By Tim Seymour
The charts tell you what you need to know about asset flows, quantitative easing (QE), and the impact on emerging markets.
I have chronicled emerging markets’ underperformance to the S&P 500 (SPX) numerous times in the last few months, highlighting what appeared to be key levels while also expressing disbelief in the extreme underperformance of the asset class.
Recently I drew a line back to 5 years to show the price relationship between the MXEF (EEM) to the SPX. (See chart 1)
After underperforming the S&P by 60% from the point of peak emerging markets outperformance, emerging markets equities are very near the level (on a relative basis) they were when they began a massive outperformance to SPY in late 2008.
Emerging markets bottomed first and in the early days of stimulus and QE1, risk assets and commodities were bid higher than U.S. assets.
It made sense that emerging markets outperformed in the first leg of this post crisis as growth returned first, and places like China were able to throw enormous amount of infrastructure building at the commodities complex.
Chart 2 simply shows that from the point the markets hit their post crisis low (Oct 3, 2011) driven by the U.S. downgrade and euro fears, emerging markets have only rallied 14%.
Meanwhile from that point, the SPDR S&P 500 ETF (SPY) has rallied 47% (see chart 3).
Brazil has done even worse than other emerging markets countries (see chart 4) as China’s slowdown and bizarre fiscal policy have made the former sweetheart market a home for broken fund managers.
Overall, emerging markets have underperformed the SPX by 33% since that low. Like commodities and other risk assets, emerging markets responded nicely to QE1. There was also a burst higher after the QE2 Jackson Hole event, before emerging markets equities began a slump that has continued to this day.
All stimulus since that point has been pushing on a string. QE3 actually has proven to undermine emerging markets as asset flows began to change dramatically. U.S. and European Union (EU) flows were the preferred route to global exposure while emerging markets equity markets have fallen victim to their own growth issues and a combination of destructive monetary policy and slumping western demand.
The Bank of Japan (BOJ) stimulus may have been the final straw. Emerging markets are starting to shake off the effects of global policy now that you have the following set up:
1) Major carry trades are being unwound and now we are at a place where emerging markets outflow, especially currencies and bonds, has hit real levels of capitulation. Emerging markets debt is still a crowded trade, but the pullback has been significant.
2) Emerging markets currencies are very cheap relative to PPP and recent historical levels. Major pullbacks in BRL, ZAR, MXN, RUB, and SKW all add to the value in the equity markets.
3) Slower growth is here for a couple more years but emerging markets is still growing 5.2% and valuations are finally getting to that place where you say, “Wow, I didn’t think I would see that price again.”
This is not a rush-in moment if the SPY breaks key support, but I’m sure that emerging markets are already at levels of support that give me confidence in making allocations at this point.