by Charlie Bilello | February 12, 2014 2:03 pm
“What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.” – Warren Buffett, October 2008
Emerging markets are in a crisis, or at least that’s what we’ve been told. By now you’ve heard the litany of causes, including slower growth, higher inflation, currency depreciation and political turmoil. This is all very concerning, but as we saw with the U.S. markets back in 2008, by the time the crisis becomes front-page news, it is often priced in.
That is likely the case today within most Emerging Market (GMM) countries. Take China, for example. While the S&P 500 (SPY) is sitting within a few percent of all-time highs, the Shanghai Composite (CAF) is down 40% from its peak in 2009 and 65% from its peak in 2007 (see chart below).
Given this long period of negative performance, it is not surprising that the narrative surrounding China (FXI) is decidedly bearish. But that is precisely the backdrop necessary to spark a sharp rally, as any incremental good news will come as a positive surprise to market participants.
Recent EPFR Global data illustrates just how hated Emerging Market equities are today. On a year-to-date basis, outflows from Emerging Market equity funds have already exceeded outflows for all of 2013. If history is any guide, this mass exodus from Emerging Market equity funds is likely a contrarian signal of a short-term bottom in these markets.
Another positive signal is the strength in Emerging Market credit (EMB). As credit typically leads equities, this is important to watch. It is also notable as much of the bearish Emerging Market thesis rests on the belief that tapering of quantitative easing would be disastrous for Emerging Market credit. The exact opposite has occurred thus far, with Emerging Market credit higher on the year and starting to show significant improvement relative to U.S. treasuries (see chart below).
Overall, this should be positive for Emerging Market equities going forward, but don’t expect a change in sentiment to occur overnight. The majority of investors, who have a propensity to buy high and sell low (recency bias), will remain bearish on Emerging Market stocks until the news backdrop improves. They will require a “catalyst” or reason justifying a move higher before coming back in.
However, the markets have a strong tendency to lead the news and by the time there is a clear catalyst, Emerging Market stocks will likely have advanced 30-40%.
For as Buffett said in 2008, “if you wait for the Robins, spring will be over.”
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
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