Investors should not consider buying back into emerging markets in the near term until there clear signs of a change in direction, according to Patrick Moonen, senior multi-asset strategist at NN Investors, who adds that there are three signals that should act as an indication to ‘buy’.
The summer months of 2015 were an increasingly painful time to be an investor in emerging markets equity funds with the asset class selling off sharply from mid-April until an apparent capitulation point during August’s Black Monday sell-off.
According to FE Analytics this has meant both the IA Global Emerging Markets sector average and the MSCI Emerging Markets index are down more than 10 per cent since the start of the year, despite some recovery in recent months.
Performance of sector and index in 2015
Source: FE Analytics
The 30 per cent drawdown in the above period along with several other crises over the past two years has pushed emerging market funds into one of the most out of favour periods among investors in the past decade.
Since Black Monday there has been some improvement with all funds making a positive return and more than one in five in are double digit territory.
Performance of sector and index since Black Monday
Source: FE Analytics
Moonen, says the multi-asset team at NN have made some increase in their allocation to emerging markets stocks since Black Monday but are still staying away from full overweight position due to concerns this ‘relief rally’ may not last.
“We have been underweight emerging markets for quite a while and we have moved to neutral since September. Now we are neutral we still have to watch out things could still go wrong. In particular I am worried about China where the authorities are really struggling to stabilise the economy. There are mixed signals but things could actually still surprise us negatively.”
“We have seen some improvements from what happened in markets recently with growth deteriorating less rapidly. I would be very cautious to go overweight emerging markets at the moment, it is too early. It might be more cautious to move towards emerging market debt.”
However he says there are some signs to watch out for to capture a plausible change in fortunes for emerging markets funds in the next 12 months or so. Firstly, he says there will have to be a signal that investor sentiment was changing.
There have been strong outflows from emerging markets funds for most of the year which for the peer group’s giants such as Aberdeen has meant a reduction in billions of pounds of assets under management, with the company suggesting it may announce job losses in the coming month.
Source: FE Analytics
Moonen said: “If you look at investor positioning, fund flows and sentiment they are all quite negative for emerging markets so there is some turn around potential building up from the past couple of months.”
In the IA Global sector, where funds have a ‘go anywhere’ potential just 10 per cent of portfolios have more than 5 per cent in emerging market names, suggesting these managers are – on average – favouring developed markets.
Luca Paolini, chief strategist at Pictet Asset Management believes sentiment is already turning in favour of emerging market funds.
“Sentiment towards emerging markets seems to be turning as tentative signs of stabilisation in economic activity have emerged in Asia while liquidity conditions have improved following easing measures by the Chinese central bank.
“The discount at which emerging market stocks trade to their developed counterparts seems excessive and we are already seeing investors rebuild their holdings in the asset class.
“However, he says he would need to see further evidence of an economic stabilisation in China also to move to a full overweight position.
Secondly Moonen says the market would need to see an end to the slowing growth of the largest emerging market countries, namely China.
“Growth momentum [would have to be] no-longer deteriorating so quickly and stabilising. If we see that trend continuing that would be one big factor in favour of emerging markets.”
China is officially growing at 6.9 per cent, a small climb down from the 7 per cent forecasted by its government at the beginning of 2015, notwithstanding the ramped scepticism of how reliable these figures actually are.
The government has said they still expect growth over 7 per cent but many in the market place have started to doubt how accurate this is.
Last week provided additional suggestions the slowdown in China is becoming more noticeable, Russ Koesterich (pictured), BlackRock’s global chief investment strategist notes.
“Exports are now down 3.6 per cent from a year earlier while both inflation and industrial production are decelerating,” he said.
Lastly, Moonen says he would need to see ‘a big policy announcement’ in China to stabilise growth that is also taken seriously by the market to become more positive on emerging markets.
He adds that it could on monetary or fiscal policy or a broad portfolio of reforms but that recent attempts to stem bearish actions by investors such as cutting interest rates by the Chinese central bank has done little for sentiment.