Amid rout, EM supporters struggle to be heard

Emerging market gurus such as Jerome Booth and Mark Mobius keep the faith, but most investors aren’t following them. So which is right?
Amid rout, EM supporters struggle to be heard

In ancient Greek mythology, Cassandra is gifted with prophecy but cursed because no one believes her. When she warns of the coming destruction of her city, Troy, people think she is insane.

These days, with portfolio managers fleeing emerging markets for the perceived safety of US Treasuries and other developed-market assets, proponents of emerging markets, particularly China, have taken on Cassandra-like qualities.

“People are terrified to defy the consensus that the US, the UK and Europe have recovered from the 2008 financial crisis,” said Jerome Booth, a co-founder of emerging market specialist Ashmore and now an independent adviser and investor.

“Valuations in US stocks, bonds and the dollar beggar belief,” he said. “But the idea that emerging markets must be riskier than the US or other developed markets – the rhetoric around that – causes us to ignore obvious truths. I’m not talking about mere market volatility, but large, permanent risk. Most true risk lies within developed markets, not within China or emerging markets.”

January saw the seventh consecutive month of portfolio outflows from emerging market funds, particularly among equity funds, according to the Institute of International Finance. It calculates that emerging markets faced a net capital outflow of $735 billion in 2015; it estimates a further $448 billion may exit this year.

The majority of that money has left China, mostly in the form of capital flight as Chinese companies reduced dollar exposure, as global investors have relatively little direct exposure.

Since Chinese authorities intervened in the A-share market in the summer of 2015 and changed the rules for the renminbi, leading many investors to perceive Beijing as engineering a currency devaluation, many investors have lost faith in Chinese authorities’ management of markets and the economy.

But for emerging market believers, the risk-off trade back to US Treasuries and other developed-market assets is even more dangerous.

“Political risks are increasing in Europe,” Booth told AsianInvestor. “The US has done next to no structural reform and faces the same conditions as 2008: a high level of debt, high unemployment and a banking system that isn’t properly regulated nor observable by its managers. Instead of intervening in banks, the Federal Reserve engaged in quantitative easing.”

He added: “China is the only country doing serious structural reform,” and described the People’s Bank of China’s shifting the renminbi from a dollar peg to a basket of currencies as progressive. It allows China to distance itself from a dangerously overvalued greenback and to prepare the renminbi to serve as a viable alternative.

Jim Rogers, the Singapore-based China bull, wrote on his blog on January 22 that he was long China and long US Treasuries, but short US equities and junk bonds. He predicted bankruptcies in China would scare investors, but: “China does have debt now, but nothing like America, Britain or Portugal." On January 27, he wrote: “It is going to be worse than 2008, you are going to see bankruptcies…” including in China.

Among traditional fund managers, emerging market specialists remain committed (what choice do they have?), but the old magic may not be working.

Mark Mobius, chairman of Templeton Emerging Markets Group, wrote on his blog on January 7: “[China’s] direction seems clear to us – toward a more open economy, a more market-oriented economy that adjusts to international movements of capital with the RMB not only a reserve currency, but a major international trading currency.”

He cited China’s ability to grow its economy this year by 6% as significant given its overall size. “The fundamentals in China are still excellent,” he said. Mobius’s colleague at Franklin Templeton, CIO Michael Hasenstab, has also said now is the time to buy China and other undervalued emerging markets.

But Franklin Templeton’s ability to deploy more capital to emerging markets at this point may be hampered by massive outflows. In 2015 it was the second-worst selling investment company, according to Morningstar, which reported investors pulled out $42 billion from the firm’s funds, particularly its emerging market offerings.

The Greek myths about Cassandra vary, but she always meets a tragic fate: mockery, abduction, rape, murder.

When the people are set against you, it’s painful, even if – especially if – you’re right.

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