Jun 9, 2017

Missing out on the Emerging Market Rally? Think Twice before jumping on

China is Recovering! Emerging Market Equities Soars!

You may have read similar headlines in the past few weeks and may be tempted to jump onto the Emerging Market bandwagon to reap the returns. Afterall, Emerging Market equities have soared 18% this year and the trend seems to be unstoppable. Popular news channel are optimistic about the China reforms and Asia is where all the growth is after all. 

For those market watcher, you will get a feeling of deja vu.

The reason behind, this trend of Emerging Market out-performance seems to be the recurring pattern for the past few years in what is a possibly region rotation by global money managers.

What is a Region Rotation?
It is the rebalancing of global equities which spans across US, Europe and Emerging Markets whereby money managers sell off the regions that have done well and is rich in valuation and buy into regions which have unperformed within a global portfolio of stocks. The trend in the past few years have been present and we can observe from the relative performance of US equities as compared to the Emerging Markets equities.

What usually happens is that Emerging Markets tend to perform well in the 1st half of the year, only to see its performance disappoint in the later half of the year. Here is an interesting comparison of the half-yearly performance since 2010.

What is even more interesting to note is that the trend is broken during 2013 when the Emerging Market suffers from "Taper Tantrum" when the US Central bank started to roll back on their Quantitative Program. During 2011, 2012 when the EU Debt Crisis is at its peak, investors also actively avoided Emerging Market even though the source of the crisis come from Europe. It seems like whenever there is a crisis, investors pull money out from Emerging Market first, not caring if the crisis does not originate from Emerging Markets nor the high growth prospect of Emerging Market.  

Investors who are observing this trend can come to 2 conclusion:
- Emerging Market tend to underperform after a period of outperformance.
- When there is a high level of global risk. Investors sell Emerging Market and scramble into "safer" US Equities.
- Under these two assumption, investing in US equities seems to have a better long term risk/return ratio for this economic cycle.

So will US Equities out perform Emerging Market as we move into the later half of the year for 2017?

There is no crystal ball we can use, but it seems like the Big Boys are itching to take their bets off the table with such a fat profit sitting in the middle of the table and move back into the US Stock Market. Than again, the US stock market valuation is considered expensive right now and the possibility of a correction is getting higher on a daily basis and when things start to get ugly in US, investors will probably sell off Emerging Market first with no questions asked.

It seems to me that the conventional wisdom of Emerging Market being high risk/ high returns is breaking down in this market cycle. Emerging market seems to have taken on the characteristic of "high risk/low returns" when compared to the US Stock Market in the last 7 years. 

Similar Trends in USD
Similar to the trend we see in the Emerging Market vs US Equities, we can see similar trends in the USD. Typically, USD will weaken against Emerging Market currencies from the start of the year and will strengthen into the end of the year and will probably end at a higher level as compare to 2016 thanks to the relatively faster monetary tightening by the US central bank as compared to the rest of the world. As currency flow is a good indication of global money flow, we can see the pattern of the fund rotation occurring again base on the currency market whereby US equities tend to perform better at the later part of the year, similar to the strength of the USD. 

So if you are considering jumping into the soaring Emerging Market Equities at this moment of time, maybe it will be good to think twice. Perhaps it is a good time to look west, whereby there is both potential capital gains in currency and equities return. 

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