'EM in 10' update - August 2022
Gustavo Medeiros, Ashmore’s Head of Research, answers some timely questions about recent events and performance in Emerging Markets for our 'EM in 10' monthly video review, including:
- As the markets have become more data dependant. What is recent global market data telling you/us?
- What are your thoughts for MSCI EM as we are a month into the second half of the year?
- Possibilities: China property market
- Any particular issues from July that cause you concern, or conversely encouragement, for the global Economy/EM Markets?
Transcript is available below.
Stephen Rudman: Good day. Today is August 5th. Welcome and thank you for watching Ashmore's ‘EM in 10’. My name is Stephen Rudman, and I am a member of the Ashmore New York client team. Today we'll be asking Gustavo Medeiros, Ashmore’s Head of Research, some timely questions about recent events and performance in the emerging markets. As always, thank you for joining our ‘EM in 10’ monthly video. Gustavo, welcome. Let's get right to it, starting with Question one: as markets have become more data-dependent, what is recent global market data telling you?
Gustavo Medeiros: Hi, Stephen. Thank you very much, and thanks everybody for watching. As you can see on slide number two of the presentation, the leading economic indicators that we've been receiving from the Purchasing Managers Index (PMI) indicator suggests that economic activity continued to slow down in July.
We've seen developed market (DM) PMIs declining another five points over the last three months to a low of 51.3. Any number below 50 suggests that the economy is going towards recessionary mode, or the economy is growing slower than expected. The interesting element is that new orders and output – which are the most important leading indicators for current activity and for future activity – actually declined even faster and are now running below 50 in the developed world.
In contrast, if you look at the table, Emerging Market (EM) PMIs have actually been accelerating and increasing. The PMIs are now above 50 (50.8 to be precise), despite the fact that in July we had a bit of a slowdown vis-a-vis the June number.
But what is interesting is that PMIs are at healthy levels and increasing in EM, whereas they are deteriorating in DM. The chart on the right shows the composite PMI, which is a combination of Manufacturing sector PMIs and Service sector PMIs. It shows the developed world economy already at recessionary levels (below 50), whereas emerging markets, after having expanded by close to 10 points over the last four months is now at 54.
So, the interesting element of what the data is telling us is that as the yield curve has been suggesting, and other market participants have been fearing, the developed world economy seems to be getting towards a recessionary environment. This is not a hard recession, this is far from a big economic downturn, but levels are suggesting that we're going to see recessionary levels of economic activity in the third quarter of the year, or perhaps the second half of 2022, whereas emerging markets are on a much better footing.
Stephen Rudman: Excellent, so the data is telling me something, that's what we can divine from that. With that said, let's talk a little more specifically about the equity market for emerging markets. As we look at that second half of the year, what does that potentially portend? What would be your expectations?
Gustavo Medeiros: Yes, thanks for the question. The markets are very good at keeping us humble, right? It's very hard to call the very short-term market developments. But as you can see on slide number three of the presentation, the emerging markets price-to-earnings ratio of the MSCI EM have been declining quite significantly over the last year-and-a-half, and are now at levels close to 10.5 to 11 times earnings, depending on the earnings window that you're looking at. I have 12-month blended forward earnings, which are consistent with 11 times earnings in EM. The interesting things to notice here first is that the S&P 500 or US stocks proxy remains at a very elevated level, particularly after the rebound seen last month. And I think that we're seeing an environment where if equity prices are soft, emerging market equities should outperform. Why? Because if you look across the table at the bottom of the slide, you'll see that many emerging market countries are trading at very cheap levels on wages. So, Brazilian stocks are trading at 5.9 times earnings, Chilean stocks are also at 5.9 times earnings, and Colombian stocks at 5.2 times earnings.
If you look at the second line, the ‘z-score’ is how many Standard Deviations these markets are trading below or above their 15-year average (or 15-year mean, to be more precise), and we are at extremely distressed levels of valuations in emerging market stocks. And that's despite the fact that earnings-per-share, as you can again see on the chart have been rolling over a little bit. The expectations of earnings-per-share have been slowing down over the last four months, but remain at relatively elevated terms. And in most of these countries that have deeply discounted earnings-per-share they are actually extremely strong.
Dividend yields are around 10% in many Latin American countries, for example, and on the far right of the table, you see that Asian countries (China, Taiwan and South Korea, to be precise), which are a large part of the MSCI EM, are also already trading at a discount to the last 15 years’ average. So again, EM stocks are looking very attractive across the board, particularly for the point of the economic cycle that we're in.
We have to remind ourselves we have just been through some pretty extreme events on the global backdrop: we’ve been through a pandemic, and we’re having much higher geopolitical volatility as a result of the war in Ukraine. We have had inflation spiking and the Fed hiking interest rates. Those events historically have served as triggers for change in market leadership. I think that US stocks won't be the outperformer over the next ten years as they have been over the previous ten years. And in that environment, I think diversification away to EM stocks is looking very attractive. Levels and ratios are cheap and as we've seen on the previous slide, current EM activity is starting to outperform the developed world economic activity, again, as China opens up and rebounds.
Stephen Rudman: Thank you, Gustavo, that sounds encouraging in the sense that the fundamentals really express value. We understand that sometimes it does take some courage in the kind of markets we've been in over the last six-plus months. That's very helpful. With that, let's ask a straightforward question. As we know, there's been a lot of news, certainly in July, out of China, particularly on China’s property market. Do you have any thoughts and comments you would like to share?
Gustavo Medeiros: Absolutely. Well, the property market in China is still in a stand-still. Property purchases remain down quite significantly in year-on-year terms. I think the good news from that space is that China’s central government is for the first time acting in a convincing way to try to backstop some of the problems.
So, the China Construction Bank was given the mandate to raise a fund of up to 300 billion renminbi, which is about $45 billion, in order to support the sector. More specifically, these funds will make sure that properties that were sold to individuals but are not yet built and where the construction is delayed will get the necessary funds to be finished up, and individuals will receive the property they paid for. The fund has a pretty open-ended mandate so the proceeds could be used potentially to help fund some of these construction companies directly on specific projects. That’s an important signal because for the first time in a year-and-a-half, the central government took steps in terms of allocating cash to the problem. I think that's an important step to the right direction.
We also had the Politburo meeting, where we didn't get a lot of news. They maintained their commitment to their zero-COVID strategy, albeit what they are now doing on the ground is very different than what was done in March and April. In other words, we had stringent lockdowns across Shanghai and Beijing at the beginning of the year, which led to a pretty strong economic slump in China. But now that the virus is spreading across other cities, the lockdowns are much more restricted in geographic terms, so they're locking down very small parts of a city rather than locking down cities across the board.
Having said that, the economic activity until July was not yet fully normalised in China, and our sense from what we've heard from the Politburo is that we're going to see much more policy stimulus. We find it hard to believe that Xi Jinping and China’s leadership will want to go to the party congress in November with the economy doing as poorly as it has done in the first half of the year. So, our overall thesis is that the Chinese economy is going to be on the other side of the global economic trend, accelerating or improving from a very low level as the developed world economies in particular are slowing down.
Stephen Rudman: Very helpful. So, we've done three things; we've talked about market data-dependent, we've talked about EM equity, and fundamental valuations. And obviously a nice update on China’s property market. For final thoughts. Was there anything that came out in July that was either cause for concern or that you might find encouraging, as we head towards the end of the summer and beyond?
Gustavo Medeiros: Yes, on the final slide, slide number four, I think is interesting to see that prices have been declining pretty much in several areas. First, if we look at the PMIs again (the Manufacturing and Services PMIs on the left and the right-hand top charts), you can see that the output prices (i.e., the prices that companies are charging for their goods and services) having been declining quite quickly. Again, there's a big divergence between EM and DM. In emerging markets, the price pressures have been moderating already since mid-2021, which is obviously a result of the earlier hiking that emerging market central banks implemented. But encouragingly, particularly for the Service sector on the right-hand side, you can see that output prices have been declining quite sharply. So that is something that we've been talking about, that potentially the hikes implemented so far, by the US Federal Reserve and across older developing economies, are already taking effect on the economy.
Now, when you look at the bottom left chart, you can see that commodity prices have been declining across the board. Energy prices (the blue line) are down quite significantly from their peaks. Industrial metals (the red line) are actually down in year-over-year terms – you can see that the one-year chart here has the lowest level throughout the year. But also food prices encouragingly declined by more than 10% over the last month-and-a-half, or so.
And finally, if you look on the bottom right chart, you can see that gasoline futures are down 32% from their peak, whereas average gasoline prices in the United States are down by only 14%. So, there are a lot of disinflationary pressures ahead. And obviously, that's coming against the backdrop of a strong labour market that the Fed has been advertising, but we've been cautioning that the labour market is typically a lagging indicator, and the leading indicators are already pointing towards the right direction.
So, we expect to see some disinflation towards the second half of the year, which at some point will allow developed world central banks also to find their stability, to stop hiking up monetary policy or at least to not hike much more aggressively than what's priced in, which I think should be helpful and supportive for risk assets at some point.
But in the meantime, we're still going to be in this summer lull that we are in at the moment, with relatively low liquidity. In that environment, I expect quite a lot of choppiness and volatility in the markets.
Stephen Rudman: Thank you, very helpful. Thank you for your thoughts. All those watching, thank you for spending the time. If you have any further questions, please don't hesitate to reach out. We're more than happy to share any further data that we can, that can help you get a grasp on what's happening in markets these days. Gus, any last thoughts before we sign off?
Gustavo Medeiros: Well, thank you very much for watching. If you have any questions, as Stephen mentioned, it would be a pleasure to be in touch.
Stephen Rudman: Wonderful. Until the next time, everyone be well and all the best. Thank you.