Strategy Note /

EM and FM: Taking stock after Coronavirus sell-off

  • Panic: Coronavirus spreads, markets sell off, portfolio contagion fears increase

  • Coronavirus so global a risk for EM and FM that should it be ignored?

  • Valuation discount of EM, FM equities versus DM still near 10-year trough

Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
1 March 2020
Published byTellimer Research

In the emerging markets we look at, we see panic among traders focused only on the sharp sell-off last week (perhaps in anticipation of a further, compounding jolt from passive fund outflows).

This is exacerbated by internal risk managers breathing down their necks (the sort who apply the brakes when a coincident indicator like the VIX has already spiked). 

We see portfolio managers taking a more sanguine long-term view but largely being ignored for now. And we see asset gatherers stoop further into depression with the fall in absolute returns of the funds they are trying to market.

Meanwhile, EM and FM equities still see a valuation discount to DM near the 10-year trough.

Coronavirus so global and unquantifiable a risk for EM that should it be ignored?

Coronavirus is a global problem with no places to hide in emerging markets from the disruption, however short or long term. Manufacturing, commodities, trade and tourism are all affected - capital flows will inevitably follow. 

Central bank monetary easing and government fiscal stimulus can only partially respond to a supply-side shock (i.e. relief on loans can, at best, keep a hotel with low occupancy running but it cannot make up for the lost visitors and this is assuming that banks with easier liquidity will pass on the benefits to their borrowers as opposed to using the cheaper liquidity, available to the banks, to invest in other assets with higher yield).

Counter intuitively, this implies one should ignore the Coronavirus risk if we are talking about a portfolio exposed only to emerging markets, as opposed to multi-asset global portfolios. See Coronavirus: Should it be ignored because it is such an unquantifiable risk?, 25 February 2020

The countries and stocks one liked before have simply become cheaper. After the sell-off in markets in last week, EM and FM equity indices are still close to 10-year wide discounts to DM. Whether the entire equity asset class has become more or less attractive versus others (real estate, fixed income, gold etc) is a separate issue but not one that the active fund manager restricted to EM or FM equities can do much about.

Below we recap our views on the Coronavirus and provide an updated set of charts on equity market valuations, liquidity levels and recent performance (of equities and a range of global commodity and risk indicators). 

More detail can be found in our last equity monthly report, Frontier-Emerging Equity Monthly, February: Diabolical, 28 February 2020. Our last fundamental overview and country ranking was in Frontier-Emerging Strategy: To the survivors the spoils, 1 November 2019.

Coronavirus (Covid-19) known knowns and unknowns

(1) Covid-19 is global but most countries are not implementing countermeasures (central government action, better education, quarantines, operating restrictions on all sectors – manufacturing, trade, tourism, entertainment, retail etc) until infections have already spread (China was merely the first example, Iran is another case but the US also fits this description). 

(2) The rate of contagion slows to much less alarming rates once draconian measures are taken (if Chinese data is to be believed).

(3) An accurate fatality rate will not be known until the virus runs its course, but simply dividing deaths by total infections is likely inaccurate (either dividing deaths by the sum of deaths plus recoveries or a rolling calculation of deaths over infections is probably better, but neither is helped by changes, at a national level, in the definition of what counts as a coronavirus case or the absence of any data at all in countries with poor healthcare monitoring and provision.

(4) Fatalities are concentrated in the elderly (if Italian data is to be believed). 

(5) The SARS experience is relevant (the fatality rate was initially under-estimated, the market sell-off was temporary) only because it is the closest comparable. But in many respects, it is a poor reference point: i) the total number of infections was much smaller and more regional, ii) China's economic size was much less, iii) China's economic reliance on domestic consumption was much less, iv) China's external trade links (particularly in the global industrial manufacturing chain) are now much deeper, and v) counter-measures were much less draconian.

(6) The response to Coronavirus is being politicised by domestic and international opponents of incumbent governments (e.g. the reaction of Democrats to the US administration or the US and others to Iran and China).

Equity valuation across EM and FM

Performance across EM, commodities and risk indicators, liquidity across EM

All market pricing, liquidity, valuation sourced from Bloomberg (as of 1 March 2020).