Why the Fed-induced rally in Asian emerging markets is petering out
Investors’ appetite for Asian emerging markets’ stocks, bonds and currencies is spent, and for reasons that go beyond the overriding question of when and how the US Federal Reserve will reverse its loose monetary policies.
Dissatisfied with the economic recovery in the region, disappointed with corporate earnings and worried that currencies have little room to rally further, investors seem to be abandoning the rally that was sparked in mid-September by the Fed’s decision not to start tapering its stimulus.
“We need to see much stronger export growth in emerging markets,” wrote UBS strategist Bhanu Baweja.
Baweja said that was a precondition to achieving better earnings growth as well as improvements in regional current account balances.
That leaves most Asian markets well below their highs for the year, struck in May. Indonesia’s rupiah is 14 per cent weaker than its May high, while the Philippine stock market is about 12 per cent below the May peak.
Markets surged after September 18, when the Fed held back from cutting its massive asset purchase programme, but investors know it’s only a matter of time, and data, before five years of easy US monetary policy is wound back.
Fed funds futures have adjusted to price in a delayed and slower pace of policy tightening, but the tightening is coming and bond prices would have to factor that in, said Sameer Goel, head of rates and currency research at Deutsche Bank.
That would warrant some risk premium being built into financial assets, but the risk premium now priced into Asian markets speaks of other concerns.
“Sustained emerging market currency gains require some form of fundamental grounding; hopes related to future global liquidity will not be – and have not been – enough,” analysts at Morgan Stanley wrote in a note to clients.
The fundamental underpinnings for a sustained rally in Asian markets have been sparse.
Leading indicators, the main ones being purchasing managers indices for each country, rose into expansionary territory in the third quarter.
But export growth has been disappointing in a region where trade drives much of the economic output and where a lot of optimistic earnings estimates are pinned on a US recovery boosting demand for the region’s tech products and cars.
That has set equity investors up for disappointment. Earnings estimates have stayed flat in most countries and sectors, barring sectors such as technology and financials and countries such as India.
But expectations have run ahead, resulting in a 14 per cent rise in the average price-earnings ratio for Asia excluding Japan since June.
The average P/E ratio based on the next 12 months’ earnings is 12.1, while consensus forecasts are for this year’s earnings to be up 8.2 per cent, according to Thomson Reuters IBES.
Investors could lose patience if earnings fail to live up to what’s been priced in, and gains this year are modest.
Malaysian stocks are up 7 per cent, Indonesian 2 per cent and South Korean 2 per cent.
Baweja said he was still long Asian equities, longer-tenor bonds and even currencies, but would be looking to cut those.
“Our base case is big change in emerging market macro isn’t forthcoming, and with this in mind we are closer to closing out long risk positions than we are to adding new ones,” he said.