Alongside other notable rallies in the last couple of weeks, the emerging markets have roared back since their Covid-19 rout in March. The EEM iShares Emerging Markets ETF has risen 34% since its March 21 nadir, reflecting the bounce-back of a number of markets. And like the stock market rallies elsewhere, it has people asking, is this rational? And if so, is it overdone?

Emerging markets equities lost $31 billion in March amid the virus turmoil. Just $700 million crept back into EM equities in May, according to the Institute of International Finance.

Portfolio managers have recently said that there was a wide disparity in preparedness for a catastrophe for the coronavirus among the emerging market countries, and there were lots of haves and have-nots. China, South Korea and Thailand had good marks for their high health-care capacity, low external debt, and stimulus wiggle room to fight the economic downturn. South Africa, Turkey, Brazil and Mexico were in trouble. These countries either faced huge debt problems or fortunes tied to oil (or both). Currencies were suffering as well. And when money ebbs from emerging markets in times of crisis, it hampers these countries’ abilities to use policy to tend to the woes of their citizens.

Yet the turmoil has also created opportunities in the minds of some emerging markets managers.

“EM equities, as measured by the MSCI EM Index, are trading at valuations in line with their historical averages, yet these valuations appear inexpensive when the index’s changed sector exposure is taken into account,” said Todd McClone, a portfolio manager on the global equity team at William Blair, writing in a May 20 blog post. “The higher-valued information technology, consumer retail, and media sectors were about 10% of the index in 2008, and the lower-valued energy and materials sectors about 40%. Today, the former is about 40%, and the latter roughly 10%.”

McClone said some themes have an advantage in the turmoil, specifically, “technology-enabled growth areas such as 5G telecom, e-commerce and online education.” He especially emphasizes themes in China, which has emerged from the Covid-19 pandemic in better stead than a lot of countries (even though the virus emerged there). China is even expected to have a slightly positive GDP this year, though the country said in reports that it is not setting a target. Chinese GDP in 2019 was 6.1%.

The U.S. GDP, by contrast, could contract by more than 5.6% this year, according to the Congressional Budget Office.

Dave Iben, the chief investment officer and lead portfolio manager at Kopernik Global Investors in Tampa, Fla., said emerging markets are appealing to investors in many cases because there aren’t a lot of other places to go. Cash is likely going to have a negative real return while sovereign bonds around the world “are priced somewhere between negative and 1%."

Bottom Up Is Better For EM
Iben says that his firm seeks bottom-up opportunities around the world and is overweight in EM. The Kopernik Global All-Cap Fund (KGGIX), he said, is currently at 40% emerging markets, whereas the MSCI All Country World Index holds only 11% in emerging markets. He said he sees a lot of attractive valuations here in things like telecom and railroads compared to their American counterparts.

“Even after this bounce, many of these companies are right back to where they were a dozen years ago,” he said. When talking about the superiority of emerging markets, he uses a company like Verizon as an example. It’s a telecom company in a triopoly with a decent P/E ratio offering a product, cell phones, that people aren’t going to give up. “Yet if one is willing to go into the emerging markets, they can go to Korea with Korea Telecom. ... They can go to China with China Telecom and get similar companies. … There, instead of 12 times earnings you can get single-digit P/Es, so double-digit earned yields, and that’s without the margins that Verizon makes, so their margins go up, so then there’s a lot more potential.

“Verizon has no tangible book value. The two Asian players I just mentioned are just over half of book value. So they are way cheaper on earnings, way cheaper on book value.” When you look at price paid per customer, Verizon is six times more expensive, he said. “I.e., Verizon’s margins need to be six times higher to justify. So we see not only better valuations but much more growth potential.”

In transportation, he said his fund used to own U.S. and Japanese railroads, but now holds a railroad in China-Hong Kong, which has suffered because of the turmoil. “Instead of paying six times book value for Union Pacific we pay less than book value for Guangshen [Railway], a passenger railroad. … The U.S. utilities, they’re trading at 30 times earnings; we are paying three times earnings for an electric distribution company in Russia [Federal Grid] and we’re paying about six times earnings for a hydroelectric generation (RusHydro), also in Russia. And pretty similar for hydroelectric in Brazil (Eletrobras).” In Russia, you can get Gazprom with three times earnings, he added.