In terms of US dollars, Turkey and Argentina underperformed mature market equities by 53 percent and 51 percent respectively. Photo: AP

JOHANNESBURG – After the initial shocks to the financial system caused by Brexit, which saw global economic indicators such as manufacturing purchasing managers’ indices pointing to a contraction in the manufacturing sector, emerging market equities kicked dust in the eyes of developed market equities. 

Emerging market equities as measured by the MSCI Emerging Market Index outperformed developed market equities as measured by the MSCI World Index by almost 19 percent in terms of US dollars from January 2016 to March this year. 

Since US President Donald Trump started to invoke his emergency authorities by imposing higher import duties and tariff increases and withdrew from important treaties, emerging markets gave away virtually all the gains against mature equity markets since January 2016, underperforming by more than 15 percent since March. 

Emerging markets with weak fundamentals fared even worse. 

In terms of US dollars, Turkey and Argentina underperformed mature market equities by 53 percent and 51 percent respectively, while Brazil and South Africa have underperformed by 30 percent and 23 percent, respectively.

The main cause of the poor performance by emerging market assets can be attributed to global investors fading risk as they are positioning for the next stage in the macro-economic cycle where growth slows and stalls.

The threat of an all-out trade war and the imposition of sanctions on Iran are already slowing down global economic growth momentum.

Although Washington is likely to continue to pursue protectionism measures if Trump stays on, economic realities are likely to strike home. 

Protectionism is not only designed to create jobs but also to reduce the impact of a global economic slowdown on domestic labour. Yes, to protect jobs. 

Should protectionism remain in place in the US, a slowdown in global economic growth elsewhere in the world will be exacerbated and developing countries will suffer the most. 

Tariffs and sanctions

If Trump goes soft on tariffs and sanctions, or he is removed from office through impeachment, or the Republicans lose the midterm elections, it will lend tremendous support to emerging market assets in the short-term. 

Emerging market equities, as measured by the iShares MSCI Emerging Markets ETF fund, are currently trading at a price-to-dividend ratio of 43, translating to a discount of about 10 percent to the 48 times dividend of developed market equities as measured by the iShares MSCI World ETF fund, and compares to 53 times for the S&P 500 Composite Index. 

In comparison, the JSE All Share and JSE Financial & Industrial indexes are trading at 32 and 35 times dividends, or at discounts of 25 percent and 19 percent to the emerging market universe, respectively.

As investors you know, or should know by now through experience, that relative profit growth drives relative price performance and dividend growth is dependent on profit growth. Emerging markets were the star performers in the global equity universe over the seven-year period from 2004 to 2011. 

Dividend growth of the iShares MSCI Emerging Markets ETF fund outpaced the iShares MSCI World ETF fund by more than 12 percent a year in terms of US dollars, while the fund's net asset value outperformed by more than 8 percent a year. 

Over the next six-and-a-half years to September 2018, emerging markets were the laggards.  

Dividend growth of the iShares MSCI Emerging Markets ETF fund underperformed the iShares MSCI World ETF fund by more than 6 percent a year, while the fund’s net asset value underperformed by more than 11 percent a year in terms of US dollars.

The risk of a further slowdown in global economic growth remains real, though. The US finds itself in a full employment situation. Employment in the US is as high as it was when it peaked in 2000 and is at the highest level since 1969, 49 years ago. 

A shortage of skills is pushing wages higher, while consumers are already growing cold, especially with housing affordability at the lowest level before the market crash in 2008. 

Stagnation in the US economy, specifically, has started to appear on the radar screen.

When US economic growth eventually slows down the markets abroad for their excess manufactured goods will already be in a downward slope. 

Even if Trump is impeached or his party loses the midterm elections in November, a move away from protectionism in the US is going to cost jobs and put company profits under pressure. 

Consumer and business confidence is the cornerstone of US stock market valuations and I agree with Trump – if he goes, the stock market could haemorrhage investors. 

Emerging markets, unfortunately, will not escape such a carnage as the global economic and investment cycles are not in their favour.

In a speech in Cape Town in June 1966, Robert Kennedy said: “Like it or not, we live in interesting times. They are times of danger and uncertainty…" 

Ryk de Klerk is an independent analyst: contact [email protected]

The views expressed here are not necessarily those of Independent Media.

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