Over the past few quarters, emerging-market (EM) equities have not looked particularly attractive, but a combination of factors is starting to signal that it may be time for investors to take another look.
Year-over-year growth in China’s M1 money supply—the amount of currency circulating in the economy plus demand deposits—has plummeted to near zero. The M1 is a good proxy for monetary stimulus, and the Chinese government did slow the spigot in 2018, deleveraging despite slowing growth. But interest rates in China have fallen more than 1%, from 4% in December 2017 to just under 3% in December 2018. And year-over-year growth in credit (the “credit impulse”) has recently ticked upward. This is a powerful combination that tends to precede an increase in money supply.
What’s so important about China’s money supply? As Figure 1 shows, a historical correlation exists between China’s M1 and the relative performance of EM equities. China is both a major market for EM exports and a large portion of the MSCI Emerging Market Index1 (approximately 30%). In the past, Chinese authorities responded to economic malaise by loosening monetary policy and otherwise injecting massive doses of stimulus. When they’ve done so, EM equities have often outperformed global markets. Following the financial crisis in 2008, and again at the end of 2015 amid sharply contracting growth, China loosened the monetary policy reins. M1 increased sharply and EM equity markets corresponded.
China’s money supply and EM equities have tended to move together
Data as of March 6, 2019 | For illustrative purposes only. Past performance is not a guarantee of future results. Indices are unmanaged and not available for direct investment. | Sources: Bloomberg and Wellington Management.
It is possible this could happen again, and I’m optimistic that it will. One caveat is that global economic growth is decelerating, and my overall market outlook is otherwise conservative. I suggest investors consider increasing EM exposure gradually, as I will be monitoring market and macro developments around the world.
It may be time to consider increasing exposure to EM equities.
EM fixed income assets are also starting to look attractive, but I prefer EM equities as China is a much larger piece of the equity index than the bond index. Read my latest perspective on EM debt, "Why I Find Emerging Markets Debt Attractive Today."
1 MSCI Emerging Markets Index is a free float-adjusted market capitalization-weighted index that is designed to measure equity market performance in the global emerging markets.
2 MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.
Important Risks: Investing involves risk, including the possible loss of principal. • Foreign investments may be more volatile and less liquid than U.S. investments and are subject to the risk of currency fluctuations and adverse political and economic developments. These risks may be greater for investments in emerging markets or in a particular geographic region or country.
The views expressed here are those of Nanette Abuhoff Jacobson. They should not be construed as investment advice. They are based on available information and are subject to change without notice. Portfolio positioning is at the discretion of the individual portfolio management teams; individual portfolio management teams and different fund sub-advisers may hold different views and may make different investment decisions for different clients or portfolios. This material and/or its contents are current as of the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management or Hartford Funds.