Emerging markets have had a shock – but confusing it with a trend could cost you
Emerging market equities have dropped 11 per cent since October’s peak and are down 7.5 per cent so far this year.
But Saxo Bank's head of equity strategy Peter Garnry is keen to stress that temporary shocks should never be confused with a new trend.
The underlying trend is still there
Despite tapering and the political turmoil pushing markets back to levels last seen in August (see chart), Saxo Bank sees the decline as an opportunity to increase exposure in emerging market equities.
Higher productivity gains, lower taxes on the private sector and fast growing middle-classes are just three things emerging markets have going for them. Moreover, they often leapfrog development stages, says Garnry – like going straight to mobiles and bypassing landlines.
Shocks happen because the countries in question grow at an above average rate, owing to large capital inflows investing in infrastructure and business – but these shouldn’t be confused with trends.
Because we have seen so many shocks over the past three decades, market investors know that when a shock hits the market you have to have options. Either you get to exit first or you ride the declines because you are more long-term and have no liquidity constraints.
Most investors go for option one, but the problem occurs when everyone runs for the exit – buyers on the other side aren’t other foreign investors because of the “stay away” perception.
That means it’s normally domestic buyers, which can mean serious constraints on liquidity and, as a result, prices fall fast.
Equities are still a buy
But Garnry says these situations “always create opportunities” – stay alert and use the declines to your advantage.
Liquidity-constrained selloffs often result in misplacing because they look at the temporary shock and not the trend.
According to Saxo Bank, on metrics like price-to-cash-flow and price-to-earnings, equities are not outright expensive. And, despite a slowing pace, it believes the asset class will continue to outperform bonds.
It’s in favour of three markets: Mexico, Turkey and Indonesia.