A polarised performance from different areas of emerging markets, an increase in the use of trackers and a temporary boost in investor sentiment caused a short-lived emerging market rally that is unsustainable over the immediate term, according to Daniel Tubbs (pictured). 
The head of global emerging market equities at Mirabaud, who co-runs the Mirabaud Equities Global Emerging Markets and Mirabaud Equities Asia ex Japan funds, says that the factors that caused the MSCI Emerging Markets index to rocket between February and May were shaky, and argues that this performance spike shows the potential end of the bear market rather than the start of a bull run.
After five years of perpetual underperformance, emerging markets appeared to fall back into fashion earlier this year after a swift recovery from February’s sell-off. While the market has since pulled back somewhat, it has still outperformed the likes of the FTSE 100, the MSCI Europe ex UK and the MSCI AC Asia Pacific indices since the start of the year.
Performance of indices in 2016
Source: FE Analytics
Tubbs, who is currently bullish on emerging markets over the longer term, says that the market area’s roaring success compared to the last few years simply isn’t sustainable at the moment.
“Countries within emerging markets have either done exceptionally well or really badly – this year, Latin America is the region that has performed the best and Brazil within that has performed extremely well. This is very unusual because over the past few years it’s been Asia that has outperformed,” he said.
“You’ve had some countries going up 30 to 40 per cent and you’ve had other countries going down 10 per cent, so the strong performance of emerging markets has been in a few countries, it hasn’t been across the board.”
“Ideally what I’d like to have seen is a true turnaround in emerging markets, you can’t just have one or two countries do well, you really need the majority to be doing well, so we’re still very early on in the turnaround stages of emerging markets.”
Not only is the manager concerned that just a couple of countries have driven emerging markets’ outperformance, he adds that Brazil’s economy is still weak despite the fact that the temporary promotion of Brazilian vice president Michel Temer to president has boosted investors’ sentiment towards the region.
Despite the fact that his portfolio has been hit year-to-date by trimming exposure to the region “too early”, Tubbs is continuing to reduce his exposure to the region and it is now one of the biggest regional underweights in the portfolio.
“A lot of the performance of emerging markets year-to-date has been flow-driven and sentiment-driven – Brazil is a classic example where the market shot up – not because the economy is improving and not because the politics were clean, far from it,” he continued.
“The economy is in dire straits and politics are incredibly murky there. Nevertheless, improvement in sentiment led to that market rallying significantly, so we didn’t do as well as we could have done in Brazil, but we’re long-term investors and we’re looking for good quality fundamentals and attractive valuations.”
Another reason the manager gives for the sudden rally in emerging markets is the increasing popularity of trackers and ETFs, which he says has been increasing year-on-year and enticing investors away from active management.
“If you buy an ETF in emerging markets, you’re basically buying the biggest countries and the biggest companies, whether they’re good quality or not,” he added.
“If an investor is putting money into an ETF, the manager has to buy into the market immediately, there’s no discretion in terms of choosing a good time to buy the stock so it tends to exacerbate stock price movements.”
Over the last month, however, the MSCI Emerging Markets index has taken a tumble and is now more or less on an even keel since the start of 2016.
Performance of indices over 1month
Source: FE Analytics
While some investors could argue that this is a blip and that emerging markets could continue their outperformance, Tubbs argues that this drop is the reversal of “irrational exuberance”.
“Oil prices have continued to edge up but you did see a huge run up in other commodities such as iron ore and those have recently started to reverse,” he pointed out.
“The reason that commodity prices like iron ore rallied so strongly then pulled back is because of pure speculation, because again if you think about end demand for steel and iron ore, the end demand for steel is strong and it hasn’t suddenly improved, the only change has been two things.”
“It has been companies building up inventories again in terms of iron ore, but more importantly it’s been driven by speculators and largely Chinese speculators.”
“The Chinese like to speculate across different asset classes, whether it’s property or A shares or commodities, and certainly what we’ve seen recently is that the Chinese government is increasingly concerned that speculators have been targeted commodity prices, so the government has raised costs of speculating commodity prices and, the moment they did that, it led to the reversal we’ve seen in iron ore prices.”
Tubbs says that the speculation of commodity prices is reflective of a broader change in investor behaviour, which again reared its head through the sudden surge in emerging markets this year.
Throughout his career in asset management, he says that markets have become increasingly sentiment-driven and has begun to outweigh economic and market fundamentals.
However, the manager says that fundamentals ultimately end up prevailing and says that it is important for investors to remain true to their investment processes without being swayed by sudden market movements.
“One of the reasons why sentiment has been so strong this year is more to do with developed markets as opposed to emerging markets, namely in that you’ve had a bull market in US equities and US equities are by far still the biggest driver of global stock markets,” he continued.
“You’ve had a massive bull market in US equities over the last seven or eight years and it’s reached the stage where US stocks are looking expensive - you’ve had the Q1 earnings season which nobody can say was positive.”
“People are nervous about the US stock market performance and in my mind quite rightly so, so that has led to a lot of questioning as to where to put your money and people are a little reticent about Europe because of Brexit and anaemic growth, that is why people have started to dip their toe in the water when it comes to emerging markets.”
That said, Tubbs is bullish on emerging markets over the long term, even if he believes that the recent strong performance in the market area is likely to have signalled the end of the bear market rather than the start of a bull run.
Areas that he believes are yielding particularly attractive opportunities are China, Taiwan and Indonesia – conversely, the areas of the market that have been dragging on the MSCI Emerging Markets’ performance over recent months.
“We believe that the strength we’ve seen year-to-date has the potential to be the turning point and we are sticking to our investment style, which is looking for good quality companies growing at a reasonable growth rate,” the manager said.
“We still need the strength of emerging markets to broaden out though, it can’t just be from one or two markets. We’re still in the early stages of a turnaround, which is a good thing. Everyone is underweight emerging markets as well so, when the tide does turn, it can really drive emerging markets up quite dramatically.”
Over Tubbs’ four-year tenure, the Mirabaud Equities Global Emerging Markets has performed largely in-line with its sector average and index.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
