By Tim Seymour
As we see global markets getting a fresh dose of new year reality on the back of plunging energy prices ("price is NOT truth" in our view) and "Grexit" conversations, it's nice to see that emerging market equities remain largely range bound despite their massive underperformance to the G3 markets over the last four years. "Nice" means that the MSCI EM (MXEF) index has limited downside in our view even in the face of what certainly will be questions about central bank policy, global demand, and the volatility that comes with capital flow shifts. Nice does not mean a race to fresh highs on the index which is 15% higher from here.
Going back 10 years in the MSCI EM has not been able to continue the ascent or even a slow move higher from the blow off top of Q3 '07. In fact, EM equities have ignored QE and lower global inflation and all the things that often were catalysts to seeing massive fund flows in and therefore extreme performance in absolute terms. Emerging market equities have also shown that there is a bottom to where sentiment and fundamentals can take the index, and where there will be buyers of weakness or where there have been numerous moments of capitulation.
That level on the index looks close. When EM spiked to 910 on December 16th with the SPX and global markets questioning the rout in commodities and risk assets, it was more or less reaching the lows set on February 5th 2014 (see Russia invasion of Crimea, Taper Tantrum, and global growth cratering), which was also around the same level we hit in August 2013 (growth and fed), May/June '13 (seasonal), May/June 2012 (Euro collapse), and even Fall 2011 (with an overshoot to 840 on MSCI) when the U.S. downgrade and EU contagion fears caused a global panic that was as bad as we saw in the fall of 2008.
If you think we are headed into a test of the eurozone or that the Fed will miscalculate their exit in a catastrophic way, then the lows of 2008 (MSCI at 454 on October 27th, 2008) can be your baseline. In the absence of that, we have a defined range for EM players to trade against in the MSCI EM Index. 875 is the level on the index to grab some risk and play for an oversold rally.
Trading from 975 to 1075 on the MSCI requires some real conviction about global growth (EU especially) and where China is successfully engineering enough of a recovery that commodity prices can at least bottom. A breakout past 1100 on the MSCI is something proven to be so elusive we have to assume we must see CBs ignore inflation and asset bubbles in the face of EU growth that hits 2.5% and U.S. growth that hits 3.5% - and do nothing to take their collective feet off the liquidity gas pedal.
Emerging markets can trade lower in the weeks ahead and may even mimic the trade from 2014 Jan/Feb where we bottom around 900(-4% from here), but at that point you have to ask what hasn't been priced in and you can own the asset class. In between the lines, we still believe stock picking will deliver your best results and emerging markets will continue to present pockets of growth and companies well positioned to be resilient in the global economy.