If you could have a long dinner with one person in history, whom would you choose? Some might tap Winston Churchill, who seems to have had an apposite quote on everything. The fitting Churchill quote for the current situation in emerging markets is as follows: “If you’re going through hell, keep going.” Emerging-markets equities were down nearly 9 percent in August, and more than 15 percent in the past two months. Every emerging market is down over the past two months — with the exception of the tiny Czech Republic. By the end of August, weekly investor outflows from the asset class were at 2008 levels, according to an August 27 report from Bank of America Merrill Lynch.
We believe there are two ways to look at this litany of woes. The first and most obvious is at face value. The second is a more nuanced view, involving thinking not just about the poor current fundamentals of the asset class but also about how the market is pricing and valuing these fundamentals.
The market is evidently very negative on the present situation, and unsurprisingly so. Measures of stock market volatility have not been so elevated for three years. The MSCI emerging-markets index, the major benchmark for equities in developing economies, is at four-year lows and 15 percent below its 200-day moving average. Brazil’s credit default swap spreads are trading at levels last seen during the 2008–’09 financial crisis, as are Chinese bank valuations. Sovereign CDS spreads across Latin America have at least doubled in the past 12 months in most cases. A survey carried out by Bank of America Merrill Lynch, published Tuesday, states that global fund managers have never been so negative on emerging-markets positions. As of the end of August, emerging markets were priced at a 33 percent discount on a price-earnings basis and a 38 percent discount on price-to-book basis to developed markets. It’s apparent that the market is taking a very negative view of emerging markets and their weak fundamentals.
As such, is it possible that much of the bad news has already been discounted by the market? The health — or wealth, rather — warning here is that it seems there is no evidence that markets have capitulated in the same way that we saw in the Asian or the global financial crises. During the Asian crisis of the late 1990s, the stock markets of Thailand and Indonesia fell more than 90 percent from their peaks in U.S. dollar terms. Whereas now may not be the time to load up on emerging-markets equities, it might be an opportune moment to remember that emotional cycles are nothing new in equity markets.
Archie Hart is a portfolio manager in the emerging-markets equity strategy at Investec Asset Management in London.
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