This month's question: Are emerging markets now an attractive proposition?
Jonathan Moyes, head of research, Whitechurch Securities
We believe emerging markets (EMs) remain an attractive proposition within a well-diversified investment portfolio. It is true that in the current climate of rising US yields, a strong US dollar, and president Donald Trump’s aggressive trade policy, sentiment towards EMs and Asia has soured in 2018.
Cheap money capital flows, which boosted EMs in the previous two years, appear to be heading for the exit as US rates move higher.
In addition, the stronger dollar may weigh on more cyclical and commodity-focused emerging economies moving forwards. These are short to medium-term concerns.
Investing in EMs is a longer-term pursuit and investors must build into their expectations that sentiment will fluctuate over time. For investors brave enough to look through these recent headwinds and focus on longer-term value creation, rather than attempting to time markets, EMs remain home to some high-quality firms, supported by excellent demographics, and strong economic fundamentals.
EM valuations have improved following the recent sell-off, and given there is scope for continued earnings growth across many Asian and EMs, these regions look relatively attractive.
We are particularly interested in higher-quality firms that did not benefit from the sugar rush of ‘hot money’ flows into EMs. In particular, areas such as India, where the longer-term case for the compounding of earnings over time remains intact and is further boosted by strong corporate governance and a positive economic and corporate reform backdrop.
Lothar Mentel, chief executive, Tatton Investment Management
Monetary tightening has yet to take effect globally. The European Central Bank (ECB) and the Bank of Japan continue to provide liquidity through quantitative easing (QE). This is enough to offset the US Federal Reserve’s balance sheet reductions, but is slowing. The ECB ceases QE in December.
The move from net easing to net tightening is likely to begin in the last quarter of this year and accelerate through 2019. Meanwhile, the demand for productive capital is fuelling a rotation from the financial economy to the real economy. This translates into a drying up of liquidity around the globe.
This isn’t good news for EMs. They still rely heavily on overseas investment and are sensitive to capital outflows – with US companies being encouraged to bring home overseas cash, they have already suffered. Emerging economies are also sensitive to global trade. One of their defining characteristics is cheap labour costs, which usually means local employment and domestic demand track global trade.
EMs have the added problem of excessive leverage; their credit build-up on the back of low global interest rates has left many firms with large amounts of debt. The last slowdown in 2016 has made many more resilient, but there’s no escaping that a number of EMs are in an extremely difficult period.