Exclusive report: Fear and loathing in emerging markets shares
By Matein Khalid: Chief Investment Officer & Partner at Asas Capital
It is impossible to make a strategy call on the emerging markets without also making a call on the trade war, the credit/property slowdown in the Middle Kingdom, the resurgence of King Dollar since April, Federal Reserve monetary policy and the slope (flat? Inverted?) of the US Treasury yield curve.
In addition, the prospects of MENA markets are impacted by the plunge in the price of crude oil and gas. The GCC states are all classic Petro-economies with the possible exception of Dubai but Egypt’s Saudi remittances, Suez Canal tolls, Sinai LNG export revenues and even Gulf aid prospects all dim when petrodollar revenues fall, as happened in October and November 2018.
Politics can help or hurt an individual emerging market. So Brazil’s Bovespa and the real soared at the prospect of right-wing maverick Jair Bolsonaro as next President and Lula da Silva blackballed from politics while Mexico’s Borsa and the peso was slammed by the victory of Lopez Obrador as the next El Jefe.
If there was ever an unloved, under-owned asset class, emerging markets equities is it. Chinese equities trade at an 18% valuation discount to the Morgan Stanley emerging markets index after 2018’s bloodbath in Shanghai, Shenzhen and yes, Hong Kong, where the Hang Seng index is a bargain at 10 times forward earnings. The “Chinese discount” to MSCI emerging markets is the highest since February 2016 and the world’s fund managers are dramatically underweight the Dragon Empire. Since I live (and occasionally die!) in the second derivative, I now believe that the merest hint of good news in trade, the US dollar, a Jerome Powell monetary pause or US growth data could mean the mother of all rallies in the Chinese stock markets. This then suggests that the MSCI emerging markets index fund (symbol EEM in New York) bottoms at 37 – 39.
Of course, if China has a hard landing or Beijing’s shadow banking Ponzi scheme goes kaput, all bets are off in emerging markets. The MSCI emerging market index fund could well plummet to 2013 “taper tantrum” levels at 32 – 34.
If Saudi Arabia stabilizes oil prices and there is no global recession in 2019, Saudi Arabian equities could go ballistic. The 960 billion riyal State Budget was the most expansionary relative to GDP since the era of the late King Faisal in the petrodollar bonanza after the October 1973 war in the Sinai/Golan. MSCI tracker funds could invest $35 billion in Saudi megacaps once it is no longer a frontier market. The banking credit crunch in the kingdom has begun to ease. The Royal Court has accelerated fiscal transfers. This spells an embryonic bull market on the Tadawul to me.
Stock market to avoid? The Pakistani rupee has plunged 35% in 2018 but I still believed it is astronomically overvalued at a time the State Bank hard currency reserves have fallen to one-month import cover and the Prime Minister has instructed his central bank governor to green light rupee policy with him. The Karachi stock exchange index has lost a third of its value since the deep state in Rawalpindi sacked thrice elected PM Nawaz Sharif in mid-2017.
As interest rates rise another 3%, the economy will move into recession and dollar investors face at least another 40 – 50% downside risk. I am haunted by the fate of Turkey, Argentina, and Venezuela in 2018. Turning to the other side of Sir Cyril Radcliffe’s Award in South Asia, India’s Nifty index is a juicy short at 10800. Despite BJP’s pre-election fiscal stimulus, Modi’s minions could lose Rajasthan and state elections now that RBI Governor Patel has resigned. India’s shadow banking crisis (non-bank lenders) financed by fickle wholesale funding will turn ugly and eviscerate corporate/consumer loan growth. Valuations for Sensex and Nifty are a nosebleed and the Indian rupee could well depreciate to 76 – 78. If the US dollar and oil rise, India is relegated to the Fragile Five. The biggest sovereign credit downgrade risk in the emerging market? Mexico.
The Santa Claus rally on Wall Street was aborted by Trump’s post G-20 tweet and the Huawei arrest but the real financial Carnival in Brazil is on the Sao Paulo borse, not the streets of Rio. South Korean shares now trade at 2008 lows and below book value. Vietnam? 2019 could resurrect the bulls on the Mekong Delta, the world’s new factory.