But try as you might, you can’t disentangle EM stocks totally from what’s going on in global equity markets. And many areas correlate more highly with what’s going on in the U.S. That became painfully obvious in early February when all the world markets caught the flu. The MSCI Emerging Markets Index fell about 10% from January 26 to February 9, in what some have seen as a long overdue correction.
Given worries about a new inflationary regime in the U.S., world stocks collapsed, and emerging markets were not spared. This seemed to vindicate critics like Jeffrey Gundlach of DoubleLine Capital and Jonathan Garner of Morgan Stanley who said emerging market prices had gotten too overheated.
Still, Richard Thies, a portfolio manager at Driehaus Capital Management, which runs a suite of emerging market funds representing some $4 billion in assets, says that his firm was impressed with the resilience of emerging markets during the selloff. The fundamentals of these stocks helped, he says. Investors will now wait in suspense to see whether those fundamentals will prop up the asset class. The P/E ratio for the MSCI index was 16.03 at the end of January.
The most important thing to remember is that few emerging market funds are interchangeable. Not many of them track to the MSCI index, which is full of state-owned enterprises and overladen with financials, and not all of them play these consumer themes. That’s why there’s a great dispersion in emerging market opportunities.
The long bet for investors in this space is still on the middle-class consumers in these markets, but Thies says the space will always be doing a tango with global economic forces—like commodity prices and dollar strength. He sees the sector’s outperformance in 2017 as part of an overdue cycle, and says these stocks are still in the growth phase of that cycle.
“Emerging markets are in general a much more cyclical asset class than something like investing in the S&P would be,” Thies says. “Emerging markets, at the end of the day, are capital importers and require capital to grow faster, so you need capital markets to be providing [it].” If the U.S. is in a classic late cycle with little excess supply of labor or manufacturing, EM countries are now in the opposite place.
“You are going from having a lot of excess supply in labor markets and in capacity just on the supply side in general, and really it’s a story about that leverage being put to use.” That’s one of the more obvious times to make money, he says.
For these macroeconomic reasons, he says, his team has been increasing its exposure to more cyclical industries. “We’ve still been increasing exposure in Brazil in a number of different names over the last several months,” he says. “The market is sort of underestimating how strong the cyclical recovery is going to be there.” Loan growth has recovered there, and there’s a lot of pent up demand in various sectors, he says.
In China, the firm has been reducing long-term winners like Alibaba and adding exposure in old economy companies like coal producer China Shenhua Energy. “Things like China tech generally trade similarly to the way companies like Facebook and Amazon trade,” Thies says.
Robert Marshall-Lee, manager of the Dreyfus Global Emerging Markets Fund, says that part of what’s changing emerging markets is the Chinese economy, which has moved from infrastructure development to a reliance more on domestic consumption.