Hitting the Pause Button on Emerging Market Equities

QMA shifts to a more neutral stance on emerging markets due to continued challenges that extend beyond trade.

July 17, 2019

In March, QMA released a publication arguing that a tactical tilt towards emerging market (EM) equities was compelling for three reasons:

  • Progress on a U.S. and China trade deal
  • The Fed’s dovish pivot
  • Continued stimulus from China

Unfortunately, the main risk highlighted in that piece materialized in May when U.S.-China trade talks broke down, blindsiding investors, weighing on global growth, and curtailing trade flows. Those headwinds caused the relative performance of emerging markets to deteriorate anew (see chart below). QMA responded by pulling back to a neutral allocation to emerging market equities at the time by shifting exposure to the United States.


Emerging markets underperform

The chart shows the Citi EM Export Surprise Index level and the Emerging Market/Developing Market (EM/DM) ratio from 6/30/16 to 5/30/19. The last three months for the Index has been negative indicating actual EM export numbers have been falling short of market expectations. The EM/DM ratio has been falling since January 2019.

Source: Bloomberg, Citi as of 5/31/19.


The trade conflict is likely to be a key factor influencing the relative performance of emerging equities. However, there are many country-specific factors likely to drive EM stocks. In India, the ruling National Democratic Alliance secured a solid majority in recent elections, fueling hopes of a continuation of market-friendly policies. In Brazil, the odds of pension reform are rising, bolstering Brazilian stocks. In South Africa, the composition of President Cyril Ramaphosa’s new cabinet increases the odds of economic reforms. On the negative side, Turkey’s relations with the U.S. remain strained, with Turkey determined to take delivery of Russian S-400 missiles and the U.S. planning to exclude Turkey from the F-35 jet program. In Mexico, the policy chaos of the Andres Manuel Lopez Obrador administration and the problems of PEMEX, the state oil company, are likely to weigh on the market.

Because U.S.-China tensions extend beyond trade, they are likely to persist. Hence, a substantive deal will be difficult to achieve near term, prompting us to stay with our neutral position for now. That said, the trade truce emerging from the Group of 20 meeting, combined with global central bank dovishness and attractive valuation, could spark another round of EM outperformance. Given the fluid environment for EM, investors need to be both flexible and nimble.

For more details, read the full QMA Q3 2019 Outlook and Review PDF opens in a new window, which is available for financial professionals.



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