This is the 2nd part of our short series on EM crisis investing; we highlight the key signposts to buy EM. The below is an excerpt from our March 30th report to VP clients.
The best signposts that mark equity market bottoms in EM crises: central bank capitulation (i.e. rate cuts), bottoming FX reserves, rising excess liquidity.
Central banks typically sell down FX reserves and hike interest rates in response to a sudden liquidity contraction that puts pressure on the currency. Markets very rarely view these policies as credible.
Once a central bank gives up its futile defense of a plunging currency it regains the freedom to lower interest rates and stops hemorrhaging FX reserves.
This then shows up in a real M1 growth upturn, restoring market confidence in the government and attracting foreign capital back into the domestic economy.
The final equity low usually sees huge volatility. E.g. KOSPI had a +70% relief rally after the 1997 devaluation, only to reverse and make a new low 6 months later (bottom right chart).
Our liquidity and growth tools set the cyclical backdrop for EM equities (6-12 month horizon):
VP global excess liquidity has not turned up meaningfully yet. EM equities are more sensitive to global liquidity vs DM equities.
VP’s China LEI does not yet confirm big hard data improvement. Our China LEI gives the best lead on EM earnings growth.
EM has front-loaded rate hikes and is in a better position to cut rates with inflation LEIs rolling over faster vs DM (top-right chart). History suggests EMs do not need to wait for the Fed to pivot.
Before cyclical leading indicators turn up, we like select EM debt overweights to hold through a global recession scare (e.g. Brazil, India).
In the next part we highlight long-term winners to buy as EM/Frontier crisis peak and dissipate in the coming quarters.
Get the full picture at variantperception.com