There is a mainstream narrative and there is a reality. Professional investors are best served when they understand both. From the perspective of BCA | Edge, the independent research provider puts on display its edge by comparing the sheep narrative with the reality of real emerging markets demand forces and China.
Their conclusion is that a reality check is required and the performance drivers attributed to the current emerging market rally “are either incorrect or have nothing to do with EM fundamentals,” the research provider wrote in an August 17 piece titled “Narratives Versus Reality.”
In a globally interconnected world, the boarderless search for yield pushes investors into emerging markets
In globally interconnected markets, news and hence trading opportunity is now officially defined by the US Securities and Exchange Commission as taking place on a millisecond basis. The increasingly global influences on markets and economies are recently witnessed in the emerging market rally.
Are local market forces exhibiting true market price discovery at play?
Don’t be fooled by the mainstream mantra, appears to be BCA’s standpoint. The emerging market rally is not due to improvement in regional fundamentals as much as it is a global search for yield. That search for yield has extended in the emerging markets and China.
BCA: No fundamental recovery in emerging markets or China has taken place
BCA highlights the key point that “there has so far been no meaning recovery in EM/China.” That’s a big statement because it runs counter to the consensus and market viewpoint.
The iShares JPMorgan USD Emerging Markets Bond ETF, for instance, hit a low of 103.11 on January 20 this year and is now flying higher, up near 15% in just seven months. Likewise the iShares MSCI Emerging Markets Index, which bottomed January 21 at 28.36, is now trading close to one third higher at 37.78.
Those significant market moves have been interperted in many corners as a sign of life in emerging market economies. Not so, says BCA.
“The narrative that EM growth has improved is hope but not reality,” they write, hope being a professional investor’s dog whistle.
Developed world trading at very high valuations and mostly tied to an interest rate correlation
With markets in the developed world trading at what are assumed high valuation points based on several correlations, including relative to interest rates, certain investors are expanding their horizons beyond the more traditional confines of the US, Europe and Japan.
What is lifting markets to high valuations is not fundamentals but rather competition for yield. This has consequences for future valuations. BCA is “not anticipating any meaningful or durable growth improvement” across the emerging market landscape. Looking at trailing price earnings ratios, BCA observes emerging market equities “are not cheap.”
BCA, looking at trend lines and forecasting into the logical future sees that
The stark reality is that if interest rates start to trend higher in any given region, and core risk assessments remain consistent, it could change the market demand forces, particularly among those solely searching for yield. This could impact not only bond prices, but to various degrees currency values might be influenced along with commodities.
Consider EM EPS not just from standpoint of local currencies, but also in terms of the world reserve currency of choice
BCA says that emerging market companies earnings per share, a fundamental measure used in valuation formulas, would be required to rise by 30% in local currency terms but more importantly 50% in US dollar terms. The world currency of choice used in trade is in a decided uptrend and with interest rate hikes bravely approaching, the report points to certain market imbalances.
Supply and demand forces in commodity markets have traditionally driven certain segments of emerging market growth. In large part commodity demand has been driven by China — with some analysts attributing much of this drop to flagging demand.
BCA says don’t expect commodity markets to bail out the economy because demand “will disappoint” and this could lead to a refocus on emerging market fundamentals “sooner rather than later.”
When that refocus takes place is when market supply and demand might be adjusted.