Emerging markets have traditionally attracted risk-takers, with high volatility and the chance to beat DM returns by a fair margin for investors who manage to time their moves correctly. That’s why PMI (purchasing manager’s index) is normally a good way to tell if it’s time to own Emerging Markets risk, but EM markets have decoupled not only from PMI in the rest of the world but from itself as well.
“Globally, there appears to be no desire to own risk when it comes in the form of Emerging Markets. Even in EM there is no desire to own risk,” write Citi analysts Markus Rosgen and Yue Hin Pong.
Risk, defined as high beta and volatility, has been the worst performing style in Emerging Markets for the last 12 months, losing 8.8%, while it was the best attribute to own in the US and Japan and was flat in Europe.
Rising PMI normally means rising interest in risk
But losing money last year shouldn’t affect what people are investing in now. Rising PMIs correlate with rising risk appetite in the US and the EU, as you would expect. “In EM, it used to be the case too, but no more: USA, EU, and EM PMI are all up, but risk trade is down in EM—down,” write Rosgen and Pong, who suggest the headline ‘EM markets hijacked by aliens.’
The decoupling from DM is especially odd since a lot of Emerging Markets growth tends to rely on exports to the US and Europe (though intra-region trade has risen in recent years).
Emerging Markets cyclicals more expensive than defensives
It could be that risk-taking investors who would normally be interested in EM stocks have simply been burned too recently to go back, especially when rising PMIs globally give them other opportunities, but the fact that risk/cyclicals have had better EPS revisions than defensives but still have cheaper valuations is hard to explain.
“Like it or not, Emerging Markets has decoupled, but in the weirdest possible ways,” they write. “A stronger global growth environment (usually a positive for equities, especially those with a higher cyclical tilt) now seems to be a reason to sell the cyclical /risk component of markets.”