The trade-war-escalation is a decidedly negative gear shift for has been a looming “tail risk” for markets. And I use that decidedly overused term very lightly, as a tail risk is supposed to be something out of left-field, rather than something that’s been a source of constant focus and rumination.
But anyway, one of the immediate casualties of the escalation has been emerging market equities, with a number of Asian markets getting particularly clobbered – giving back some of the hard-earned gains that had been chalked up since the Dec lows for EM equities.
On the bright side, it’s helped push valuations back towards more interesting levels. I remarked on this in my weekly report last week (talked EM equity valuations + the evolving macro/sentiment picture). But I also previously talked about it a few weeks back when I noted that the valuation story was looking less compelling…
On with the key chart for today, this chart has a lot going on, and needs some explanation, but the key takeaway is that EM valuations look reasonable.
The chart shows the median and upper/lower quartiles of the blended historical z-score of the trailing PE, forward PE, price to cash earnings, and price to book ratio, across the 24 countries which are currently included in the MSCI emerging markets index. In other words, it gives a generalization of where valuations are tracking across EM countries relative to history.
The median country looks cheap vs history, and for long term investors fortune tends to favor the buyers of lower rather than higher valuations (there are of course many exceptions to this across countries and epochs).
The logical next question is who what where? …or at least who/where?
Next chart shows the valuation map for EM countries, and for those who pay any attention it should come as little surprise who occupies the top right vs bottom left quadrants.
For completeness, the chart shows the blended PE ratio across the bottom axis, and on the side axis: where the current valuation reading sits vs history for that particular country.
See I like to look at things this way, because often times you’ll be looking at a country that has a low PE – but then you notice that it’s not particularly out of the ordinary for that country e.g. compare and contrast Brazil vs China.
But for EM more broadly (i.e. talking about an index/aggregate level), there’s a few simple drivers.
Given the lower starting point valuations, EM equities are at an advantage but still need a few things to go right. The nascent economic recovery/stabilization needs to gain traction, China stimulus needs to come through, and ideally DM/US don’t go into a full blown recession. A trade deal might be nice, but not essential.
As for what could go wrong, it’s the usual things – as noted if the US or developed markets in general rollover into recession it’s going to be hard for EM to perform. The other threats overhanging are the possibility of a stronger dollar and a commodity market re-bear.
It’s not clear cut or easy, because both the negative and positive drivers I just mentioned are all entirely plausible. Thankfully, over the long run valuations have a habit of speaking for themselves, so I’ll leave you on that note.