundamentals – the influence of these three factors is likely to diminish in 2014. This would alleviate pressure on emerging market assets at a time when their valuations have become more attractive on both a relative and absolute basis.
Yet the answer is not for investors to rush and position their portfolios for an emerging market recovery that is broad in scope and large in scale. Instead, they should differentiate by favouring companies commanding premium profitability and benefiting from healthy long-run consumer growth dynamics, residing in countries with strong balance sheets and a high degree of policy flexibility, and benefiting from a rising dedicated investor base.
Mohamed El-Erian is chief executive and co-chief investment officer of Pimco
Valuations are more attractive but stock picking is important
One striking aspect of last year’s markets is the extent to which emerging market assets underperformed those in advanced economies. As investors search for returns this year among some frothy asset markets, such unusual underperformance attracts even greater attention.
Emerging markets’ underperformance was broad-based, affecting virtually every asset class. EM equities underperformed the aggregate world index by a stunning 29 percentage points as measured by their MSCI index components. In external credit, the return on EM sovereign bonds was a notable 14 percentage points lower than that on high yield bonds (as measured by JPM EMBI Global and ML HY indices, respectively). Local currency EM bonds did even worse, returning minus 9 per cent according to the GBI EM index.
Some “classic” factors contributed to the disappointing performance of emerging markets. Top line revenue suffered on account of more muted growth and lower government stimulus, with related global demand uncertainties compounded by structural changes taking place in China. Profit margins also came under pressure due to inflexible cost structures.
Meanwhile, highly visible company debacles, such as OGX in Brazil, reignited concerns about corporate governance and legal protections; as did political instability in countries such as Turkey and Ukraine. Moreover, and again in contrast to their US counterparts, EM equities did not benefit from the financial engineering that many corporate treasurers pursued as a result of the interest rate policies adopted by G3 central banks. For example, aided by Federal Reserve policy, US company boards authorised as much as $750bn in share buybacks in 2013 (equivalent to almost 6 per cent of the capitalisation of the S&P 500 at the start of 2013).
As significant as these factors are, they do not fully explain the breadth and size of emerging market underperformance in 2013. Also, they are not enough to confidently anchor predictions for 2014. If they were, broad emerging market exposure would probably outperform this year, given the stabilisation in growth rates, higher export receipts, and declining Fed policy support for US corporate buybacks and dividend hikes.
To shed more light on what happened in 2013 and what is likely to occur in 2014, we need to look at three factors that many had assumed were relics of the “old EM”.
First, and after several years of large inflows, emerging markets suffered a dramatic dislocation in technical conditions in the second quarter of 2013. The trigger was Fed talk of “tapering” the unconventional support the US central bank provides to markets. The resulting price and liquidity disruptions were amplified by structural weaknesses associated with a narrow EM dedicated investor base and skittish cross-over investors. Simply put, “tourist dollars” fleeing emerging markets could not be compensated for quickly enough by “locals”.
Second, 2013 saw stumbles on the part of EM corporate leaders and policy makers. Perhaps overconfident due to all the talk of an emerging market age – itself encouraged by the extent to which the emerging world had economically and financially outperformed advanced countries after the 2008 global financial crisis – they underestimated exogenous technical shocks, overestimated their resilience, and under-delivered on the needed responses at both corporate and sovereign levels. Pending elections also damped enthusiasm for policy changes.
Finally, the extent of internal policy incoherence was accentuated by the currency depreciations caused by the sudden midyear reversal in cross-border capital flows. Companies scrambled to deal with their foreign exchange mismatches while central bank interest rate policies were torn between battling currency-induced inflation and countering declining economic growth.
Absent a major hiccup in the global economy – due, for example, to a policy mistake on the part of G3 central banks and/or a market accident as some asset prices are quite disconnected from fundamentals – the influence of these three factors is likely to diminish in 2014. This would alleviate pressure on emerging market assets at a time when their valuations have become more attractive on both a relative and absolute basis.
Yet the answer is not for investors to rush and position their portfolios for an emerging market recovery that is broad in scope and large in scale. Instead, they should differentiate by favouring companies commanding premium profitability and benefiting from healthy long-run consumer growth dynamics, residing in countries with strong balance sheets and a high degree of policy flexibility, and benefiting from a rising dedicated investor base.
Mohamed El-Erian is chief executive and co-chief investment officer of Pimco
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Comments
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Is this a puff piece for Pimco active management?
Sure some will do better than others, but how do you pick them in advance?“It is difficult to get a man to understand something, when his salary depends on his not understanding it.” --Upton Sinclair0 -
Glen_Clark wrote: »Is this a puff piece for Pimco active management?
Sure some will do better than others, but how do you pick them in advance?
Depends if you believe active management works.
Will be interesting to see in a few years if many managers beat the index trackers by picking these better stocks!Remember the saying: if it looks too good to be true it almost certainly is.0 -
Glen_Clark wrote: »Is this a puff piece for Pimco active management?
Yes.
Anything else I can help with?
I am not a financial adviser and neither do I play one on television. I might occasionally give bad advice but at least it's free.
Like all religions, the Faith of the Invisible Pink Unicorns is based upon both logic and faith. We have faith that they are pink; we logically know that they are invisible because we can't see them.0 -
Depends if you believe active management works.
Will be interesting to see in a few years if many managers beat the index trackers by picking these better stocks!
I do believe it works (or should work) for emerging markets and have consequently foregone my Vanguard EM Index tracker in favour of some investment trusts for this sector. Got nothing with Pimco I have to say!0 -
If you want to invest in companies that make their living in EMs then invest in Unilever and so on. Or at least that's one attitude.Free the dunston one next time too.0
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Unilever, Diageo, Reckitt Benckiser, WS Atkins and Compass were my investments along these lines during 2011.I am not a financial adviser and neither do I play one on television. I might occasionally give bad advice but at least it's free.
Like all religions, the Faith of the Invisible Pink Unicorns is based upon both logic and faith. We have faith that they are pink; we logically know that they are invisible because we can't see them.0 -
If you want to invest in companies that make their living in EMs then invest in Unilever and so on. Or at least that's one attitude.
Yes, that's one approach. Although I don't want to get into the realms of individual stockpicking.gadgetmind wrote: »Unilever, Diageo, Reckitt Benckiser, WS Atkins and Compass were my investments along these lines during 2011.
Gadget, on another thread you were tipping EM and resources for 2014. Out of interest, have you substantially increased your exposure in these sectors? Or just thrown a bit in their direction via rebalancing?0 -
Who the hell buys EM stocks directly?0
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