Is now the right time to buy emerging market (EM) assets?
A growing number of the world’s largest money managers are saying yes, such as BlackRock, Franklin Templeton, Goldman Sachs, and an adviser to PIMCO.
Against a backdrop of an oil price crisis which has been battering economies, markets, and companies; alongside worries over a slowdown in global growth led by China and concerns over the U.S. Fed‘s next move, EM economies have been feeling the sting.
The oil industry is in crisis as Brent crude, the global oil benchmark, has tumbled from an average of almost $100 a barrel in 2014 to about $30 this year, a plunge of 70 percent amid a global supply glut. As such, EMs that are heavily dependent on oil exports — such as Nigeria, Venezuela, and Gulf nations — have been particularly enduring the hardship.
The next Fed move has also made investors jittery, amid fears that another wave of turmoil could hit EM economies that have already been rocked by financial storms and rising debt levels.
A strong U.S. dollar has also been a burden to EMs.
The Fed-induced appreciation of the U.S. dollar has brought deep pain for EM countries like Russia, Brazil, South Africa, and Turkey, where such firms have borrowed heavily in the dollar and are finding it much harder to refinance their $3.3 trillion dollar debt with their weaker local currencies. EMs are also finding it more difficult to find cash to borrow as lending has started to dry up.
That aside, from a valuation perspective EM assets are cheap, following three straight years of declines, the worst for EM assets may be over (at least for now).
EM assets are so cheap that they could be “the trade of a decade,” according to Research Affiliates LLC, an adviser to Pacific Investment Management Co. (PIMCO), one of the world’s largest money managers.
“The exodus from emerging markets is a wonderful opportunity — and quite possibly the trade of a decade — for the long-term investor,” Christopher Brightman, chief investment officer at Research Affiliates, said in a post on Pimco’s website Wednesday. “We are increasingly confident of our positioning in emerging market stocks and bonds.”
Brightman said EM stocks are “exceptionally cheap” after MSCI’s benchmark EM gauge has fallen some 30 percent over the past three years.
Brightman highlights that the Shiller P/E Ratio, a measure of valuation based on cyclically adjusted price-to-earnings ratio, fell to 10 in January, an event he says that has only happened six times in the past quarter century. In the five years following such an event, stocks rallied an average 188 percent, he said.
“From the rear-view mirror, the bear market in emerging markets has been painful,” Brightman wrote in the post. “When we look out of the windshield, however, these very asset classes offer the highest potential returns available to today’s opportunistic investor.”
EM assets accounted for 35 percent of the PIMCO’s All Asset Fund and 39 percent of PIMCO’s All Asset All Authority as of January, according to Brightman
As far as EM bonds, the world’s largest money manager, BlackRock, says that downside risks have are already priced in, and furthermore the policies of the major global central banks have made “riskier” assets more attractive.
“It is premature to say that the weather has totally cleared,” a team of emerging-market debt managers at BlackRock led by New York-based Pablo Goldberg and London-based Sergio Trigo Paz wrote in a research note Tuesday. “But with many of the market ‘negatives’ accounted for, it is time to concentrate on some of the ‘positives,’ which we see gaining strength as market drivers going forward.”
BlackRock’s Goldberg and Paz said that they favor EM debt that is dollar-denominated and investment grade and that local-currency bonds are becoming “more balanced” after the three-year selloff, although volatility remains high.
Michael Hasenstab, Franklin Templeton’s Chief Investment Officer for global macro, who oversees $125 billion in assets, says that negative sentiment toward EMs has reached extreme levels, and favors countries such as Brazil, Mexico, and South Korea.
Templeton’s Hasenstab says that pessimistic sentiment toward EMs today resembles that of during the global financial crisis, which proved to be a buying opportunity.
Hasenstab acknowledges that opportunities in EMs are now “a lot narrower,” however they are still available in countries such as Mexico, South Korea, Malaysia, Indonesia, and the Philippines, he explains in a blog post. These such countries have “solid fundamentals,” but are treated as if they were already in a crisis, he said, adding that he’s staying away from countries like Turkey, Russia, Venezuela, and South Africa.
“The markets are pricing in a collapse,” Hasenstab said. “So this to us is a fantastic opportunity when you have a huge disconnect between reality and market prices.”
After previous contrarian bets on distressed assets including debt in Ukraine and Ireland, Hasenstab believes that Brazilian securities could be his next winner.
Brazilian bonds are attractive because the country “appears to have a clear path” to recovery despite near-term volatility, he said. While Brazil has yet to improve its fiscal policy, yields at more than 16 percent are high enough for the risks.
“Overall, we view the country as economically strong; it’s just the policy mix that needs to be corrected.”
Hasenstab, said that he doubled his holdings of Brazilian debt to $5.9 billion in the fourth quarter of 2015.
Goldman Sachs is recommending selective buying of EM bonds.
In January, Goldman Sachs’s EM bond manager Yacov Arnopolin said that 2016 could be the year when EM economies and currencies bottom out.
Arnopolin says that he favors oil importing countries such as the Dominican Republic and Costa Rica, where as he remains bearish on Middle East nations.
The benchmark EM gauge, the MSCI Emerging Markets Index — created by Morgan Stanley Capital International (MSCI) which tracks equity performance across 23 EM nations — is down some 30 percent over the past three years, and has declined around 7 percent so far this year and trades at about 1.3 times net assets, its lowest level in seven years.
The world’s largest EM ETF (exchange-traded fund), Vanguard’s FTSE Emerging Markets ETF (VWO), with total net assets of over $46 billion in a basket of nearly 3,500 stocks and boasts one of the cheapest expense ratios among ETF peers at 0.15 percent, has mirrored such losses as the benchmark MSCI EM gauge.
Although EM assets at this level are with cheap valuation, and may look like a great short-term buy, caution is urged, as the short-term outlook deteriorates and a growing number of economic warning signs are flashing that the next Global Financial Crisis is arriving — or has already arrived.