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Stephen Rudman: Good day. Today is Wednesday, June 8, 2022. Thank you for joining Ashmore's ‘EM in 10’. My name is Stephen Rudman. I am part of the New York client facing team. Today we have our Head of Research Gustavo Medeiros to answer some questions during our monthly video ‘EM in 10’. We’re all very excited about it as obviously there's been a lot of market activity of substance. With that said, welcome Gustavo, happy that you're here. Let's jump right into the first question. As markets have become a bit data dependent, what is the data telling you – or more importantly telling us –  about the markets and what we may be looking at, moving forward?

Gustavo Medeiros: Thank you very much for the question. And thanks for the opportunity to record this video. Thanks for watching everyone. That's a great question, and it's interesting because we just had last week the  release of the latest global manufacturing Purchasing Managers Index (PMI), which basically asked the question of purchase managers around the world on how the economy is doing and they interesting in the data tells us is that first, the global economy is slowing down, but not quite for recession yet. The second interesting point, as you can see on the left-hand side of the slide on the screen, is that EM PMIs have been increasing quite sharply, actually. The manufacturing PMI is up almost three points in the last month and close to the 50 level. Developed world manufacturing has declined but again, to  levels that are still above 50, which is consistent to an economic expansion rather than an economic contraction.

The other interesting elements in terms of what is going on in emerging markets specifically is that as you can see on the right-hand table, most EM countries have their PMIs above 50, which is slightly counterintuitive, considering the headline PMI number for emerging markets is at 49.5. Obviously, that is down to the very large weighting of the Chinese economy, which is at the bottom of the table on the manufacturing PMI, and is dragging emerging market PMI lower. But overall PMIs or global Purchasing Managers Index have been increasing across most emerging market countries. As you can see, there's quite a lot of blue shaded data points here and is above 50 (which is on the second column of this table) in the vast majority of countries with all of them except for four, as a matter of fact. So the key message here is that we're seeing economic slowdown but no recession on the global economy, but emerging markets is actually accelerating from a low level, whereas the developed world is decelerating.

Stephen Rudman: Excellent, thank you very much. I guess that begs the question simply as we're looking towards the second half of the year, what might that portend for MSCI Emerging Markets purely on the equity side? Obviously, it's been a fairly difficult year for all markets, and certainly MSCI EM has been part of that. What are your thoughts as we move forward?

Gustavo Medeiros: Indeed, it’s been a very difficult year for global equities in general and an environment where China  GDP growth surprised on the downside in the second quarter due to zero-COVID policies, and an environment where the US Federal Reserve (Fed) and other central banks turned much more hawkish. Obviously, you have global GDP going down and the discount rate increasing, which is negative for the net present value of all assets.

An interesting point is that MSCI EM is actually outperforming the S&P 500 and outperforming the MSCI World in a down market. That's quite unusual. But it's not totally unexpected given the large discounts that we've had in emerging market equities vis-a-vis developed world equities. I’m posting a slide up right now that shows basically that MSCI EM trades at close to 19 times long-term earnings against the S&P 500 trading at still very elevated levels close to 30 times long-term earnings, just after peaking at very similar levels to the 2001 dot.com bubble.

So obviously, extensively elevated levels of valuations in the developed world, but EM is suffering in line with that. Now, we think that from here, we're likely to see EM assets outperforming the developed world for two main reasons. The first reason is that China growth is likely to be improving from here after a pretty shocking second quarter in terms of economic activity, as mobility recovers not only in Shanghai, but also in other parts of the country that were most impacted due to the zero-COVID policy.

I think the politburo of China seems to have taken on board the economic challenges that the zero-COVID policy has dealt, and have adjusted policies accordingly in order to avoid a repetition of the situation. Furthermore, China announced a number of fiscal and monetary policy easing measures that are likely to boost economic activity over the next few quarters. And third, we have seen several signals that the crusade against the big technology platform companies in China is over. Just this morning, we've seen China approving a number of games that were in the pipeline for a while, giving a boost to a good number of technology companies in China. A couple of days ago we also saw more signs in terms of policy that China was turning the corner.

The second point is that we believe that the Fed hawkishness is likely to be peaking. In other words, we think that the amount of interest rate hikes already priced in the curve is already leading to a tightening of financial conditions and will lead to lower economic activity. On slide number three you can see that the affordability of houses in the United States has dramatically changed over recent moments as mortgage rates have increased. So, for example, 20% mortgage deposit to buy the average house will take about 17 months of the average employee’s income in the United States. Ten years ago, mortgage instalments absorbed 35% of the average employee’s income. Today that has increased to closer to 50%. Those levels are very similar to 2007/2008 when demand for housing collapsed. I’m not saying that we’re going to have a housing crash – we’re in a very different market environment. But what I’m saying is that the current financial conditions have been tightening to enough of an extent for the Fed to ‘stop and see’ after hiking monetary policy twice. I think these are conditions for EM stocks to perform well within the next six months or so.

Stephen Rudman: Excellent , that’s very helpful, and I know a lot of our clients are thinking about this. They recognise that with declining prices, there may well be opportunity, but we also understand that it takes some courage, given the market we've been in over the last several months.

For the third question, which is really built around something that you cover consistently and very nicely in weekly research, but emerging market elections are often meaningful relative to opportunity or speak to potential concerns about certain markets. Can you give us some timely updates relative to upcoming emerging market elections?

Gustavo Medeiros: Absolutely. Thanks for asking the question. I think the key one in the short term within two weeks involves the run-up to the presidential election in Colombia. Polls are showing a coin toss between the surprising centre-right candidate Rodolfo Hernández versus the leftist candidate Gustavo Petro for the run-off in Colombia. There is a big binary situation here. I think that the market will prefer Rodolfo Hernández winning the presidential election – he has a set of policies that is much more towards liberalisation and reducing the size of the government and implementing a thorough fiscal consolidation.

The question mark on whether Gustavo Petro would be able to implement all his policies and whether his policies would be geared towards far left or more of a centre-left agenda, similar to what we've seen in Brazil between 2002 and 2008 when Lula da Silva won. Therefore, we might have an opportunity depending on how Petro’s economic team shapes up and how his economic policies come to fruition. But that's one election we're going to be monitoring very closely and I think it's going to be pretty important.

We also have a referendum taking place in Chile, to decide whether or not to vote for the constitution that was just drafted. The good news is that the constitution is not as bad as some people expected as a lot of the far-left proposals made by constitutional assembly members were vetoed. The bad news is that the constitution is a very long document and is going to take a while to be implemented, which means more uncertainty at the margin. But it's quite possible, and something that is very far from being priced, that they don’t manage to approve this constitution at all. The popularity of newly appointed president Gabriel Boric will go hand in hand with the decision on whether or not to vote in favour of this new constitution. That’s going to be something important to monitor.

And finally, towards the end of the year there’s going to be presidential and parliamentary elections in Brazil. Here we have Lula running against Bolsonaro, two candidates we know very well.

The third wave consolidation process is unlikely to introduce any outside candidate apart from these two alternatives. The bad news here is that obviously, there was quite a lot of poor economic policies, not from the Lula administration itself, but during his successor (Dilma Rousseff administration) and there would be some uncertainty about that. The good news is that we know Lula, he had a pretty pragmatic government in the first eight years of his own government. He has installed Geraldo Ackmin as his running mate who is a centrist former governor of São Paulo and Lula’s adversary for a number of years. That's a sign of moderation. Also, Bolsonaro suffers from a number of negative aspects, specifically on the environmental policy side. But on the positive side, he runs as more pro economy and with more of a liberal agenda, such as being in favour of privatisation.

I think that overall, the mantra for 2022 onwards is that geopolitical risk is becoming a much bigger part of the overall risk spectrum, and crowding out this political risk that we've been monitoring for a long time in emerging markets. This is what markets are pricing in at the moment. That said, all of these Latin American markets are performing quite well, despite these political challenges, and I think that this structural element is likely to remain with us. Having said that, markets love to trade political events, and I don’t think this time will be any different.

Stephen Rudman: Good point, and I guess that's part of our day job to be sure of that balance between what the markets actually care about in terms of political activity, and what the economics tell them.

Again, thank you, very helpful. I know it's going to be a very busy year here. With that said, as always, Gustavo, thank you for the update, we do this monthly and we look forward to coming back for July’s call, most probably after the US Fourth of July independence weekend. Thank you all for watching. If there's anything we can do in terms of follow up information, we’re more than happy to do so, please  reach out to your Ashmore representative. With all that said, be well, and we look forward to seeing you next time. Thank you very much.