By Saira Malik, Chief Investment Officer, Nuveen
Headlines:
- Geopolitical “guilt by association” has meted out undeserved punishment. Beyond its devastating humanitarian toll, Russia’s invasion of Ukraine triggered knee-jerk selling across global financial markets, especially in China and across emerging markets. The tendency to view the EM universe as monolithic ignores its exceptionally diverse nature. Variations run the gamut not only in terms of geopolitical risks, but also by economic profile, fiscal and monetary policy, balance of trade and the role of commodities and currency regimes. Failure to consider these differentiating factors has led to broadly oversold conditions in EM.
- China, the world’s largest EM, is addressing its challenges. While not a proxy for all of EM, China’s economic health is a key barometer for these markets and for global growth more broadly. A slowing domestic economy being further hampered by rising COVID-19 cases, delicate internal politics and a desire to maintain good relationships with its trading partners have prompted China to enact or announce a series of pro-growth, market-friendly policies. These include monetary easing (lowering the required reserves ratio, cutting the benchmark lending rate), fiscal stimulus (proposed tax cuts) and a potentially lighter regulatory hand (in contrast to last year’s tech sector crackdown).
- Navigating the nuances is essential. As the People’s Bank of China maps out its easing policy to support economic growth, other EM central banks have implemented monetary tightening to help combat inflation. In this environment, we favour select exposure to areas where relative valuations look particularly attractive, such as EM debt.
Portfolio construction implications
Some EM equities might be cheap for a reason. With the MSCI EM Index trading nearly 20% below its 52-week high, it might appear on the surface to be a screaming value opportunity for investors with a tolerance for volatility. However, compared to non-U.S. developed stocks and historical standards, those bargain prices might not make up for heightened geopolitical uncertainty. On an enterprise value (EV) to forward EBITDA basis, EM valuations remain in the top quartile, mainly driven by EM Asia’s (and China’s) outsized weighting (Figure 1). EMEA also appears stretched in light of negative earnings revisions due to its Russia exposure.
Latin American stocks may be poised for better performance. Valuations in Latin America (90% of which consist of Brazilin and Mexican companies) appear more favourable. In part, this is due to relative interest rates and currency valuations. The U.S. dollar has appreciated this year versus the euro, yen and pound, but not against currencies in Latin America, where central banks are further along in their tightening cycles (Figure 2). We continue to see solid opportunities in these regions and potential for further currency gains.
Look to debt markets for more EM exposure
Overall, we remain constructive on EM equity markets, particularly China where uncertainty associated with geopolitics and COVID-19 containment measures might make for a bumpy road in the near-term, but economic fundamentals remain intact. We also favour attractively-valued commodity exporters like Brazil and Mexico. Given its higher weighting in Latin America and yields north of 5% (Figure 3), EM debt might be a better way for investors with a more moderate risk tolerance to add EM to their portfolios. Our EMD specialists continue to find opportunities in commodity exporters and idiosyncratic reform stories, including Saudi Arabia, Oman, Ecuador, Iraq and Zambia. They also favour local markets where central banks have already been tightening, such as South Africa, Brazil, and Chile.
