Emerging Markets: Trade Woes Continue but Valuations Remain Attractive

​July​​ 2019

Market Environment​

The -1.14% return of the MSCI Emerging Markets Index during July lagged global developed equity markets as represented by the 0.52% return of the MSCI World Index. The month ended with a well-flagged 25 basis point (bp) cut by the U.S. Federal Reserve, the first since the Global Financial Crisis. It accompanied comments by the Fed chair that this is a “mid-cycle pause” rather than the start of a new easing cycle. No further progress was made in the U.S.-China trade war although trade negotiators agreed to meet again in September. In other Asia news, President Donald Trump and North Korea leader Kim Jong Un met in the demilitarized zone early in the month, but later in July North Korea test fired two rounds of ballistic missiles. Energy prices were essentially flat during the month.

Latin America was the best-performing region once again, driven by Brazil as the passage of pension reform drew closer. During the month, the reform passed voting in the lower house with less dilution than expected and projected savings far exceeding market expectations of 700 billion Brazilian Reals ($182.7 billion) over ten years. Brazil’s central bank ended the month with a larger-than-anticipated 50 bp rate cut. The remainder of markets in Latin America was in the red for the month. While Mexico avoided a technical recession, growth has been lackluster and the reporting season confirmed weakness in business investment and other economic activity. The country’s finance minister abruptly resigned during the month and was replaced by his deputy minister. The specter of a potential credit rating downgrade seemed ever more likely for Mexico’s sovereign debt.

Emerging Europe, Middle East and Africa was the next-best performing region for the month, led by Turkey and the United Arab Emirates. The Turkish central bank delivered a whopping 425 bp rate cut, helping to propel the country’s equity market forward. The South Africa central bank delivered a 25 bp rate cut but also cut its year-over-year growth outlook to only 0.6%. The Russian central bank also delivered a 25 bp cut. Protests erupted in Moscow after the city’s election commission said that many independent candidates faked voters’ signatures on petitions required to run in September’s elections and therefore will be banned from the contest.
 
Asia ex-Japan was the worst-performing region for the month with Taiwan and Indonesia the strongest performers. South Korea and India, however, were notably weak in July. In the former, disputes broke out between Russia and South Korea and there was a sense that a Japan and South Korea rift was deepening. South Korea is an open economy highly sensitive to global trade and is likely feeling the headwinds from slowing global growth. India is suffering through a homegrown crisis as its state-owned and non-financial banking sectors continue to be pressured. Protests continued for a second straight month in Hong Kong over a proposed extradition law, which was removed from consideration. Chinese economic data released during the month was universally better than expected, especially June retail sales, which were up 9.8% year over year.

Outlook​​

The EM consensus earnings growth estimate for 2019 has fallen slightly to 1.2% while the 2020 estimate remains at 14%. Given the deteriorating global growth environment, current 2020 earnings estimates should be discounted. The asset class remains undervalued but rallies are likely to be short lived while trade dissonance remains at the forefront of global challenges. The schism between the U.S. and China remains quite large and is unlikely to be resolved to the satisfaction of both countries in the near term. It is possible that the status quo continues for some time. Our view remains that an escalating trade war between the U.S. and China would not be in either country’s best interest; one should continue to watch how these actions unfold. The forward price-to-earnings multiple discount of EM equities relative to developed markets widened again in July and finished the month at 24.6% but there has been no change in the longer term structural support for EM.


The views expressed are the views of Fred Alger Management, Inc. and Alger Management Ltd. (together with their affiliated entities “Alger”) as of July 2019. Alger has used sources of information which it believes to be reliable; however, this publication is not intended to be and does not constitute investment advice. These views are subject to change at any time and they do not guarantee the future performance of the markets, any security, or any funds managed by Alger.

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The Morgan Stanley Capital International (MSCI) Emerging Markets Index (gross) is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets The MSCI World Index is a broad global equity benchmark that represents large and mid-cap equity performance across 23 developed markets countries. Investors cannot invest directly in any index. Index performance does not reflect the deduction for fees, expenses, or taxes

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