This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Tyler Mordy, president and chief investment officer of Toronto-based Forstrong Global.
Emerging markets—deflating, despised, discounted—are the subject at hand. Even a casual browse through today’s financial media highlights a seeming shortage of magazine covers on which to announce the coming collapse of China and its now-enlarged economic ecosystem. Bearishness has become a universally approved view (much like bullishness on almost anything else).
To be sure, this treatment is far removed from the red carpet on which emerging markets (EMs) trod during China’s roaring bull years. But is it warranted?
The following is a departure from the voluminous stacks of negative commentary. Enough exists. Our interest lies in the strong consensus that has surfaced. Whenever a deeply unified one appears, it’s always useful to question what could be missing from the analysis. As the old saying goes, “When everyone is thinking the same, no one is thinking at all.”
Skipping to the bottom line, our actionable takeaway is that EMs are forming a bottom, albeit with new leadership underway. This conclusion rests on two foundations—one of the fundamental variety and another of the behavioral kind. Both point to a favorable entry point immediately ahead.
3 Misunderstandings On EMs
Starting with the fundamentals, three issues are widely misunderstood.
First, revulsion toward China. The consensus has spun a narrative that policy has finally pivoted to pursuing a weak yuan, providing evidence of an imminent hard-landing scenario. While growth is slowing and should not be trivialized, the more important story is China’s solid progress on the road to rebalancing; namely, a shift away from manufacturing and construction activity toward consumers and services. Urban hiring trends are still growing at a robust clip, and services expanded by 8.5 percent in the first half of 2015—hardly statistics associated with economic recessions.
The above is encouraging. And, exactly what well-intentioned Western economists urged EMs to do: Rebalance economies away from cheap exports to a more self-sustaining middle class. While Beijing can be criticized for a poorly communicated agenda, its longer-running ambitions shouldn’t be understated—internationalize the currency, modernize the financial system, address excesses in debt markets and transform state-owned enterprises—all couched in a nationalistic revival of the “China dream.”
Higher-Quality Growth For China
This transition will be bumpy, but investors should not lose sight of the longer-running game. Over the next several years, China will see slower but higher-quality growth—thanks to reduced capital waste (less inefficient infrastructure spending, less corruption, less unproductive debt). This is enormously positive for asset prices.
Second, forecasts of a widespread EM crisis are also off the mark. Here, the commentary has focused on slowing growth and high debt, with extravagant comparisons to the 1997-98 Asian crisis. Yes, exports are slowing. But this is concentrated in the commodity exporters (declining by almost 40 percent in July on year-on-year terms).
And the outlook is actually improving for a number of countries. It’s important to recognize that EMs already had a large slowdown between 2010 and 2012. Since then, currencies have weakened (boosting competitiveness), commodities have fallen (raising consumption) and policy has turned stimulative (lowering the cost of capital). These benefits always show up with a lag. Why should this time be different?