Strategy Note /

EM equity valuation in front of the wall of worry

  • EM wall of worry: US yields, stagflation, China Covid, Russia-Ukraine, commodity prices and protests, reforms on hold

  • EM glimmers of light: commodity exporters, China stimulus, Covid's global fade, IMF-led policy correction

  • We check on valuation of equities (PB vs. history) and FX (spot rate vs. REER history), as the wall blocks out the light

EM equity valuation in front of the wall of worry
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
9 May 2022
Published byTellimer Research

Higher US treasury yields, stagflation signals, China zero-Covid lockdowns, the Russia-Ukraine war, roaring commodity prices and the protests they are sparking and reform efforts they are de-railing: these are the bricks in the wall of worry facing emerging market equities.

Market performance, with MSCI DM and EM down 9% each quarter to date and down 1% and 4% month to date, respectively, suggests that the wall is overshadowing the glimmers of light in EM: those markets that benefit from commodity exports, the capacity for policy stimulus in China, the global fade of Covid disruption (ex-China) and the course correction under IMF supervision for some of the worst policy frameworks in EM.

These factors are not new, as discussed in our last monthly report. So, the real question is what level of concern is already reflected in the valuation of equities and FX rates.

Below, we chart trailing price/book versus the five-year median and the change in the spot FX rate implied if there is a reversion to the 10-year median real effective exchange rate.

Valuation of equities and FX in emerging equity markets

The following comparisons are noteworthy (in all cases, considering the combination of equity and FX valuation versus their historical average):

  • Europe is cheaper than the US in developed markets;

  • China is cheaper than India among the mega-population plays in large EM;

  • South Korea is cheaper than Taiwan in the Tech-centric large EM;

  • Brazil is significantly cheaper than the other commodity exporters in large EM, Indonesia, Saudi Arabia and South Africa;

  • Copper exporters, Chile and Peru, are cheaper than the oil exporters, and, among the oil exporters, Colombia and Oman are cheaper than, for example, Abu Dhabi, Kuwait and Qatar;

  • Mexico and Vietnam are cheaper than Bangladesh in the EM manufacturing plays;

  • Among the tourism-exposed markets, Thailand, in large EM, and Egypt, Georgia and the Philippines are cheaper than Dubai, Greece and Iceland; and

  • In the neighbourhood of the Russia-Ukraine war, Poland is cheaper than Romania.

The common refrain to a focus on valuation metrics is, "what is the catalyst?" But, if one could convincingly identify the catalyst, it would likely be priced in already.

In any event, we are not advocating an exclusive focus on these metrics – for an analysis of the many factors (spanning growth, politics, liquidity, valuation, ESG) driving the top-down investment case, see our EM Country Index, where weights attached to factors, such as valuation, are customisable.

Note that this chart has little to do with the debate between 'value' and 'growth'. Countries (and companies) in both categories can be cheap relative to their history.