Invesco Canada blog

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Steve Cao | February 10, 2017

Is uncertain U.S. trade policy harming EM economies?

Uncertainty about U.S. trade policy changes that could potentially harm emerging market economies dragged them down about 2.2% during the fourth quarter of 2016, underperforming developed international markets by about 3.5%.1 Yet emerging-market economies generally showed positive signs, with exports beginning to recover, commodity prices rebounding, and inflation remaining benign.

Country snapshots

Here’s a quick look at how individual countries fared:

  • Growth in China was driven mainly by a rebound in property sales and infrastructure spending. It’s encouraging to note that China’s economic rebalancing effort is making progress – services and consumption are experiencing robust growth and now account for more than 50% of the country’s gross domestic product
  • Continuing its reform agenda, India passed a major tax reform
  • Higher oil prices, low inflation and lower interest rates helped Russia’s economy during the fourth quarter
  • Brazil benefited from strong commodity prices and started cutting interest rates. More importantly, the country is making progress on fiscal reform

A closer look at Mexico

The brunt of the trade policy fallout from the U.S. election has fallen on Mexico. While specifics remain unknown, the probability of changes in U.S. trade policy has caused concerns about the Mexican economy, hurt investor confidence, precipitated a sharp devaluation of the peso and otherwise generated lots of volatility. To contain inflation and the impact on currency, the Mexican central bank had to increase interest rates.

EQV look at emerging markets

Analyzing emerging markets using the Invesco International and Global Growth team’s Earnings, Quality and Valuation (EQV) criteria, we see that corporate earnings continued to improve through the fourth quarter. Many emerging market companies have not yet reported fourth-quarter results, but based on results from the first three quarters, it is likely that emerging markets will end the year with an 8% earnings growth for 2016, a nice rebound from earnings decline in the past three years.2

With a consensus growth forecast of 13% for emerging markets in 2017, it appears likely we’ll see another year of good growth.2 The fundamental conditions for an improving outlook – including higher commodity prices, stabilizing growth in China and recovery of growth in the economies of Russia and Brazil – remain in place.

Regarding valuation, on a price-to-book-value basis, emerging market equities are trading at a large discount to their own long-term history and at more than a 30% discount to developed markets.3 In addition, free cash flow yield is the highest since 2000.3 While valuation for emerging markets is generally attractive, many of the high-quality business models we focus on are still not attractive enough, in our view. We do see pockets of opportunity, but emerging markets are not compelling across the board, given our investment discipline.

The year to come may present emerging markets with political challenges, but we don’t make decisions on policy changes. We stick to our discipline of owning businesses that possess the competitive advantages to be able to sustain changes in the dynamics of global trade, and we seek to use volatility to our advantage.

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1 Source: Morningstar Research Inc., as of Dec. 31, 2016. Emerging markets represented by the MSCI Emerging Markets Index. Developed international markets represented by the MSCI EAFE Index.

2 Source: UBS, “EM Equity Strategy,” Jan. 9, 2017

3 Source: Bloomberg L.P., as of Dec. 31, 2016. Emerging markets represented by the MSCI Emerging Markets Index. Developed markets represented by the MSCI EAFE Index.

Price-to-book (P/B) ratio is the market price of a stock divided by the book value per share.

Free cash flow yield is a method of calculating a company’s value by dividing free cash flow by enterprise value.

The MSCI EAFE Index is an unmanaged index considered representative of stocks of Europe, Australasia and the Far East.

The MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.

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