InFocus: Global Macro 2.0

Why everything you think about emerging markets could be wrong

Why everything you think about emerging markets could be wrong

It’s been a rough few months for emerging market stocks, with many EM countries feeling the brunt of geopolitical uncertainty and escalating tension over trade. But rather than being an indicator of a downturn, the recent emerging market struggles are simply a “bump in the road” within a longer term period of outperformance.

That’s the opinion of Tyler Mordy, President and CIO at Forstrong Global, who says this year’s volatility has been driven by a “made in America” trade war. Market moves are being dictated by headline risk and reactionary investment behaviours rather than fundamentals.

“This recent volatility has led to a sharp resurgence in the US dollar, rising interest rate expectations and damaged confidence for future global growth - a toxic mix for emerging markets,” Mordy says. “Yet, the US’s enthusiasm for trade brinksmanship will almost certainly be self-defeating, akin to the proverbial boiling frog. The damage to their own economy will be gradual; unaware they are being boiled until it’s too late.”

The Trump administration’s determination to embrace protectionism has increased the cost of imports for US consumers. So, naturally, the US imports less and, consequently, the US dollar rises and US exports become more expensive. It’s a knock-on effect of one of President Trump’s most central policy decisions; a decision that means the US is “shooting itself in the foot”, according to Mordy.

“Host countries could easily retaliate and make the business environment much less hospitable,” Mordy says. “What’s more, countries outside the US could shift their import demand. The tariffs implemented in July will undoubtedly impact EMs via their integration into China’s supply chains. Over the long run, however, EMs will very likely see a redistributive effect whereby China shifts their import demand away from the US and toward other emerging market countries.”

Mordy also encourages investors to ignore the negative attention surrounding Argentina and Turkey. It’s not uncommon for a small group of EM or frontier countries to experience serious macroeconomic instability, but, as Mordy points out, it makes no sense superimposing the experience of a few idiosyncratic, troubled nations on an entire universe of more than 75 countries, many of which have solid fundamentals.

“Economies are much more shock-resistant than previous, owing to a whole host of improving macroeconomic factors,” Mordy says. “For example, in the mid-1990s inflation rates above 20% were not uncommon. Today’s emerging market inflation is trending below 4%. The list of improving factors is lengthy: the emergence of domestic pension systems, improved trade balances, better fiscal positions and a number of other strong secular growth drivers.”

Unlike US equities, which Mordy expects to enter a period of underperformance, emerging market stock valuations are extremely appealing right now. “EM stocks trade at a hefty discount to their developed-market peers and EM debt presents good value, offering higher yields than the US high yield space with arguably less risk,” he says. “And, emerging market currencies can only be described as a deep value play.”

“History shows that EM outperformance cycles typically unfold over several years. The last eight years of emerging market underperformance - for the period ending in 2016 - were preceded by nearly nine years of outperformance. Furthermore, EMs already had a large slowdown between 2010 and 2016. Since then, currencies have weakened and policy has turned stimulative. These benefits always show up with a lag. Why should this time be different?”

 

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Founded in 2001, Forstrong Global Asset Management Inc. manages money on behalf of individuals, financial professionals and institutions. Our multi-asset global macro thematic approach has demonstrated the ability to safely steward client assets through challenging markets and economic environments. Forstrong is part of the Industrial Alliance Insurance and Financial Services Inc. (TSE: IAG) family of wealth management companies, which together serve over $100B in client assets.