Quarterly Liquidity Insights

Global Emerging Markets Liquidity Insight

March 31, 2022

Monetary indicators continue to give a cautionary signal for global economic and equity market prospects. EM equities could show relative resilience based on Chinese policy easing, pre-emptive policy tightening elsewhere, an absence of major imbalances and favourable valuations.

Underperformance of the MSCI EM Index relative to MSCI World in Q1 was entirely due to Russian stocks being repriced to zero – the rest of EM slightly outperformed. Commodity producers were winners from the interruption of Russian / Ukrainian supply, with China lagging again on economic / policy concerns and Taiwan / Korea hit by tech underperformance.

Global six-month real narrow money growth – our key leading indicator – fell to a low level during 2021 and weakened slightly further in early 2022, suggesting a significant economic slowdown through late 2022 at least. Our two measures of global “excess” money, meanwhile, are both negative, a condition historically associated with global equities underperforming cash.

While cautionary for absolute returns, a “double negative” excess money signal has not historically been associated with EM equities underperforming DM. There are grounds for expecting relative resilience now.

Chinese monetary policy remains key. A recovery in six-month real narrow money growth in H2 2021 was, as expected, reflected in better economic data for January / February. The hope here had been that monetary recovery would accelerate during Q1; real money growth did rise further but remains modest – see chart 1. Covid outbreaks, meanwhile, have delivered another negative shock to the economy.

Chart 1

Chart showing China GDP and Real Narrow Money

Policy-makers have promised increased support for the economy and further PBoC easing measures could be announced soon. As before, we await a clearer signal from monetary trends to turn positive.

Most EM central banks are still on a tightening tack but local rates may be at or close to a peak – policy adjustment is much further advanced than in DM. High inflation is mostly due to commodity prices and does not reflect DM-style irresponsible polices and monetary excess in 2020-21. E7 annual broad money growth returned to its pre-pandemic pace in mid-2021; G7 growth, by contrast, is still elevated – chart 2.

Chart 2

Chart showing G7 and E7 Broad Money

Relative valuation is a further supportive factor for EM equities. A forward PE discount on the MSCI EM index of 35% relative to MSCI World is the largest since 2005. The dividend yield premium recently reached over 40%, the largest since 2001. (Within DM, high yield outperformed as a style on average historically when the excess money indicators were negative).

The view that the global economy is heading for a harder landing than the consensus expects suggests downside risk for commodity prices despite the Russia / Ukraine supply shock. Commodity price momentum is strongly correlated with the global stockbuilding cycle, which may be beginning a 12-18 month downswing (the next low is scheduled for H2 2023 based on the cycle’s average length) – chart 3

Chart 3

Chart showing G7 Stockbuilding as percent of GDP and Industrial Commodity Prices

The economic / monetary backdrop argues for underweighting cyclical markets and sectors. Historically, consumer staples and health care were the strongest EM sectors under double negative excess money signals and could benefit as recently outperforming cyclical sectors – financials, materials and industrials – lose momentum. The cyclical consumer discretionary sector has already underperformed significantly along with tech.

Six-month real narrow money growth is holding up better in most of the larger EMs than in major DMs (the US and Eurozone / UK are now in contraction) – chart 4. Brazil is an exception, suggesting very weak domestic economic prospects. The Brazilian index has outperformed partly because of its high weightings in materials and energy but these may now become a drag.

Chart 4

Chart showing Real Narrow Money for Brazil, China, Korea and Taiwan

India, like Brazil, is classified as a cyclical market – its relative performance has been positively correlated with the OECD’s G7 leading indicator historically. Monetary policy has been supportive but the RBI recently signalled a hawkish shift. Six-month real narrow money growth has fallen back and a cross-over with China – where policy is easing – would argue for a reallocation between the two markets following substantial Indian outperformance.