Not much has changed with respect to our thematic views on emerging market assets. After having been the bears throughout 2013 and into 2014, we’ve been extremely bullish on the EM space since MAR of this year and see no reason to alter that stance.
Specifically, both our top-down quantitative signals and bottom-up GIP fundamentals augur for continued outperformance of EM assets over the intermediate term.
TACRM Quant Signals (CLICK HERE to download the expository white paper):
- The 29% Optimal Asset Allocation to EM Equities is +6ppts and +12ppts above its trailing 3M and TTM averages, respectively. These deltas suggest the presence of rotation based capital flows (i.e. marginal investor interest). Moreover, 29% is as high a Optimal Asset Allocation to EM Equities we’ve seen on both a TTM and trailing 5Y basis. This effectively means global equity investors with flexible mandates that aren’t overweight EM have likely underperformed and are likely to continue to underperform.
- Across the six primary liquid asset classes (Fixed Income & Yield Chasing Instruments, DM Equities, EM Equities, FX, Commodities and Cash), EM Equities is currently the only asset class with a “high-conviction BUY” rating according to TACRM.
- 14 of the top 20 most bullish ETFs (roughly ~200 in aggregate) from the perspective of TACRM’s Volatility-Adjusted Multi-Duration Momentum Indicator readings are EM Equity exposures.
GIP Fundamentals: Core to our bullish bias on EM assets is an deep understanding of the role DM monetary conditions has historically played in determining valuations for EM assets. Specifically, as those conditions ease – especially US dollar liquidity – EM assets tend to benefit from a tailwind of marginal investor interest. We’ve discussed this carry trade at length over the course of our thematic work on emerging markets (CLICK HERE for the most recent example… refer to slides 17, 19 and 20).
- #GrowthSlowing in the US:
- #GrowthSlowing in Europe:
Looking to the scoreboard, EM has certainly been the place to be since we introduced the thesis (performance since 3/26):
- MSCI EM Index: +13.3%
- MSCI US Index: +8.4%, or -490bps of underperformance
- MSCI Europe Index: +5.4%, or -790bps of underperformance
This outperformance makes perfect sense in the context of the outperformance of the slow-growth, yield-chasing style factor domestically. Specifically, the performance of REITs, MBS and stocks with high dividend yields have explained anywhere from 60-78% of the MSCI EM Index’s price movements across the trailing intermediate-term duration, per the table below which shows the average of trailing 1M, 3M, 6M and 1Y correlations.
All told, until the outlook for domestic and European economic growth ticks up (it won’t in our models through at least year-end), we think investors will have adequate fundamental cover to remain overweight EM. That call is certainly not without risk in the context of #VolatilityAsymmetry across every major asset class, but that remains a bridge we’re happy to cross when we get to it. Calling stock market tops on a prospective basis tends to amount to little more than a fool’s errand.
Our current best ideas across the EM space are highlighted in the table below. A couple of changes to note:
- We are swapping out the iShares MSCI Emerging Markets ETF (EEM) for the Vanguard FTSE Emerging Markets ETF (VWO) to maximize our exposure to China (17.4% VWO vs. 14.7% of EEM) and India (10.8% of VWO vs. 6.7% of EEM) and to minimize our exposure to South Korea (0% of VWO vs. 14.7% of EEM), which is suffering from both deteriorating GIP fundamentals and idiosyncratic risks (Samsung lawsuit and ownership transfer). The +14.1% advance for the EEM since MAR 26 compares to a +6.2% advance for the MSCI All-Country World Index, effectively generating +789bps of research alpha.
- We are booking the gain in both the WisdomTree Emerging Currency Fund (CEW) and the Market Vectors Emerging Markets Local Currency Bond ETF (EMLC). While a net +141bps of alpha between the two exposures is nothing to scoff at, both ideas have become stale in light of the recent quantitative breakout in the US Dollar Index.
Best of luck out there and feel free to email us with any questions.
Associate: Macro Team