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EM resurgence leaves stock bargains on the table

Published on 06-05-2024

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Crisis-level valuations leave room for re-rating


As I noted in my previous article on the resurgence of emerging markets (EM), few saw this resilience coming. EM capital is moving in a way it has never done before. War and sanctions have buoyed commodity prices and profits for EM commodity exporters. Money is now heading back into domestic markets, funding all stripes of entrepreneurial dynamism.

Most expected EM economies to be especially vulnerable to rising rates, based on the view that rate increases caused serial crises in the 1980s and 1990s. But this perspective extravagantly misses the big picture. EM economies entered the pandemic with repaired banking systems and heightened financial discipline after a decade-plus of deleveraging.

During the pandemic, they borrowed less heavily for stimulus spending, and saw deficits rise on average by half as much as the U.S. In fact, excluding China, total EM government debt-to-GDP figures have fallen over the last year with improving fiscal deficits and higher nominal growth. External debt, often called the original sin in EM, has also declined dramatically. Only about 12% of EM government debt is now funded from foreign sources.

What happens next? Starting points matter in macroeconomics. Stronger sovereign, corporate, and household balance sheets have lowered external vulnerabilities. But also, after a long period of foreign disinterest in EM, local currency valuations are trading near the crisis-lows of the early 2000s.

Cheap currencies are the cheat code for national economies. In fact, low currency valuations have always been wonderful starting points for EM outperformance in the past. Heightened competitiveness boosts exports. Capital then follows higher growth. And so, a virtuous cycle begins.

Layered on top of all this, is an unfolding policy-easing cycle. The absence of fiscal excesses and more proactivity toward combating inflation has kept prices more contained in EM compared with the developed world. In fact, for the first time ever, average inflation levels in major EM economies are lower than major developed economies. Now, having lots of levers to pull – in the form of lower interest rates or higher fiscal spending – provides a huge comparative advantage.

Of course, trends in EM have never fit neatly into one storyline. The last EM boom in the 2000s was driven by China’s rapid industrialization phase. This new phase extends far beyond China with far deeper participation. Importantly, India, long deficient in critical infrastructure, is now deep into a major capex boom, as evidenced by a steep rise in gross capital formation and surging private sector new project announcements.

The global push to build a greener economy is increasing demand for raw materials, benefitting commodity-exporting countries like Brazil, Chile, and South Africa. Countries where wages are low, populations are young and relatively skilled – such as Vietnam, Indonesia, and Mexico – are benefitting enormously from supply-chain diversification. Even the Gulf states, lured by Asia and eager to diversify their economies away from fossil fuels and restore national images are witnessing a boom in cross-border trade and current account surpluses.

It should not be difficult to see what is happening here. Increased infrastructure investment and trade is integrating more of the world’s developing economies into the global economy at an accelerated pace. So much for deglobalization. Excluding China, these countries comprise more than 3 billion people, where demographics are favourable, incomes are growing, and constructive dialogues are leading to a surge in cross-border commerce and economic partnership. To ignore this new reality is now an exceptionally risky position for long-term investors.

Investment implications

Despite better growth, lower debt and lower inflation, many EM stock markets are still trading at crisis-level valuations. That leaves plenty of room for re-rating. But an index-based approach to EM is unlikely to be the right strategy. Passive investing in broad-based indexes often means buying yesteryear’s winners. Today, EM stock markets allocate far too much capital to digital economy heavyweights like Chinese internet stocks and not nearly enough to real economy sectors like manufacturing, industrials, and natural resources. The top four nations – China, Taiwan, India, and South Korea – currently comprise nearly 75% of the MSCI EM Index.

This makes passive investing in EM a concentrated call on a small number of Asian economies, who (apart from India) have economic growth trajectories that are now in a more mature phase relative to the high growth experienced in recent decades. Active management will be crucial to capture the pockets of opportunities within countries, sectors and themes.

In fact, at Forstrong, we have such strong conviction in this thesis that we launched our own actively-managed EM-focused equity ETF (TSX: FEME) based on the view that this region of the world will dramatically outperform in the period ahead. The last decade’s carnage in EM offers an excellent entry point at a time when momentum has begun to take hold. Given the potential returns, investors need to have a strategic allocation to this part of the world brimming with opportunity.

Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. This article first appeared in Forstrong’s Insights page. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at Follow Tyler on X at @TylerMordy and @ForstrongGlobal.


Content © 2024 by Forstrong Global. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. Used with permission.

The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Performance statistics are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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