I thought this chart was really interesting and worth highlighting, particularly given I’ve been writing a lot about emerging markets recently. The reason I highlight this chart is because in October the emerging markets composite manufacturing PMI rebounded to a 5-month high. Now it is important to note that this is a relatively volatile index month-to-month and ideally we’d like to see another stronger or at least stable month to confirm… but this is a really promising sign. The worst case scenario for EM from an indicator perspective would have been to see a precipitous and unabated decline and breakdown through the 50-point mark which delineates economic expansion vs contraction. In short – it looks like EM has stopped slowing.
Emerging markets have taken a beating this year on the back of softer China growth, the trade wars, a stronger USD, and Fed tightening… along with a few idiosyncratic issues (Turkey, Argentina, et al). While I think EM still faces a number of headwinds in the short term I wanted to highlight a few longer term charts on the representation of emerging markets on the global economic stage, global equity markets, and portfolio allocations.
There’s a lot of debate around emerging markets, even with issues like what’s the difference between EM and DM, And invariably EM assets fall in and out of favor through the cycle like any freely traded asset market. But there are a couple of key structural trends that don’t appear likely to change any time soon, and will only continue to grow in importance.
1. EM vs DM – Share of World GDP: First of these key trends is the rise of emerging markets on the global economic stage. Around the time of the financial crisis, not only was there great upheaval in global financial markets, but there was a perhaps little noticed moment of history where emerging markets took the lead. From about 2008 onward EM took over as the dominant share of world GDP. This is a key event in economic history and will have wide reaching implications for the path of economic growth, volatility, and capital market opportunities.
By Kevin Muir
Wild day in the markets. Emerging markets are getting crushed like a 1980s teenage nerd asking the head cheerleader to prom. As I write this, the EEM ETF is down roughly 3% on the day, and down more than 7% over the past week.
We’re past some simple mid-summer-illiquid shenanigans and definitely into the biting-on-the-pillow stage.
Another update to a really important chart for emerging markets, this one shows the median 5-year sovereign CDS premium across 14 emerging market countries. Basically it is a market-based measure of sovereign credit risk for emerging markets. As noted previously, the fact that the indicator has crossed up through its 200-day moving average is key, particularly against the backdrop of softer macro data for EM and ongoing rate hikes and quantitative tightening from the Fed (and thus, a stronger US dollar). As I showed in yesterdays chart on EMFX, the path of the US dollar is going to be key for EM risk assets, and that path points to caution at this point.
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Forecasting is hard, especially about the future, but with the right indicators we can make it at least a little less hard. In today’s article I show how important valuations can be in shedding light on long term expected returns for emerging market equities. It’s a unique angle on what is generally a well-understood principal in asset allocation.
The chart comes from a piece of research I did which looked across global equity markets at the relationship between the PE10 and expected returns. The chart shows the 10-year forward price change across time against the PE10 valuation metric.
This week it’s Emerging Markets sovereign CDS (Credit Default Swaps). The reason why I think this chart is really worth paying attention to is that after reaching a record low in mid-January, there has been a swift reassessment of risk in Emerging Markets. Typically when EM sovereign CDS turns up from a low point like this, it will tend to keep going, and the logical conclusion of that could even be some sort of emerging markets financial crisis.
The chart appeared in a recent report on the tactical risk outlook for emerging markets, it tracks the median 5-year sovereign credit default swap premium across 14 different emerging market countries. Basically this indicator shows the perceived risk of default, or market pricing of sovereign credit risk, across EM. The fact that it has turned up through the 200-day moving average is also a trigger point to put EM on watch.
At the start of the year I posted an article on The Charts to Watch in 2018. It covered some of the key charts and indicators from my 2017 End of Year Special Edition and at the time attracted a lot of interest. So I thought it would be a good idea to do an almost halfway point update as an eventful 2018 has so far seemingly rushed by.
The format of this article is the same as the original, but I will leave in the exact comments on the charts (in italics and quote marks) for the sake of transparency. Aside from updating the charts, I have added my updated views and what has changed or become more apparent since then.
But before we get into the charts, here’s a quote from the introduction of original post:
“I’ve said it before and I’ll say it again: 2018 is going to be harder and more complex for investors than 2017. The cross currents of rising valuations across asset classes, maturing of the business cycle at a global level, and the turning of the tides in monetary policy could make 2018 a watershed year.”
Yep. Sure looks that way!
1. “No more spare capacity in DM. (Next step = Inflation)”
Nothing to add to this. If anything investors should be paying even more attention to this chart.
By Tim Knight
I have 88 – – count ’em, 88 – – positions. All of them short, of course. One of my favorites, which I’ve mentioned so many times here, is EMB, the fund for emerging market bonds:
As I’ve suggested with the arrows, we are approaching key support. If we break it – whoop-de-doo! – – it’s breakdown time.
Emerging market equities had a dream run since the bottom in 2016 (where, if you recall, they took a pummeling as a number of EM economies went into recession, China slowed, currencies crunched, and commodities crashed). But if you look at the long term cycles of EM vs US relative performance, it appears that EM equities may only just be getting started.
Indeed, as I highlight below, EM equities appear to go through 7-9 year cycles of outperformance, and 5-6 year cycles of underperformance. Looking at the charts it appears as though a new cycle of outperformance may be getting underway, and if the historical experience of this phase taking 7-9 years to play out continues, this could be a really key theme for investors to be across.
Bringing in some other data points, the EM equity earnings/macro pulse has been on the positive side for the past year, and cuts in monetary policy rates at an aggregate level across emerging market economies also reinforces the case for EM equities. Finally, the relative value picture also lines up with the observations around long-term cycles of under/out performance. Thus it presents an interesting short term and longer dynamic for the outlook.
The key takeaways on EM equities and outlook for relative performance against the S&P500 are:
-EM equities appear to go through long-term cycles of under/out performance vs US equities.
-The chart suggests that a new cycle of outperformance may be underway, and the earnings/macro/policy/valuation picture seems to support this assertion.
-Cycles of EM outperformance seem to take 7-9 years to fully play out, so this could be a key long term theme for investors.
1. Emerging Markets vs the S&P500: EM equities appear to undergo long term cycles of under/out performance against US equities. The first two up cycles in the chart below took 7 and 9 years respectively to complete, and the down cycles took 6 and 5 years respectively to complete. So we can deduce that down cycles are more rapid and up cycles are more prolonged. This is important context given we now appear to be in a new up cycle.