Page 15 - ISQ UK_October 2021

OCTOBER 2021

WHAT TO KEEP AN EYE ON IN CONCLUSION

CHINA We continue to believe that emerging markets will remain a
While China emerged quickly from the pandemic, lingering virus powerful driver of global growth and the recent narrowing in
outbreaks and ongoing supply chain issues have taken a toll on its its growth premium should be short-lived. The longer-term
domestic economy. The slowdown is coming at a time when Bei- benefits of investing in economies with superior growth pros-
jing’s broadening regulatory crackdowns have also undermined pects and supportive demographic and consumer trends
investor confidence in the market, leading to underperformance should lift valuations relative to its developed market peers.
of Chinese equities over the last six months. It has also weighed on While the coming months may bring some additional turbu-
the performance of emerging market equities given China’s heavy lence, emerging market equities remain cheap. As always, it
weight in the index. While it is impossible to know how long Chi- pays to be selective when investing in emerging markets as
na’s regulatory reforms will continue to weigh on Chinese stock the asset class is not a homogeneous group.
prices, the weakness does not seem to be spilling over into the
wider emerging market universe. One of our favoured indicators
for flagging risk aversion in emerging markets is the JP Morgan KEY TAKEAWAYS:
Emerging Market Bond Index spread, which has been remarkably • Global growth continues to shift away from advanced
stable through China’s recent rout. nations toward emerging markets.
• Emerging market equities are nearing their cheapest
FED TAPERING levels in over 20 years.
Emerging markets are extremely vulnerable to changes in Federal
Reserve (Fed) policy. History has shown that Fed tightening, or • The rising middle class should support increasing
even the expectation of future rate increases, can often trigger consumption and underpin growth trends for years
instability and capital flight away from emerging markets. With to come.
the Fed inching toward tapering its asset purchases, emerging
markets have been bracing for what could come next. The last
time the Fed signalled tapering was on the horizon in 2013,
10-year Treasury yields climbed nearly 1.25% over a four-month
period, which caused a 10% decline in emerging market equities.
We do not expect a repeat of the 2013 episode, as the Fed has
been carefully preparing the markets so there will not be any
surprises that would lead to an unwanted tightening in financial
conditions.

US DOLLAR
There is a strong inverse relationship between the performance
of emerging market equities and the US dollar. This means that
when the dollar is appreciating relative to foreign currencies,
emerging market equities tend to underperform the S&P 500
Index, and vice versa. Emerging markets have remained weak
as the Fed’s Broad Trade Weighted Index has been in a structural
uptrend since late 2011. While our longer-term view suggests the
dollar is overvalued and should weaken relative to its foreign
trading partners, pandemic-related uncertainties and the dollar’s
role as a safe-haven currency have kept its value elevated on a
relative basis.

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