Emerging markets: Cheap, but not cheap enough yet

LONDON (Reuters) - After taking a beating from a strong dollar this year, emerging markets are looking pretty cheap, and at some point in 2019 the sector will be back in favor, top money managers told Reuters this week.

Byron Wien, Vice Chairman of Private Wealth Solutions group, speaks during the Reuters Global Investment 2019 Outlook Summit, in New York, U.S., November 13, 2018. REUTERS/Brendan McDermid

The greenback’s rally that began in February and accelerated in April has smashed through emerging currencies like a wrecking ball this year, triggering crises in Argentina and Turkey and sending foreign investors rushing for the exits.

The pressure piled on as China’s yuan depreciated, inflicting more weakness on Asia. Many economies such as India or Indonesia also suffered as global oil prices soared.

Fund managers who spoke this week at the Reuters Global Investment Outlook Summit in London and New York said the asset class was attractively priced.

But maybe not cheap enough just yet.

"Emerging markets are really undervalued. They're very attractive," said Byron Wien, vice chairman of the Private Wealth Solutions Group at Blackstone Group BX.N - one of the world's most influential asset managers.

“I would do some buying there - but it’s like catching a falling knife,” he added.

The reason is the dollar, which has risen more than 5 percent .DXY this year against a basket of other currencies. As a result, returns on emerging market local and hard currency debt .JPMEGR.JGEGDCM as well as equities .MSCIEF are all deep in the red.

GRAPHIC: EM Indexes in 2018 -

The greenback’s ascent has been especially bruising for economies that rely heavily on external flows to plug their current account deficits.

Capital flows have reflected investors’ concerns. Research from the Institute of International Finance showed developing economies suffered net capital outflows of $44 billion in September - the biggest such monthly loss since 2016.

The question is will the dollar’s fortunes change? With U.S. growth showing signs of slowing, many investors reckon the market could be turning. And Fed chairman Jerome Powell this week hinted that the boost the economy received from various policies could soon begin to wane.

As a result the Fed’s hiking cycle could well pause in 2019.

“When the dollar finally weakens because the Fed would throw in the towel, then – and we better not miss that moment when it comes – that would be the time to move into emerging markets,” Didier Saint-Georges, who helps manage over 50 billion euros as Carmignac’s managing director, told the summit in London.

“But it’s not for now,” he added.

There are other issues too, at the moment. One is the need for more clarity on world economic growth to which emerging markets are particularly attuned, Saint-Georges noted.

Second is valuations. Measured against their major trade partners, many emerging currencies are trading cheap relative to their history. MSCI’s emerging equity index too trades around 10 times forward earnings, versus more than 14 times for its global counterpart.

But Pascal Blanque, who oversees 1.5 trillion euros at Europe’s biggest fund manager Amundi, said these levels may not suffice for “a strong positive call”.

“EM is not yet cheap enough to adopt a positive stance, though we should see this moving forward. It’s too soon, you need to see more dislocations,” Blanque said.

And when recovery does kick in, it won’t be broad-based but will depend on individual reform stories. A number of fund managers, such as Penny Foley at TCW Group Inc, have their eyes on Brazil after right-wing Jair Bolsonaro won the presidential election in October.

Valentijn van Nieuwenhuijzen, CIO at NN Investment Partners which has 240 billion euros under management, is closely following central and eastern Europe.

“Poland is one of our preferred stories for next year because we do think their political winds will become a bit more supportive of reform.”

What could wreck the party? In a word: China.

Most summit guests expect the yuan to slip below the key seven per dollar threshold. How far it goes below that will be crucial for emerging markets’ fortunes.

For more summit stories: here

Follow Reuters Summits on Twitter @Reuters_Summits

Reporting by Karin Strohecker in London; Additional reporting by Svea Herbst-Bayliss and Trevor Hunnicutt in New York, Sujata Rao and Marc Jones in London; Editing by Hugh Lawson