Twenty years ago, on June 30, 1997, the sovereignty of Hong Kong reverted to China. Two days later, the devaluation of the Thai Bhat launched the Asian crisis, though by that point emerging market (EM) assets had been underperforming developing market (DM) assets for several years. Three years passed before the Asian and U.S. economies rebounded and China joined the WTO, spurring commodity demand to benefit EM producer markets. By December 2001, a world economy ripe for renewal began a decade of spectacular outperformance.
Prolonged periods of EM out and underperformance relative to DM has been a reoccurring phenomenon throughout the last three decades coinciding with shifts in the relative pace of EM vs DM economic growth. Now, on the 20th anniversary of Hong Kong’s transfer, investors must again decide whether a bounce in EM assets is a temporary blip or a promising signal of prolonged outperformance. GSAM’s Global Portfolio Solutions strategists Anders Nielsen and Ameya Muley strongly believe in the latter. Below, find a summary of their views on EM valuation, economic growth and headwinds to growth.
- On the valuation front, EM currencies are currently about as undervalued as they were in the early 2000’s, before the last large bull market. EM equities are also attractively valued relative to DM equities, with the relative ratio between price and earnings currently being at the 37th percentile of its historical distribution. The compounding of these two factors with the room for earnings to rebound could potentially support outperformance to the tune of 10% per year over the next 5 years.
- We expect the catalyst to be a rebound in EM growth as headwinds fade. We believe the headwind from declining commodity prices is behind us and expect range-bound commodity markets in the near term. There will likely still be some headwind from further slowing of Chinese growth, but we are optimistic that the pace will be gentle compared to the rapid decline that has continued since 2007. Additionally, imbalances, such as large current account deficits in EM countries, have improved significantly.
- There is room for growth to rebound, as the headwinds have pushed current growth in EM outside of China substantially below our estimates of what can be supported in the long run given population increases and technological progress. As the headwinds fade we would expect growth to approach and potentially overshoot this longer term potential. A key risk is the pace of credit creation in China. It is unlikely to be sustainable in the long term, but we think the government has both the will and the resources to avoid a hard landing in the next few years. And if history has taught us anything, that’s a risk we are willing to take.
Read more about Anders and Ameya’s take on the cyclical case for EM equities.
