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EMs — Any silver lining amid volatility?

Data released by the International Monetary Fund at end-June 2018, noted that an annual growth rate for EMs over the next five years will remain at high level, while the growth rate of GDP for the developed markets will be declining (Pic by Muhd Amin Naharul/TMR)

By SHERMAN TAM CHENG WEI / PIC BY TMR

Investors got a blunt reminder that emerging markets (EMs) are risky assets. The MSCI Emerging Market Index has fallen 8% year-to- date (as of Aug 24, 2018).

Sino-US trade tensions, a slowdown in China’s economy and a stronger US dollar coupled with tighter US monetary policy could derail EM equities further.

Is volatility here to stay? Yes. Are we seeing a repeat of the Asian Financial Crisis of 1997? No.

As the US Federal Reserve starts raising interest rates faster than expected, it makes EM assets becoming less attractive.

The financial crisis in Turkey further reduces investors’ appetite for riskier assets and intensifies the movement of foreign capital from higher-yielding assets to relatively safer ones in developed markets.

This explains why the US dollar has been appreciating this year. China’s economic slowdown and intensifying global tension has fuelled anxiety about global growth and corporate earnings outlook.

EMs reliant on external borrowings to fund economic growth and large current account deficits like Turkey and Argentina have felt the heat.

Currencies of both countries have depreciated about 40% against the US dollar year-to-date. Yet, both Turkey and Argentina are relative outliers within the EM space.

In other words, with trade disputes as well as tighter US monetary policy dominating headlines and both the US and China in the late stages of an economic cycle, some volatility is to be expected for the remaining months of 2018. The tone is more upbeat from a fundamental perspective. Many EMs in Asia appear healthier with improving current account balances as well as lower external debt to gross domestic product (GDP) ratios.

Structural reforms in countries such as China and India are likely to put economies on the path to a more sustainable long-term growth.

Data released by the International Monetary Fund at end-June 2018, noted that an annual growth rate for EMs over the next five years will remain at high level, while the growth rate of GDP for the developed markets will be declining.

This is a very compelling reason to take a harder look at the EM region of the world, and position portfolios for this coming shift.

After a gloomy spring, economic data coming from the

EM space is starting to improve, at least relative to expectations.

Equity market underperformance is relatable with a rapid deterioration in EMs economic prospects.

From late April through mid-June, the Citi EM Index of Economic Surprises plummeted from +31 to -12.

Long story short, economic data went from reliably beating expectations to consistently missing expectations.

Since mid-June things have started to look better, indicating economic data is strengthening relative to expectation.

From a valuation standpoint, the MSCI EM Index is trading at price earnings (PE) ratios of 12.1x and 10.8x based on estimated earnings for 2018 and 2019, way below to its estimated fair PE ratio of 13.5x (as of Aug 24).

As of Aug 27, an investor’s potential annualised return for the emerging equities by end-2020 is a compelling 17.7% compared to developed counterparts like MSCI World (6.7%), US (2.7%) and Europe (7.3%).

Therefore, we maintain a positive view for EM equities moving forward given the recent downfall within EM space has created pockets of value.

EM equities are always more volatile than those of developed markets and as a result, news and expectations, both positive and negative, tend to get overplayed.

Since the Asian Financial Crisis in 1998, key improvements across EMs, such as stronger economic fundamentals, higher foreign currency reserves and lower inflation, indicate an imminent EM crisis is an overblown statement.

In today’s EM, a repeat of the financial crisis that spread from Thailand’s currency collapse in 1997 seems unlikely.