For many years, emerging markets were a must-have in every investors’ portfolio. The idea was that a large swath of the world was on an inevitable path towards economic parity with the west, and that there was a great deal of money to be made by investing in that growth. For several years, that view held. However, changes over the last decade mean that such a thesis is increasingly in doubt as many of the factors that drove EMs have fallen away. In the words of the Financial Times, “high commodity prices are a fading memory. Trade is stuttering and global supply chains are being disrupted. Far from catching up with the developed world, many supposedly emerging markets are growing more slowly”.
FINSUM: It is not just economic either. Governments have not cleaned up as fast as many had hoped, which means the law and governance aspect of EMs has hardly improved.
There have been a lot of stories, admittedly in this publication too, that have diminished the threat of the current trade war with China for the US economy. In a very direct sense, that may be true, but there is a lot of misunderstanding about the Chinese economy. Most people think that China is currently slowing because of the trade war with the US, but that is not really the case. The much bigger issue is that the country’s credit boom has run its course and the government is running out of options to boost growth. The credit boom was caused by the government needing to stimulate consumer spending in an effort to spur a domestic consumption economy, but credit has more or less reached it limits, and therefore, so has the economy.
FINSUM: If China has a big contraction/meltdown, it will ripple across all the countries who are part of its ecosystem, including all the EMs in the region, Africa, and then ultimately the big developed economies with which it is now inextricably linked.
How does a big global housing meltdown sound? Crappy. Well, that is exactly one of the things that the IMF is currently warning investors about. Americans will already be well aware of the several month downturn in real estate, but what is likely much less well understood is that many markets around the world, including emerging markets, look at risk of a major housing bust. One of the big worries of the IMF is that a real estate downturn will spark a banking crisis in overseas markets that could then bubble over to the rest of the world.
FINSUM: We don’t tend to think of real estate as a particularly globally-correlated asset class. However, the banking industry that underpins it certainly is, so the risk is definitely there.
American investors generally don’t pay enough attention to merging markets. We have such a big economy and markets that investing abroad often feels foreign and unnecessary. However, the diversification benefits of doing so can be huge, and right now may be an excellent time, says Morgan Stanley. The bank’s lead emerging markets strategist, Ruchir Sharma, is changing tune. For the last decade he said US shares, and particularly tech, would outperform. Now the pendulum is swinging back, with EM likely to take the lead.
FINSUM: EMs have obviously been beat up over the last decade, so there is certainly value to be had. The big worry for us is about global trade policy and how that constrains EM growth.
The Daily FINSUMMARY- Sponsored by ETF Action
US markets hit five-month highs as major averages climbed steadily up and to the right throughout the day. A day after the Fed announced a very dovish position, tech shares (Apple) and positive earnings led domestic equities higher. At the close, the S&P 500 (SPY 1.13%), the Dow (DIA 0.89%), and the Nasdaq 100 (QQQ 1.56%) all gained.
Jobless claims were down W/W (and below consensus estimates) and the Philadelphia manufacturing survey had mixed results. Current conditions rebounded from last month, buoyed by increases in new orders and shipments. However, future expectations fell to a three-year low. Meanwhile, the Conference Board Leading Indicators Index rose for the first time in five months, primarily due to a bounce in equity markets and accommodative financial conditions.
Earnings & Movers: Micron Technology (MU 9.62%) was up big after beating estimates after yesterday's close while Apple surged (AAPL 3.68%) and hit a four month high on several analyst upgrades. Darden (DRI 6.87%) was up on an earnings beat before the bell and Nike fell after hours on a revenue miss. It was a bad day for Biogen (BIIB -29.23%) after its Alzheimer's drug was discontinued due to ineffectiveness.
Small-caps (IJR 1.31%) edged out large-caps (IVV 1.12%) but mid-caps (IJH 1.35%) led all sizes (and still do YTD). With 10 of 11 sectors gaining, tech (XLK 2.51%) provided leadership on the shoulders of Apple while Financials (XLF -0.31%) lagged again, pushed down by banks (KBE -1.03%).
Emerging markets (EEM 0.14%) narrowly outperformed developed ex-U.S. (EFA -0.06%) as global regions were mixed. Latin America (ILF -1.70%) was dragged lower by clouding uncertainty surrounding Brazil's (EWZ -2.30%) pension reform after former Brazilian President Temer was arrested on corruption charges. The U.K. (EWU -0.18%) fell along with Developed Europe (IEV -0.27%) as EU officials deliberate over possible extension deadlines for Brexit.
Treasury yields remained largely unchanged with the 10-year settling at 2.54%. Muted movement in yields had the Ag (AGG 0.02%) mostly flat while Investment Grade (LQD 0.19%) bested High Yield (HYG -0.02%). While the 10-2 year spread remains at ~13 basis points, the spread between the 10-year and the 3-month T-bill dipped below 10 basis points for the first time since 2007.