Global equity markets have started this year on a sour note with a sell-off partly caused by investors overreacting to the low oil price and disappointing economic data coming from China and the United States.
As things stand, financial markets are pricing in a very high probability of a global recession. On balance, we believe this is unjustified and therefore think it is a good time to rebuild positions in emerging-market asset classes.
One of the reasons for the sell-off is that various sovereign wealth funds in the Middle East have liquidated some of their equity holdings.
This move came in response to the oil price, which has fallen because of oversupply, whereas oil demand is actually rising year-on-year.
Over the medium term, lower oil prices will lead to an increase in consumer spending power and improved economic conditions for energy importers in emerging markets.
Meanwhile, in China, years of unproductive investment and government efforts to make the economy more consumption-orientated have taken their toll on manufacturing growth. But the nation’s difficulties are not a new story and the latest data shows that economic conditions are stabilising.
Indeed, China’s service sector is showing resilience, public spending is rising and property sales are growing amid continued monetary stimulus.
Some of the recent downward pressure on the yuan appears to have stemmed from the early repayment of US dollar debt by Chinese corporations, worried that the US Federal Reserve’s recent rate rise would raise their borrowing costs.
China’s heavy-handed and unsuccessful economic interventions have somewhat dented the government’s credibility for economic management. But Beijing is unlikely to embark on further clumsy devaluation and investors can instead expect a gradual but modest depreciation in the currency, such as the 5 per cent fall now priced in by the market.
Given that emerging markets stocks are now trading at a 30 per cent discount to their developed market counterparts on a price-to-earnings basis, emerging markets are now looking attractive from a valuation point of view.
China, Taiwan and Poland are the cheapest markets on our scorecard. We also think that cyclical markets with very low multiples and potential upside on growth momentum, such as Korea and Russia, offer good potential. Overall, we find emerging Asia more attractive than Latin America.
The fragile state of emerging markets makes the Fed’s rate rise in December, and the subsequent draining of excess liquidity, look badly timed. Added to this, US economic data has been extremely disappointing, with retail sales growing at less than half the pace of last summer – just 2.3 per cent per year. Industrial production is on the verge of contracting and the final quarter of 2015 is likely to have been the US economy’s weakest quarter since it pulled out of recession in 2009. As a result, we believe that US monetary tightening will now continue at only a very gentle pace.
But interestingly, each time the US economy has hit an air pocket but avoided recession, stocks gained by an average of 30 per cent in the subsequent 12 months.
While the oil price collapse, the US rate increase and China’s economic slowdown have damaged investor sentiment, few economic and financial indicators predict a recession ahead.
Technical gauges suggest an equity market bounce is more likely than a protracted sell-off. Also, with the US dollar likely to appreciate at a slower pace, we believe it makes sense for investors to consider increasing their allocations to emerging market assets.
Luca Paolini is the chief strategist for Pictet Asset Management.
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