How the World is Shaping Up for a Significant Rotation into Emerging Market Equities.

November 10, 2020

BY Eric Anderson

A Biden Presidency, Excess Global Liquidity and China’s Resilience: How the World is Shaping Up for a Significant Rotation into Emerging Market Equities.

After a decade of US outperformance, there is talk of a great rotation in relative performance away from U.S. equities into Emerging Markets for the next decade. Below are the 5 tailwinds that support this shift and justify investors making the move into EM stocks TODAY.

Tailwind #1: The Biden Factor

  • Less erratic policy-making, a more predictable trade policy and a multilateral approach by the Biden presidency will give both companies and investors more confidence to invest across the emerging world.
  • The implications of a widening US deficit, lower bond yields and the relatively weaker expected recovery path in the US will lead to a weaker US dollar. All of which are positive for EM assets. 
  • Moreover, a Biden-induced weaker dollar would allow developing world central banks to keep interest rates lower, aiding growth
  • While pressure on China is likely to be sustained under Biden, any talk of a ‘new cold war’ is misplaced. American companies, particularly in industries such as semiconductors that depend on Chinese demand, will not allow anything close to a complete “decoupling” of supply chains. The Chinese economy has also evolved into one that is driven by domestic demand, and not by manufacturing or exports.

Tailwind #2: The Liquidity Bazooka

  • With interest rates near zero and stimulus measures amounting to over 25 trillion dollars globally from both monetary and fiscal policies, there is a tremendous amount of liquidity in the world today with quite a lot of money still sitting on the sidelines. This will likely sustain support for equities for the foreseeable future even if economic growth stalls.
  • Equity investors can either ride the already expensive U.S. stocks with outsized exposure to a handful of tech- and tech-related shares, or rotate into markets that are already seeing a faster recovery in earnings and appear to have a more solid growth trajectory such as in the Emerging Markets. We are betting on the latter taking shape.

Tailwind #3: The Economic and Earnings Momentum

  • Historically, Emerging Markets have been able to substantially outperform the Developed Markets universe when both economic and earnings momentum are superior. 
  • We are now seeing relative earnings momentum for EM stocks being far greater to that of the DM world in both local and common currency terms. 
  • While China’s economy is on a solid growth trajectory, Europe is slipping back into recession as it combats the surge in COVID-19 cases by renewing lockdowns, and U.S. economic momentum has also waned with the pandemic raging. It is only a matter of time before economic momentum in the EM world surpasses that of the DM world. We believe this is imminent.

Tailwind #4: Valuations

  • Over the last 10 years, the S&P 500 has outperformed Emerging Market equities by 100% leaving Emerging market equities at historically low valuations relative to developed markets. 
  • The price lag of EM stocks over the past decade provides investors with a significant valuation cushion
  • EM equities have also suffered net outflows this year of US$25.8 billion according to Morningstar data covering both passive and active investment vehicles, leaving most institutional investors underallocated. A mean reversion in positioning would drive valuations higher.

Tailwind #5: China

  • China is by far the most important component of the EM universe accounting for a record 42% of the widely tracked MSCI EM Index. If China does well, EM does well.
  • Chinese growth momentum continues comfortably above trend, for now. This is in marked contrast to recessions in other major economies. 
  • China is the only major economy recording positive GDP growth this year, and its central bank is the only one signalling policy normalization ahead. 
  • According to the WEO, when 2020 and 2021 are taken together, global GDP will have expanded by some US$3.5 trillion on a net basis, and 60% of this will have been generated by China alone. It is difficult to overstate the impact of China on the global economy. 
  • Strong growth and potentially higher interest rates are usually a recipe for currency appreciation. The Chinese Yuan remains very stable and serves as an attractive destination for investors investing in EM.

Milltrust was founded in 2011 and is headquartered in London and Singapore.  Milltrust’s flagship product, the Milltrust Global Emerging Markets Fund, brings together leading, locally-based country-specialist teams from across the Emerging Markets into a single portfolio solution.  The regulated Fund offers daily NAVs and a low management fee-only share class.  The company’s investor base includes pension funds, sovereign entities, family offices, entrepreneurs, and high net worth individuals.

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