A turnaround in emerging markets

Emerging markets experienced many challenges in 2018, including fears around trade wars, political instability, and higher interest rates in the U.S. and other developed markets contributing to less global liquidity.

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As a result, emerging markets saw falling equity prices and widening valuation spreads last year, said Allison Fisch, principal and portfolio manager at Pzena Investment Management in New York.

MSCI’s index of emerging market shares was down almost 15% for 2018. However, the challenges are easing, Fisch said in a Feb. 15 interview. In January, the index rebounded 8.76%.

She attributes the turnaround to positive macro developments, including the Federal Reserve signaling a pause in rate hikes and trade talks “taking on a slightly more positive tone.”

“People [are also] thinking that equities have gotten too cheap,” she said, leading to flows returning into emerging market equities.

Fisch warns against trying to time the market, though.

“Short-term stock price moves are not something that we’re able to predict,” she said. “But they can be opportunities. When you have moments where markets are selling off and valuation spreads are widening, that gives us the chance to buy really great companies for very cheap prices.”

Also, there is no single set of risks to watch for, she said. Instead, her team evaluates risks from industry to industry and region to region. For instance, they analyze the downside scenario of a specific company based on various geographic and macro factors.

“We’re watching this data come in as the situation develops to monitor whether [a] company is on the path that we would like for it to be on,” she said, adding that this includes normalization of earnings and stock price improvements.

In Brazil, for example, her team recently added utility exposure within the portfolio with power company Cemig. Their analysis shows that utility business earnings “are going to improve because the regulatory regime has moved more positive.”

She added, “There are a number of self-help levers the company can pull, and there are even hopes of privatization, which would improve earnings further. If any of these situations doesn’t happen, or the regulatory environment moves in reverse, then that is a risk to our thesis.”

Another example is Taiwan’s tech space, where Fisch said her team has added a number of mid-cap companies with exposure to Apple.

“These companies became cheap because of fear around Apple volumes, which harms the earnings of a supplier business,” she said. “But we believe that the earnings were unfairly penalized as a result of the short-term volume pain.”

However, she noted that if there was a big change beyond her team’s volume expectations, or the companies lost their competitive foothold in the market, it could be a risk to earnings.

Overall, if you take a long-term approach, said Fisch, then the underlying earnings of emerging-market companies has been improving since coming off the bottom in 2016. “In fact, return on equity for the index overall is at about average or slightly above average levels.”

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