Strategy Note /

Emerging-Frontier Equity Monthly – August: Taper, Covid, Afghanistan

  • Real interest rates diverge substantially across EM, implying different states of preparedness for inflation or US taper

  • EM Covid vaccines still lag in general, but in pockets there is a ramp up which should help growth and re-open tourism

  • Afghanistan is a domestic tragedy but not the regional vortex most assume, nor a signal of waning US commitment to Asia

Emerging-Frontier Equity Monthly – August: Taper, Covid, Afghanistan
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
30 August 2021
Published byTellimer Research

Last month I half jokingly wrote that the month of August has a history of major geopolitical events. Afghanistan's fall to the Taliban duly provided the main highlight of the month.

  • EM equity index was flat, FEM up 7%, FM up 3%, and DM up 2%.

  • US Dollar (up 1.0%) was driven partly by concerns of tapering by Federal Reserve and a bout of risk-off appetite on global growth concerns.

  • US 10-year bond yield barely budged (up 7bps), which is in one way positive for EM, in terms of low rates for longer, but not good in another, as EM equity funds struggle to attract assets away from US equities, with asset allocators spellbound by TINA ("there is no alternative" to US equities amid high priced bonds as the US Fed continues its bond purchases, faster growth in the US than in much of EM, and China-specific consensus concerns on growth and regulation).

  • Hard commodities, across the board, were hit by concerns over Covid disruption and China deceleration and curbs on speculative trading: Iron (down 6%), Oil (down 5%, also partly because of a cut in demand forecast by the IEA), and Copper (down 4%).

  • Soft commodities were mixed, eg with Maize, Wheat, and Sugar (all up 2%) but Palm Oil (down 2%) and Soybean (down 4%).

  • Large EM performance was bookended by outperformer India (up 7%) and underperformers South Korea (down 4%) and China Tech (down 6%):

    • India's rally was spread across Banks and Technology sectors and was helped by an unchanged low policy rate, at 4%, which implies a real interest rate of negative 1.6%, and an indication from central bank minutes of a continuation of this stance.

    • South Korea's decline was driven by the 8% decline in DRAM (memory semiconductor) prices, to which bellwethers Samsung Electronics and Hynix are exposed, which, in turn is due to lower expectations for near-term growth in the main products that use DRAM – PCs – because of the end of Covid lockdowns in developed markets as well as logistics disruption.

    • China Tech (Alibaba et al) was again hurt by concerns over new regulations in a continuation of last month's theme.

  • Small EM and FM outperformers were:

    • Argentina (up 29% for MSCI Argentina, which is mainly non-Argentina Globant, and up 20% for the broader local Merval index, amid upgraded GDP growth forecasts and renewed hope of an IMF deal).

    • Small EM-FM Tech (up 14%, as both Mercado Libre and Sea reported better-than-expected 2Q revenue growth).

    • Philippines (up 11%, on hopes that the worst of Covid-related lockdowns may have passed and the tentative return of foreign investors).

    • Colombia (up 8%, on post-protest GDP growth data, the bounce back in oil price, and the emergence of centrist candidate Gaviria for the 2022 election).

    • Kenya (up 8%, driven both by Safaricom, after indications that its mobile money service will be permitted in Ethiopia, and the largest banks, Equity and KCB, which both saw rebounds in first-half earnings because of lower cost of risk).

    • Bangladesh (up 7%, driven by its smaller, locally-driven stocks rather than consensus foreign favourites like Brac, Grameenphone, or Square Pharma, and by the lifting of lockdown despite little slowdown in the latest Covid infection wave).

    • Thailand (up 7%, on the moderation of new Covid infections and the decision to lift some of the lockdown from the start of September).

    • Turkey (up 7%, on a combination of an increase in FX reserves and accelerating credit growth, even though inflation risks remain).

  • Small EM and FM underperformers were:

    • Peru (down 1%, over ultimately unfounded concerns that President Castillo's new cabinet would not be approved by Congress).

    • Nigeria (down 1%, on 2Q GDP growth of 5.0%, below expectations of 5.6%, and continuing FX shortages).

    • Pakistan (down 2% on Afghanistan-spillover and IMF review concerns).

    • Sri Lanka (down 3% on external funding and FX risks).

  • In EM geopolitics:

    • Afghanistan's government fell to the Taliban, following months of sweeping gains and the withdrawal of US troops, chaotic and tragic scenes ensued at Kabul airport, and the local "Islamic State" affiliate launched a deadly terror attack. Elsewhere:

    • Vice President Harris continued the US effort to build its ASEAN anti-China front, to a mixed reception, in Singapore and Vietnam.

    • Japan committed to defend Taiwan, in rhetoric at least, and backed its entry into the Trans-Pacific Partnership trade pact.

    • Iran was accused of attacking Israeli and Saudi commercial vessels.

    • UAE initiated a diplomatic detente with both Turkey and Qatar.

    • Algeria broke off diplomatic relations with Morocco.

  • In EM domestic politics:

    • Malaysia saw a new Prime Minister appointed, but with the same fragile coalition as his predecessor.

    • Philippines President Duterte sought to lay the ground for his political dynasty by announcing his candidacy for vice presidency in 2022, after his single term limit expires.

    • Kenya's high court struck down efforts by the Building Bridges Initiative of outgoing President Kenyatta and Opposition leader Odinga, where Kenyatta and Odinga are apparently united in their efforts to avert a Ruto presidency, to reform the constitution (in a manner likely unfavourable to Ruto).

    • Tunisia's President Saied extended his emergency powers, ie the suspension of parliament.

Our monthly review of EM and FM equities is laid out as follows:

  1. The month's performance in Emerging and Frontier in one chart

  2. Global context: EM central bank preparedness for rate hikes, Covid vaccination ramp in pockets of EM, and Afghanistan implications for Asia-Pacific and the Middle East

  3. Technology chart: China Tech the cheapest

  4. Commodities chart: Copper is cheaper than Oil

  5. Tourism chart: Mauritius vaccinating fast and among the cheapest

  6. Performance, valuation, liquidity summary table: equities, commodities, currencies

  7. Global EM equity strategy recap in 600 words with downloadable slides, centred on the themes of Tech versus Commodities and Tourism, Locals versus Foreigners, Small versus Large EM, as well as updated charts on the Buffet Indicator and Dividend Yield versus Real Rates.

  8. Recent reports: links to reports published this month on global EM and FM top-down issues.

1) The month in one chart

August performance and valuation of Emerging Markets

2) Global context: Rates, Covid, Afghanistan

EM central bank preparedness should inflation strike

The feverish debate over whether the US economy is heading for reflation, sustained high inflation, or, before too long, deflation, persisted this month.

Fed Chair Powell generally stuck to the same message on the transitory nature of inflation and sustained accommodative policy but hinted, during the Jackson Hole symposium at the end of the month, at a tapering of bond purchases as soon as later this year.

A number of central banks in EM are already setting their own more contractionary course, eg Sri Lanka and South Korea became the first Asian EMs to increase rates, with a 25bp hike.

Some emerging markets are already tightening interest rate

One way of measuring central bank preparedness should global inflationary pressures worsen significantly or US rates increase much quicker than expected (undermining the global "search for yield") is the real interest rate, defined as policy rate minus inflation.

The lower, or more negative, the real interest rate, the further "behind the curve" that country is in combatting existing inflation and the less attractive a "carry trade" on the currency it offers foreign investors. Policy rate hikes should global conditions (inflation and US rates) deteriorate may end up having to be significantly greater, and more damaging to growth, than in countries that start with higher, or more positive, real interest rates.

EM central bank preparedness for inflation or FX pressure

Covid struggles in EM but vaccination ramping up for some

The economic damage from Covid is undeniable and this partly offsets the pressure to withdraw policy stimulus (ie raise interest rates in the face of inflationary pressure). This was a universal experience in 2020.

The challenge for countries in EM this year and next will be how to balance infection control, re-opening, policy normalisation (without triggering capital outflows) when some of the larger markets in DM, particularly the US, recover sooner.

Covid-19 fully vaccinated minority globally and in EM

Faster vaccination would make this an easier task in EM and, in pockets, the vaccine rollout is picking up pace. This is particularly positive for those markets dependent on tourism, eg Mauritius, Morocco, Sri Lanka, Turkey, or where lockdowns have persisted to much economic detriment, eg Philippines. (See the separate section on valuation in Tourism markets below.)

Covid vaccination in EM lags DM but some are ramping fast

US allies in EM face the consequences of US withdrawal from Afghanistan

Countries such as China are already engaging publicly with the Taliban in Afghanistan. Whatever they think of the values espoused by the Taliban, the terror attack on Kabul airport by the local Islamic State affiliate IS-Khorasan reinforces that all external powers will have to work with the Taliban.

Given, firstly, that the old Afghan government did not deliver on improved security, poverty alleviation, corruption reduction, or opium output control and, secondly, that no external power has the political will to locate massive troop numbers on the ground, then the Taliban may be better than a complete breakdown where terror groups, like IS-K, Al Qaeda, Haqqani Network, and Eastern Turkistan Movement thrive.


The main global impact for emerging markets is the shift of US attention to the Asia-Pacific region.

  • There are more US troops stationed in Asia-Pacific than in any other overseas region. Vice President Harris and Defence Secretary Austin have made a push to get ASEAN countries like Singapore, Philippines, and Vietnam to host more troops, rather than relying on Japan and South Korea alone.

  • US allies in Asia-Pacific include the largest components, Taiwan (14.6%) and South Korea (13.0%), of the MSCI EM index after China-HK (34.2%) and, in our view, some of the most attractive equity market stories in EM globally, namely Vietnam, Philippines, and Indonesia.

  • Greater US involvement and support, at least to the degree that it does not antagonise an aggressive response from China (a risk clearly most acute for Taiwan), is generally a positive for the investment case in these countries (they have to spend less on defence and retain relatively favourable access to the US for their exports).

Middle East

The US withdrawal from Afghanistan is not a new signal for greater security risks for those Middle East countries which rely on US defence cover.

  • The indications of less US commitment came a decade ago with the Iraq drawdown, the withdrawal of US support for Hosni Mubarak during the "Arab Spring", and the growth of US Shale oil and gas.

  • US troop numbers in the region have, in fact, simply returned to where they were prior to the Iraq and Afghan wars.

  • Regional allies of the US are slowly weaning themselves off US dependence, with the higher military spend of their own, UAE-Israel normalisation, the Saudi-Qatar détente, and the UAE detentes with Turkey and, most recently, Qatar, demonstrations of this.

US troop numbers in Asia-Pacific have been fairly consistent

3) Technology: China cheapest

Cheapest Tech in EM is in China bellwethers

4) Commodities: Copper cheaper than Oil

Copper cheaper than Oil (ex-Colombia) in EM equity markets

5) Tourism: Mauritius vaccinating quickly and cheap

Egypt, Mauritius among cheap Tourism Emerging Markets

6) Performance and valuation summary

7) EM Equity strategy: Tech-Commodities-Tourism mix; the Reformers, Locals vs Foreigners; Small over Large EM

A slide presentation that summarises this strategy view is available via this link.

Download .pdf
Amid so much uncertainty on the biggest macro factors affecting emerging markets (EM) – the Covid pandemic, US rates and inflation, the balance of local and foreign as well passive and active flows – we recommend, in large EM, a tilt from exposure to Technology's secular growth (eg Korea-Taiwan Hardware) to the stuttering post-Covid recovery in Commodities (Brazil, Russia, Saudi) and Tourism (Thailand). Also, amid the panic about the domestic regulatory crackdown on the China Tech sector, we advocate revisiting this substantially de-rated, former darling sub-sector of EM.

Small EM-FM is generally cheaper (apart from the Technology sector, where scarce listings attract a premium) than large EM. And it is locals, driven by low interest rates, that are the catalyst for a re-rating. In contrast, foreigners are too restricted by mainstream benchmark indices or too small, if they are the heroic survivors in the dedicated small EM-FM asset class, to drive their markets as they once did on their own. This does not stop them benefiting from better performance driven by locals.

For those able to think long term – through Covid-19 disruption, on the one hand, and through the liquidity demands of periodic redemptions along the way, on the other – we stick to many of the long-term factors we have discussed before to determine our top picks, such as secular Tech growth (cheaper in EM than DM), macro growth (Vietnam, Bangladesh), reform (Indonesia, Pakistan, Philippines), resilience (Qatar) and a mix of all of these factors (India).

So far this year, the pick-up in US yields, the slightly stronger US Dollar (at times), the prospect of stronger fiscal stimulus in developed compared to emerging markets, US-China friction, and Covid-19 second and third waves have hurt the relative performance of emerging market equities in general. But this has also made for more compellingly valued opportunities across a range of themes:

  1. China Technology (particularly Alibaba and Tencent), is amongst the cheapest and most liquid exposure to structural growth, which has benefited, of course, from Covid-19 disruption but will outlast it, albeit the entire sector now has to conform to the diktats of the one-party state.

  2. Alternative manufacturing locations to China that are able to benefit from US-China friction – such as Bangladesh and Vietnam – still have positive macroeconomic transformation ahead.

  3. Commodity exporters, particularly those not at significant valuation premia versus history – such as LatAm trio Chile, Colombia, and Peru, and Tourist destinations like Thailand – and others at deep valuation discounts, like Dubai, Georgia, Philippines, and Sri Lanka, offer recovery opportunities, for those prepared to look beyond Covid disruption.

  4. Homegrown structural reform continues, despite the Covid shock and domestic political challenges, in markets like Indonesia, Pakistan and Philippines.

Regardless of the foreign flows into international equity funds and the increasingly absurd misrepresentation of EM countries by benchmark index providers (eg South Korea and Taiwan have per capita incomes closer to Italy than most truly EM countries but make up 28% of MSCI EM), local investors are recognising these prospects, as reflected in the pick-up in trading activity.

Of the 50 EM and FM countries we look at, the instances where policy on interest rates, fiscal spend, FX regime, or banking supervision are so poor that they fatally undermine the investment case in locally-listed equities, for most foreign funds, is limited to perhaps four – Argentina, Lebanon, Zimbabwe, and to a lesser degree, Nigeria.

Ironically, Turkey, between November 2020 and March 2021, is the most recent example of how quickly and how much those funds can reward, from a low base, a return to better policy and how, as long as capital controls are not imposed, those funds can price the risk of poor policy (ie they remain engaged).

Buffet indicator, relative to history, highlights small EM-FM

Local investor appetite in EM driven by the attractiveness of equity dividend yield relative to local real interest rate

8) Recently published reports


Youth unemployment in emerging markets, 26 August

Inequality in emerging markets, 23 August

IMF approves historic US$650bn SDR allocation (Culverhouse), 3 August

Limited number of sovereign defaults so far in 2021 defies expectations (Culverhouse), 9 August

Why emerging market currencies are undervalued, according to the IMF (Curran), 7 August

Commodity food prices drop again but from a high level, 5 August


Afghanistan terror groups, 27 August

Taliban go from rebel to ruler in Afghanistan, 16 August

Afghanistan's abyss in 10 charts: China's power reduces risk for Pakistan, 11 August


Morocco and Algeria friction, 25 August

South Africa: Cabinet reshuffle creates fiscal uncertainty (Curran), 6 August

Ethiopia: Conflict and economy worsen (Curran), 19 August

Tunisia: Political standoff delays IMF talks (Curran), 12 August

Zambia: Opposition landslide boosts prospects (Curran), 16 August


Pakistan: External risks to rise if IMF programme cannot be secured (Curran), 25 August

Philippines: Duterte's dynastic drama, 25 August

US allies in Asia-Pacific do not need reassurance, 23 August

Malaysia's new PM is not a fix for dysfunctional politics, 23 August

Malaysia political dysfunction persists, more middle-income mediocrity ahead, 17 August

Sri Lanka tightens monetary policy, but more is needed (Curran), 19 August


Turkey: Rising inflation keeps the CBRT on hold (Curran), 12 August

Middle East

Middle East security risks unchanged by US withdrawal from Afghanistan, 24 August

Iran, tanker attacks, and oil, 4 August

Iraq: Oil softens and elections approach (Curran), 26 August