Categorize EM before running analysis

There are several ways of classifying emerging markets. JP Morgan Wealth Management has looked at a system of three key factors: economies with a large private sector which focuses on making money in a competitive environment; economies where companies generate high earnings per share; and economies with strong and growing export industries. The likelihood of success should be higher with holding country exposure in these economies. It does not guarantee success, but these are the countries which have a good environment for generating higher returns. There are five countries in this intersection. Four are in Asia and one is our southern neighbor. More focus should be spent on studying the dynamics of these countries. 

The weak link between EM returns and growth

Focusing on macro relationship and how they can be exploited in a model, we have looked at the relationship between growth and equity returns. We have been disappointed by the fact that the link has varied significantly across countries. In places like the US and Japan, equity returns have far exceeded nominal GDP over the last 15 years. In many other countries, GDP growth have exceeded equity returns. These numbers will be impacted by the percentage of companies within a country that have global business, but there is the impression or assumption that there should generally be a positive link between GDP and returns especially in the long run. Simple data does not suggest a link and deeper analysis is necessary. 

China GDP and investor returns - the big disconnect

 

The large macro disconnect in China is between its significant growth earnings, and stock returns. If we just look at China growth since 2010, we will see that the size of the economy increased by a factor over 3x. Earnings have increased, but little has changed in the last ten years. The stock market is almost flat since 2010. This is not the story that investors expected. Of course, the macro link between GDP and stock performance is far from perfect, but if you were given the growth numbers, most investors would have expected strong returns especially given the strong China export numbers. The negative view toward China is closely associated with the poor quality of this macro link.

The big rate breakout in historic context

 

There are short-term, medium, and long-term trends, but these are all usually inside a half a year for most trend-followers; nevertheless, it is good to focus on the very long-term to get a sense of the regimes that dominate the market view. If you look at trends over the last few decades, you will the great upward move of the 70’s and the 40+ year downtrend. The shorter-term cyclical credit trends show rates going up only with the market being hit with crisis which causes a reversal. Each shorter-term peak is at a lower high, but the chart is not the end of the story because we have not included the added two year period to November 2024. Look at the current level of 4.30 is way outside what anyone was thinking given the long trade. The last two years has been the great bond yield breakout and is nothing like we have seen in terms of a reversal of the bond channel. Discussion should always start with the new world bond view.