Email of the day
Comment of the Day

July 24 2013

Commentary by Eoin Treacy

Email of the day

on emerging markets
“Not a lot of new news here, in fact her view seems like a growing consensus. I suspect you both will say the charts will tell us when the EM rotation turns. Any indication that they bottomed last month?”

Eoin Treacy's view Thank you for this note by Rebecca Patterson at Bessemer. It raises a number of important topics which are likely to be of interest to subscribers. Here is a section:

The shift in Fed policy seems likely to generate volatility for a while, as investors get used to a new fixed-income regime . However , a gradual shift by the Fed, a long side modesty improving growth and still - robust corporate balance sheets, should help lift equities, albeit with some bumps along the way.

We remain overweight U.S. stock s but are always on the lookout for country rotations - parts of Europe are looking more interesting as peripheral European Monetary Union business confidence improves and equity valuations become more attractive.

Finally , we believe developed markets are likely to be more in favor than emerging markets for the foreseeable future. That said , a desire to globally diversify and our managers' mandate to identify specific attractive investments through bottom-up research suggest that we will continue to have some emerging - market exposure - equity ; debt, and currency - in our model portfolios.

Emerging markets in a general sense have taken a beating over the last few months, with leveraged participants taking flight at the prospect of tighter monetary policy. There are a number of points that seem relevant to the discussion of whether it is time to get back into these markets but let's first take a look at the MSCI Emerging Markets Index

The Index trended consistently higher in the early 2000s, collapsed during the credit crisis, recouped the majority of the decline by 2011 and has been mostly rangebound since. It is currently rallying from the lower side of its range as it unwinds its short-term oversold condition. A break in the progression of higher reaction lows would be required to question current scope for some additional upside. It is worth highlighting that the Index is heavily weighted by securities listed in China, Russia and Brazil while South Korea and South Africa have relatively significant minority weightings. Therefore while the MSCI Emerging Markets Index is a popular benchmark, it cannot be considered an all encompassing measure.

Following the Asian financial crisis, a large number of the constituents of the Asian Dollar Index implemented fiscal reform and attempted to run trade surpluses which bolstered their currencies and led to considerable appreciation, not least against the US Dollar. For foreign investors this was powerfully attractive because of the potential for concurrent currency and capital market appreciation. The Asia Dollar Index has been mostly rangebound since 2011 and recently tested the lower boundary. With Japan now engaged in currency devaluation, its neighbours are less likely to tolerate currency appreciation. This suggests that the Index's performance is likely to be much choppier in future.

To put this in perspective, here are some long-term charts of the Singapore Dollar, Taiwan Dollar, Brazilian Real and the Russian Ruble. None can currently be described as trending and a general pattern of base formation development of the US Dollar is the most obvious conclusion. It is looking increasingly likely that individual emerging markets will need to be addressed on their individual merits rather than simply taking a one size fits all approach.

For example the Mexican Peso is mostly rangebound while the stock market Index has rebounded impressively and a sustained move back above the 200-day MA would further bolster the view that a medium-term low has formed.

The US Dollar has base formation characteristics against the Malaysian Ringgit but the stock market in US Dollar terms, found support in the region of the upper side of the underlying trading range last week and a sustained move below that level would be required to question potential for a further rebound.

Qatar was recently inducted into the MSCI Emerging Markets universe and its stock market continues to extend its breakout from an almost three-year range. The Dinar is pegged to the US Dollar.

As discussed in a number of previous pieces, China's stock market is fundamentally cheap, at the lower side of its base and its currency remains steady against the US Dollar.

In conclusion, there are ample opportunities in the emerging markets and they continue to represent some of the greatest potential for capital appreciation over the medium to long-term, subject to improving standards of governance. An important caveat is that currency gyrations are likely to be a more important consideration in future and will either necessitate hedging or a tolerance to wait out volatility.

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