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Could 2019 be better?

2018 saw five overlapping waves of negativity overwhelm EM: 1) rising US rates (bond yields and Fed funds); 2) a strong dollar; 3) escalating trade tensions; 4) global/Chinese growth concerns; and 5) the 4Q18 sell-off in US equities. Combined, these were enough to push EM equities into bear market territory, with MSCI EM closing 2018 down 17% for the year, 24% off its January peak. The bad news for bottom-up investors is that top-down themes are again likely to dominate in 2019. The good – and little noticed – news is that EM equities bottomed in (and have started to outperform DM since) early October.

Our base case is that the US avoids recession in 2019 (which this summer will make the current expansion the longest since records began in the 1850s), but that growth slows as the sugar rush of stimulus fades and given the lagged effects of higher borrowing costs, the stronger dollar, weaker external demand (accompanied by rising protectionism) and the partial US government shutdown.

The positive story for EM is that we enter 2019 with: 1) much lower US bond yields (10year Treasuries yield of 2.67 vs 3.24 in early November); 2) the Fed indicating greater flexibility, with Fed futures now suggesting that the Fed might not hike at all in 2017 (sharp falls in interest rate expectations can precede an EM equity rally, see Figure 14); 3) China stimulating its economy via RRR cuts and big sign-offs for new railways (with more stimulus likely to be unveiled during 1H19) in order to report the required 6.2% annual growth rate in 2019 and 2020 to double the economy over 2010-2020; 4) some easing of the strong upwards dollar pressure of 2018; 5) oil $30/bl lower – bringing down inflation expectations and helping C/As for the 89% index weight of MSCI EM (and 64% of FM) that imports oil; 6) many EM currencies trading slightly cheap vs their long-run REER averages; and 7) the potential for a US-China trade agreement to add to risk appetite – we think recent equity market declines and softening lead indicators make such an agreement more likely, with President Trump in a pre-election year.

We examine these factors below and conclude that while plenty depends on policymakers and politicians taking the right actions, on balance, we think the 2019 EM equity pain trade is likely to be on the upside, and recommend investors take more risk in EM in 2019. But couldn’t 2019 just be a continuation of 2018’s poor performance? Yes, if financial market declines become a self-fulfilling prophecy and bring with them the next global recession, we can expect further declines.

1. The Fed and US bond yields

Trump’s $1.5trn of tax cuts helped push US growth above 3% during 2Q-3Q18. Democrat control of the House of Representatives makes a repeat fiscal stimulus unlikely, and the sugar rush for the economy should fade over the course of 2019. Together with the lagged effects of higher borrowing costs, the stronger dollar and weaker external demand (accompanied by rising protectionism) and the partial US government shutdown, the US economy should slow in 2019 vs 2018. A slower economy accompanied by the recent $30/bl decline in oil prices should in turn help keep inflationary pressure under control despite the tightening labour market (five-year inflation swaps have been coming down with the oil price, see Figure 19).

December’s ’dovish hike’ by the Fed (a 25-bpt hike, accompanied by a shift down in the dot plot for 2019 from three 25-bpt hikes to two) was perceived by the market as offering insufficient flexibility, and triggered sharp falls in US equities in December. January saw Fed Chairman Jerome Powell clarify that “there is no pre-set path for policy” and that the Fed is “prepared to shift economic policy and shift it significantly”, with flexibility including both the path of interest rates and the size of the Fed’s balance sheet size; several other senior Federal Reserve policymakers have counselled a wait-and-see approach to rates.

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14 January 2019

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Powell specifically referenced the Fed’s policy shift under then Chairman Janet Yellen in early 2016 when markets feared a Chinese hard landing. The Fed had raised rates in December 2015 (to 0.5%), and the accompanying “dot plot” suggested four 25-bpts of hikes during 2016. By February 2016, however, Yellen was suggesting the Fed may delay hikes and in the end, the Fed paused for a year, raising rates to 0.75% only in December 2016. That Fed pause prompted a 27% rally in MSCI EM over 12months.

The Fed futures market no longer expects the Fed to tighten at all during 2019. As we show below, sharp falls in US interest rate expectations can precede an EM equity rally.

Figure 14: Sharp falls in interest rate expectations can precede an EM equity rally

Amount of Fed tightening priced in to US OIS curve for next 12m (lhs)		MSCI EM (rhs)

0.8									1,300
0.7									1,200
0.6
0.5									1,100
0.4									1,000
0.3
0.2									900
0.1
0.0									800
-0.1									700
-0.2
-0.3									600
2010	2011	2012	2013	2014	2015	2016	2017	2018	2019

Source: Bloomberg, Renaissance Capital

The increase in US 10-year bond yields from 2.04% in September 2017 to 3.24% in November 2018 was a significant repricing of dollar assets. Previous sharp upwards moves in bond yields have triggered bull market corrections in EM, as we saw in 2005, 2006, 2007 and 2013. Given the 120-bpt increase in yields, we should not have been surprised to see MSCI EM fall by 21%. In fact, trade tensions saw that the decline was larger, 27% from top to bottom, taking EM into a bear market. Since then, US 10-year bond yields have reset downwards as growth and inflation expectations have come down.

Figure 15: Recent EM bond market-driven corrections

Increase in US 10yr yields (%)

	60	70	80	90	100	110	120	130	140
	-5%
	-10%	2005
correction	-15%
				2007	Average				2013
EM	-20%						2004
	-25%			2006
							2018
	-30%

Source: MSCI, Bloomberg

2. Inflation is back well below the 3% ‘danger’ level

US headline inflation hitting 3% has historically acted as a warning sign for EM equities (coming as it did ahead of 30%+ sell-offs for EM in 1994, 1997, 2000, 2007 and 2011).

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14 January 2019

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14 January 2019

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Our rationale for that is that 3% inflation brings with it fears of a behind-the-curve Fed (even if the Fed’s preferred inflation measure is the core personal consumption expenditures price index). US inflation almost reached 3% in the summer (hitting 2.9% in July), but subsequent falls have brought it back in to safer territory: November CPI was 2.2% and together with falling oil prices, inflation break-evens have declined.

Figure 16: EM, US CPI and the Fed – 1994-2002

Figure 17: EM, US CPI and the Fed – 2003-present

MSCI EM		Fed funds rate (%, rhs)
US CPI	3%
US 10yr yield (%)

600								8	1,400
550								7	1,200
500								6
450								5	1,000
400								4	800
350								3	600
300								2	400
250								1
200								0	200
Jan-94	Jan-95	Jan-96	Jan-97	Jan-98	Jan-99	Jan-00	Jan-01	Jan-02

MSCI EM	Fed funds rate (%, rhs)
US CPI	3%
US 10yr yield (%)

10

8

6

4

2

0

-2

-4

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

Jan-18

		Source: Bloomberg, Renaissance Capital		Source: Bloomberg, Renaissance Capital
Figure 18: Major MSCI EM downturns following US headline CPI hitting 3%
MSCI EM index	MSCI EM	US CPI	CPI>=3% - MSCI EM peak
peak	decline (%)	>=3%	(months)
Sep-94	-33	Sep-94		0
Oct-97	-59	Sep-96		13
Feb-00	-54	Feb-00		0
Oct-07	-66	Oct-07		0
May-11	-31	Apr-11		1

Source: Bloomberg

Figure 19: 5Y Inflation swaps, CPI, core PCE, the Fed and oil

	5y5y inflation swap	CPI	Core PCE		Fed target	Brent ($/bbl, rhs)
3.0						90
2.5						80
						70
2.0						60
1.5						50
						40
1.0						30
0.5	Jul-16		Jul-17		Jul-18	20
Jan-16		Jan-17		Jan-18		Jan-19

Source: Bloomberg, Renaissance Capital

3. Watch the US yield curve, but don’t panic

The flattening US yield curve has caused concern, as an inverted curve (10-year yields falling below three-month yields) has been seen ahead of the last five US recessions (1980, 1981-1982, 1990-1991, 2001 and 2007-2009).

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14 January 2019

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For now (despite a small inversion in the middle of the curve, where five-year yields are lower than two-year yields) the spread between 10-year yields (2.67%) and three-month yields (2.41%) is still 26 bpts.

In the run-up to the global financial crisis, such a level was reached in January 2006, but EM equities would continue to rally for almost two years (and by 90%) before peaking in October 2007. DM equities would rally another 34% before peaking (also in October 2007).

Figure 20: Fed December 2019 meeting expectations

Figure 21: US yield curve slope, bpts

1.25-1.5	1.5-1.75		1.75-2	2-2.25	2.25-2.5		2.5-2.75
100%2.75-3	3-3.25		3.25-3.5	3.5-3.75	3.75-4		4.0
							3.5
80%							3.0
							2.5
60%							2.0
							1.5
40%							1.0
							0.5
20%							0.0
							-0.5
0%	Jul-18						-1.0
Jun-18		Aug-18	Sep-18	Oct-18	Nov-18	Dec-18	Jan-19

Source: Bloomberg

							10Y3M				5Y2Y
1983	1985	1987	1989	1991	1993	1995	1997	1999	2001	2003	2005	2007	2009	2011	2013	2015	2017	2019

Source: Bloomberg

4. Dollar strength

42 years of EM history tells us that EM equities tend to struggle when the dollar rallies. 2018 has proven to be no exception. We think several factors could slow or even reverse the dollar rally during 2019.

Figure 22: EM equities vs the dollar

EM - IFC Composite/MSCI EM (from 1987) relative to DM, TR		Dollar Index (RHS)

210	1. Credit Bubble											5. Boom time							150
				3. Rediscovery
																		Dollar
190																			140
																		strength
170																			130
150																			120
130																			110
110																			100
															6. End of the affair
90																			90
70																			80
50																		Dollar	70
		2. Debt crisis
30									4. Rolling crises								weakness		60
Jan-76	Jan-77 Jan-78 Jan-79 Jan-80 Jan-81	Jan-82 Jan-83 Jan-84 Jan-85 Jan-86	Jan-87	Jan-88 Jan-89 Jan-90 Jan-91 Jan-92	Jan-93	Jan-94	Jan-95	Jan-96	Jan-97 Jan-98 Jan-99 Jan-00 Jan-01	Jan-02	Jan-03	Jan-04 Jan-05 Jan-06 Jan-07 Jan-08	Jan-09	Jan-10	Jan-11 Jan-12 Jan-13	Jan-14 Jan-15	Jan-16	Jan-17 Jan-18 Jan-19

Source: IFC, MSCI, Bloomberg

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Fed less of a stand-out. 2018 saw the Fed stand out as being alone among the ‘Big Four’ central banks (US, Japan, eurozone, UK) in implementing a regular series of quarterly rate hikes. With the Fed now closer to its terminal rate, we don’t expect a repeat of 2018’s hikes, and an on-pause Fed is likely at some point in 2019. Meanwhile the European Central Bank (ECB) has confirmed that it will end new asset purchases in December 2018. A first rate hike from the ECB is possible late in 2019.

US corporate repatriation slowing rapidly. US corporate repatriations appear to be slowing significantly. The Commerce Department reported that corporates repatriated $295bn in 1Q18, $170bn in 2Q18 and $93bn in 3Q18.

Dollar no longer cheap, verbal intervention more likely. The US dollar has moved to the expensive side vs its 25-year average (taking data back to 1994). While only 6% above its long-term average, a further rally could prompt concern from US policymakers. Trump has already been tweeting that he sees the dollar as very strong, raising the prospect of more verbal intervention should the dollar rally further.

Chinese renminbi. We would expect Chines authorities to aim to avoid sudden depreciation of the renminbi to provide a more positive backdrop for trade talks with the US ahead of the 1 March deadline, thus reducing the tendency for competitive EM devaluations.

A widening US fiscal deficit has previously coincided with dollar weakness (see Figure 23). Why didn’t it work in 2018? The Fed’s reaction function is important here, given the threat of the economy overheating in 2018 given fiscal stimulus.

Figure 23: US fiscal balance vs trade-weighted dollar

			US fiscal balance (lhs)				CBO projection				USD Trade Weighted Index (rhs)
12														150
10														140
8
														130
6
4														120
2														110
0
														100
-2
-4														90
-6														80
-8
														70
-10
-12														60
Jan-72	Jan-74	Jan-76	Jan-78 Jan-80 Jan-82 Jan-84 Jan-86 Jan-88	Jan-90	Jan-92	Jan-94	Jan-96 Jan-98 Jan-00 Jan-02	Jan-04	Jan-06	Jan-08	Jan-10 Jan-12	Jan-14 Jan-16 Jan-18	Jan-20	Jan-22

Source: MSCI; Bloomberg; Renaissance Capital

5. Trade war

The ‘truce’ announced following the meeting of President Trump and Chinese President Xi Jinping at the G20 meeting in Buenos Aires on 1 December provides breathing room until 1 March for both parties to agree a deal to prevent the US imposing a further 15% on the $200bn of Chinese goods that are already subject to a 10% tariff, and to avoid tariffs on the remaining $267bn of Chinese exports to the US.

President Trump’s sensitivity to the performance of the US equity market (and the wider economy) is well known. In a pre-election year, Trump is likely to wish to avoid further falls in the stock market and the impact on employment caused by a trade war, which we think makes such a deal more likely. For China, lead indicators are already pointing to a manufacturing slowdown. The fiscal and monetary stimulus to offset this risks

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14 January 2019

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14 January 2019

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compromising the authorities’ desired shift to higher quality of growth, which should also encourage an agreement to be made.

But the questions remain. Trump has been espousing protectionism for over three decades, suggesting a deal might only provide respite. And the trade war may not actually be a trade war, but more a clash of opposing value systems. Such a shift in US attitudes towards could be long-lasting and destabilising, not just for EM (where China accounts for over 30% of the MSCI EM Index).

Figure 24: ‘Death spiral’ of world trade during the Great Depression, $mn

January

December

4000

February

3000

1929

November

2000

March

1000

1930

October

0

April

1931

1932

September

May

1933

August

June

July

Source: League of Nations’ World Economic Survey, 1932-33

Figure 25: EM exports to GDP

Figure 26: Frontier exports to GDP

Exports to GDP, 2017

Exports to GDP, 2017

90%

120%

80%

100%

70%

60%

80%

50%

60%

40%

30%

40%

20%

20%

10%

0%

Hungary Malaysia UAE Taiwan Thailand Poland Qatar Korea Mexico SouthAfrica

Russia Peru Philippines China Turkey Indonesia Greece Colombia India Brazil Egypt

0%

Lithuania

Serbia

Croatia

Lanka

Lebanon

Arabia

Tanzania

RepublicCzech

Vietnam

Romania

Jordan

Iran

Chile

Pakistan

Bahrain Kuwait

Bangladesh

Zimbabwe

Kazakhstan

Mauritius

Sri

Ukraine Saudi

Georgia

Slovenia

Estonia Oman

Tunisia

Ivory

Morocco

Senegal Nigeria

Argentina

Kenya

Zambia Ghana

Uganda

Rwanda

Coast

Source: IMF, Taiwan Ministry of Finance

Source: IMF, Taiwan Ministry of Finance

Figure 27: EM exports to US, % of GDP

Figure 28: Frontier exports to US, % of GDP

Exports to US, % GDP

Exports to US, % GDP

30%

25%

25%

20%

20%

15%

15%

10%

10%

5%

5%

0%

Taiwan Malaysia Thailand Korea China Chile Colombia Peru Philippines AfricaSouth

RepublicCzech

India Indonesia Hungary Brazil Poland Pakistan UAE Turkey Egypt Russia Greece

Qatar

0%

Sri

Ivory

Mauritius

Bangladesh

Morocco Argentina

Romania

Kazakhstan

Lebanon

Saudi Georgia

Rwanda

Zimbabwe

Mexico

Vietnam

Bahrain

Lithuania Kuwait

Estonia

Slovenia

Tunisia

Serbia Kenya

Senegal

Ghana Ukraine

Tanzania

Zambia

Jordan

Coast

Nigeria

Croatia

Oman

Arabia

Uganda

Iran

Lanka

Source: IMF, Taiwan Ministry of Finance

Source: IMF, Taiwan Ministry of Finance

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14 January 2019

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Figure 29: EM exports to US, % of exports

Figure 30: Frontier exports to US, % of exports

90%

Exports to US, % of total exports

30%

Exports to US, % of total exports

80%

25%

70%

60%

20%

50%

15%

40%

30%

10%

20%

5%

10%

0%

0%

Mexico Colombia China Pakistan India Peru Philippines Chile Brazil Taiwan Korea Thailand Indonesia Malaysia SouthAfrica Egypt Turkey Greece Russia Poland Hungary RepublicCzech UAE Qatar

Jordan

Mauritius Bangladesh

Kenya Coast

Lithuania

Croatia

Tunisia

Romania

Serbia

Arabia Georgia

Ukraine

Zimbabwe Zambia

Sri

Ivory

Estonia

Senegal Kazakhstan

Saudi

Uganda

Lanka

Vietnam Nigeria Bahrain Argentina Kuwait Morocco

Lebanon Slovenia

Oman

Rwanda

Ghana

Tanzania Iran

Source: IMF, Taiwan Ministry of Finance

Source: IMF, Taiwan Ministry of Finance

6. Growth concerns

2019 is likely to see slower GDP growth in the US (as stimulus fades), the eurozone, Japan and China.

For the US, given the shift in language from the Fed, this likely means the Fed on hold at some point in 2019, perhaps for all of 1H19 (positive for EM). For the eurozone it means no rate hike is likely until late 2019. The current US expansion – assuming it continues – will this summer become the longest since records began in the 1850s. That in itself is causing some nervousness about the timing of the next recession. Investors are asking whether this is the end of the cycle and whether it makes sense to ‘pick up pennies in front of a steam roller’. While previous Fed Chair Janet Yellen maintained that expansions don’t die of old age, long expansions, in our view, can lead to a build-up of excesses making the economy more vulnerable to shocks. However, as the current expansion saw two mid-cycle dips (mid-2011 and late-2015) which saw the economy slow and high-yield spreads spike above 750 bpts this could have acted as a restraint to a build-up of excesses, which in turn could support arguments for an extended cycle. And the expansion has been relatively shallow, and is only now approaching the average increase in real GDP of the last 10 expansions.

Figure 31: US expansion could still have room to run…
	60%		1949
			1954
	50%		1958
(%)			1960
	40%		1970
growth
			1975
GDP
	30%		1980
Cumulative			1982
			2001
	20%		1991
	10%		2009
			2.5% growth
			Avg growth
	0%		Avg duration
	0 2 4 6 8	10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42
		Quarters
		Source: NBER, Bloomberg, Renaissance Capital

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14 January 2019

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For China, recent PMI readings, particularly on new orders, suggest a slowing Chinese economy in 2019, with an escalation of the trade dispute the key downside risk. But sizeable fiscal stimulus (including new railway lines) and easing of financial conditions (RRR cuts and potentially interest rates), as well as the lifting of restrictions on the housing market, are likely to cushion the slowdown in order to reach a reported 6.2% growth rate required over the next two years to deliver on the promise that 2020 GDP would be double that of 2010. However postponing deleveraging and increasing fiscal spending delays China’s transition to a more sustainable economic growth model, and there are some suggestions that the growth rate might already be much lower.

7. EM vs global markets

Can EM perform when US/global equities decline? It seems so: MSCI EM actually bottomed on 29 October, and has since risen albeit modestly despite declines for US and global equities. And during the S&P 500’s sharp 19.8% sell-off in October-December, MSCI EM fell by only 8.1%.

8. Lower oil prices

Oil exporters make up only 11% of MSCI EM (36% of MSCI FM). A lower oil price should be positive for C/A positions of oil importers and reduce inflationary pressures. Rising oil prices can result in political pressures in fuel importers (not just in France).

The decline in oil prices, with Brent falling from $86/bl in October to c. $60/bl has helped drive US inflation break-evens lower, easing pressure on the Fed. As our oil team writes, US sanctions on Iran have proved less severe than we feared, as six-month waivers granted have reduced the expected negative effect on global crude supplies. Elsewhere, strong OPEC and non-OPEC production growth over 2018 are contrasted with slightly reduced demand expectations, with the OPEC+ agreement necessary to keep markets in balance until at least 2H19. We expect OPEC+ compliance will be high, supporting a 2019 Brent oil price around our unchanged $65/bl estimate. While supply risks are still abundant (Iran post-waivers, Venezuela), we believe there is sufficient global capacity for stronger production growth elsewhere. In particular, the surge in US oil production continues with a significant 3mnb/d YoY increase recorded in August 2018, according to the IEA; there are also many other growth spots in the world, notably a recovery in Libyan production, Canada, Russia, Kazakhstan and Brazil, as well as the reversal of Venezuela’s and Iran’s oil production declines at some point. We therefore retain our somewhat lower $60/bl Brent oil price (real) assumption for 2020 and beyond.

While a headwind for oil producers, low oil prices should reduce inflationary pressures globally and help oil importers, as well as making energy subsidies in EM less costly and easier to remove.

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14 January 2019

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Figure 32: EM net fuel exports to GDP, 2017 (index weight in brackets)

Figure 33: FM net fuel exports to GDP, 2017 (index weight in brackets)

35%

30%

25%

20%

15%

10%

5%

0% -5% -10%

SouthCzech (1.1%)Qatar (0.7%)UAE (3.7%)Russia (0.4%)Colombia (2.4%)Malaysia (2.2%)Indonesia (7.5%)Brazil (6.3%)Africa (0.4%)Peru (2.6%)Mexico(31.1%)China (0.3%)Greece (1.2%)Poland (0.2%)Republic (0.1%)Egypt (1.1%)Chile (1.0%)Philippines (9.0%)India (0.7%)Turkey (0.3%)Hungary (0.1%)Pakistan(14.0%)Korea (2.4%)Thailand(11.3%)Taiwan

Source: IMF, Renaissance Capital

50%

40%

30%

20%

10%

0% -10% -20%

IvorySri (22.0%)Kuwait (1.6%)Oman (4.2%)Bahrain (0.8%)Kazakhstan (6.7%)Nigeria (0.1%)Coast(16.3%)Argentina (0.3%)Estonia (4.6%)Romania (2.8%)Bangladesh(16.1%)Vietnam (1.1%)Slovenia (1.6%)Croatia (4.9%)Kenya (0.2%)Lanka (0.2%)Lithuania (1.6%)Serbia (0.7%)Tunisia (0.7%)Senegal (8.0%)Morocco (2.1%)Mauritius (1.9%)Lebanon (1.2%)Jordan

Source: IMF, Renaissance Capital

9. EM currencies cheap

The sell-off in EM currencies has taken the EM (ex-China) REER measure to 4% below its long-term (24-year) average, suggesting that EM currencies are cheap. The same is not true for FM, which is 5% above its long-term average.

Figure 34: EM and FM REER indices

EM and FM REER and long-term averages

130

125

120

STRONGER

115

110

105

100

95

90

85

WEAKER

80

Jan-95

Jan-96

Jan-97 Jan-98 Jan-99 Jan-00 Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Jan-15 Jan-16 Jan-17 Jan-18

EM ex-China aggregate REER

EM aggregate REER

FM Aggregate

REER

Source: MSCI; Bloomberg; Renaissance Capital

10. EM equities cheap

EM equities have had a tough year, and markets have de-rated. However, EM’s P/E discount to DM has not changed significantly.

EM’s 12-month forward P/E has decreased from a peak of 13.3x in January 2018 to 10.9x currently, but the discount to DM moved only from 22% to 21% as DM also de-rated from 17.1x to 13.9x over the same period (the discount to the US is currently 28%, or roughly where it was in January as the US has de-rated as well). The 10-year average discount of EM to DM is 18%, while the 10-year average discount to the US is 24%.

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14 January 2019

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EM equities appear cheap on a P/B basis: 1.5x vs 2.2x for DM (and 3.1x for the US).

EM’s 31% P/B discount to DM is much wider than the 10-year average of 17%. EM’s 52%

P/B discount to the US is much wider than the 20-year average of 34%.

Figure 35: MSCI EM and DM 12M fwd P/E and long-term average

MSCI EM 12M fwd P/E (x)		MSCI DM 12M fwd P/E (x)

18

16

14

12

10

8

6

4

Jan-19

Jul-18

Jan-18

Jul-17

Jan-17

Jul-16

Jan-16

Jul-15

Jan-15

Jul-14

Jan-14

Jul-13

Jan-13

Jul-12

Jan-12

Jul-11

Jan-11

Jul-10

Jan-10

Jul-09

Jan-09

Jul-08

Jan-08

Jul-07

Jan-07

Jul-06

Jan-06

Figure 36: MSCI EM 12M fwd P/E (x) premium/discount to DM (%)

MSCI EM 12M fwd P/E premium/discount to DM (%) LT. avg.

10% +/-1SD

5% 0% -5%

-10% -15% -20% -25% -30% -35%

Jan-19

Jul-18

Jan-18

Jul-17

Jan-17

Jul-16

Jan-16

Jul-15

Jan-15

Jul-14

Jan-14

Jul-13

Jan-13

Jul-12

Jan-12

Jul-11

Jan-11

Jul-10

Jan-10

Jul-09

Jan-09

Jul-08

Jan-08

Jul-07

Jan-07

Jul-06

Jan-06

Source: MSCI, Bloomberg Source: MSCI, Bloomberg

Figure 37: MSCI EM and DM 12M fwd dividend yield and long-term average Figure 38: MSCI EM and DM trailing P/B

MSCI EM 12M fwd Div yld (%)		MSCI DM 12M fwd Div wld (%)

5.5

5.0

4.5

4.0

3.5

3.0

2.5

2.0

06-Jan 06-Jul 07-Jan 07-Jul 08-Jan 08-Jul 09-Jan 09-Jul 10-Jan 10-Jul 11-Jan 11-Jul 12-Jan 12-Jul 13-Jan 13-Jul 14-Jan 14-Jul 15-Jan 15-Jul 16-Jan 16-Jul 17-Jan 17-Jul 18-Jan 18-Jul 19-Jan Source: MSCI, Bloomberg

3.5	MSCI EM Trailing P/B (x)	MSCI DM Trailing P/B (x)
3.0
2.5
2.0
1.5
1.0
0.5	Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19

Source: MSCI, Bloomberg

11. EM vs DM growth outlook could improve

In its October 2018 outlook, the IMF expects the US, eurozone, Japan, Australia and Canada all to slow in 2019, with DM growth falling from 2.4% in 2018 to 2.1% in 2019 vs a more stable 4.7% growth outlook for EM in both years (the IMF assumes China slows from 6.6% in 2018 to 6.2% in 2019). The World Bank’s more recent January 2019 outlook sees DM growth falling from 2.2% to 2.0% and EM growth stable at 4.2%. Historically, widening EM vs DM growth outperformance has been relatively bullish for EM equities. 2018 has seen the EM vs DM growth differential narrowing and EM equities underperform.

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