Stocktake: Unpopular emerging markets a good bet

Emerging markets, Merrill Lynch strategist Michael Hartnett said recently, "are about as popular as Dennis Rodman at a UN Security Council meeting". He's right – and that brings opportunity for investors with a strong stomach.

Emerging markets were pounded in January, but the current crisis didn’t start in the last fortnight. US investors have withdrawn money from emerging funds for 13 straight weeks, the longest run since 2002. Valuations, relative to developed markets, are near the crisis levels of 2008.

Though cheap, they may go lower. “People will overstate how bad fundamentals are as price action worsens,” hedge fund manager Mark Dow last week warned. Many will “revert to old-school EM biases, even though many things, fundamentally, are different [better] this time”. This may not be 1997, but “don’t try and fight the old school and their anachronistic biases”, says Dow. “They are bigger than you are.”

Perhaps, although long-term investors should not fret about lower prices – catching the bottom is an impossible dream. Last November, Jeremy Grantham’s GMO issued a seven-year forecast predicting negative real returns for US equities and mediocre returns for most international markets. Only emerging markets were priced for decent returns.

The valuation gap has widened since. Yes, there are risks facing emerging economies, but rotating out of expensive equities and into cheap ones rarely proves a bad long-term bet.


Politicians not talking turkey
You know times are nervy when politicians start whinging about speculators and the media. Turkish prime minister Tayip Erdogan (above), who has form in this regard – last summer, he promised to "choke" and "throttle" so-called "speculators" – last week growled that the BBC and the Wall Street Journal had "stolen the national will" and "pocketed the resource and energy" of Turkey.

Argentinian politician Jorge Capitanich, meanwhile, said the "speculative behaviour" is "antipatriotic and shameful", while Venezuelan president Nicolas Maduro was similarly indignant, recently condemning the "economic war of gross speculation" and the "psychological war from abroad".

It’s reminiscent of the Asian financial crisis of 1997, Malaysian prime minister Mahathir Mohamad arguing at that time that currency trading was “unnecessary, unproductive and immoral” and “should be illegal”.

Such guff may go down well domestically, but it’s hardly likely to impress foreign investors. Erdogan and his ilk would do well to see the contradiction inherent in blaming “outside sabotages” while simultaneously promising capital inflows “will keep coming to Turkey”.

Pullback long overdue
Global selling might indicate investors feel a real risk of contagion from emerging markets.

However, it’s more likely an excuse for a long-overdue pullback.

It’s been seven months since the S&P 500 suffered a 5 per cent pullback, and 27 months since a double-digit correction, the index barely pausing for breath as it advanced 30 per cent last year.

Complacency had set in: as we noted last week, the percentage of global fund managers taking above-average risk was close to its highest-ever level in January.

When investors are caught that one-sided, the potential for a reversal is obvious, leading to the S&P 500 breaking below its 50-day average last week for the first time since October, and a technically oversold condition for the first time since June.

Last week, 33 per cent of stocks were above their 50-day average – a level that has marked bottoms over the last year.

However, double-digit corrections tend to see readings below 20 per cent, while indiscriminate selling can lead to single-digit readings.

Further selling may be in store, but it’s not likely to be the end of the bull.

The ratio of stocks hitting new highs relative to those hitting new lows is similar to "what typically occurs in a maturing bull market rather than an imminent market top", Lowry Research noted recently.

The Vix, or fear index, has surged, but remains below historical norms, indicating little panic.

Additionally, cash levels are high among fund managers – many investors will feel they missed out on last year’s upswing, and are looking for an entry point.

While that mentality persists, pullbacks are likely to be seen as opportunities.


In numbers
20
Facebook's market capitalisation surged $20 billion, to $150 billion, following last week's earnings beat. It trades at 21 times last year's sales, 39 times forward earnings, and 158 times trailing earnings.

39
Apple's market cap fell by $39 billion after announcing disappointing iPhone sales. It trades at 2.6 times sales, 10 times forward earnings and 12 times trailing earnings.

88
The S&P 500 has closed down three weeks in a row, the first such occurrence in 88 weeks – the second-longest streak of the last 40 years.

300
The S&P 500 closed at a 50-day low last week for the first time in 300 days – the longest streak recorded in 18 years.