Emerging market equities can be highly volatile and tend to move in deep cycles. This means there are times when they will pay and times when they don’t. In retrospect, these cycles are easy to identify, but tough to forecast in advance. However, we believe there is increasing evidence that many emerging market countries, governments and companies are now beginning to respond to the challenges facing them, with evident improvements coming through.
Global markets and economies are cyclical – emerging markets are more cyclical still. One way to understand emerging market cyclicality is Morgan Stanley’s CRIC theory (Crisis-Response-Improvement-Complacency, see Figure 1).
The CRIC cycle in action:
Figure 1: The CRIC Cycle in action
The CRIC cylce: Crisis - Response - Improvement - Complacency
The CRIC cycle has historically been more cyclical and a bit wilder in nature among emerging markets, as weaker institutions tend to result in more exaggerated ‘overshoots’ and ‘undershoots’. While this may sound a little bleak for emerging market investors, we are in fact more upbeat on emerging markets than we have been for some time. We believe there are many strong indications that we are in the ‘Response-Improvement’ part of the cycle. Some of the changes we are seeing indicate real efforts to improve the longer-term institutional framework of many key emerging markets, resulting in a more promising investment environment.
We would illustrate our optimism by focusing on a few countries where we believe policymakers are beginning to drive significant positive change: Brazil, China, Hungary, India and South Korea. These five countries together account for almost 60% of the portfolio at the time of writing. However, we are selective, bottom-up investors, which means that we are currently underweight three of the countries where we believe policymakers are beginning to implement positive reforms.
Across these countries we observe that a number of our positions in banks are experiencing recoveries from extended bad debt cycles, or seeing a more risk-aware/returns-focused management. We also have some positions in basic materials stocks, which are beginning to benefit from China’s more proactive stance in closing surplus capacity. In India, we are primarily positioned in stocks which will benefit from rising consumption and incomes in that country, while in eastern Asia we have a number of positions in China’s high-growth internet stocks and an overweight position in Samsung Electronics.
Figure 2: Emerging Markets Equity Strategy
Country relative weights
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