Lazard’s sanguine view on emerging markets


There are changes afoot in emerging markets, not the least being the imminent inclusion of China in the main indices from next year. More importantly, emerging markets are now dominated by tech companies, not old-world manufacturers.

According to James Donald, New York-based portfolio manager for Lazard Asset Management, emerging markets leaders are increasingly being populated by entrepreneurial companies in a wide range of exciting burgeoning fields.

“We believe the implications of these changes are wide ranging and may necessitate a different approach to investing in emerging markets,” he said on a recent visit to Australia.

IT was now the largest sector within the emerging markets universe, according to the MSCI emerging market index (and that’s before China gets its full quota). IT currently represents 27.6 per cent of the index compared with just 2.3 per cent in 1995. The “traditional” industries such as telecoms, utilities and materials have fallen substantially as a percentage of the index in recent years.

Key points from Donald’s visit to Australia include:

  • Emerging market equities have been performing very strongly over the past 12 months – up around 25 per cent in Australian dollar terms
  • This has partly been driven by a momentum rally in Chinese tech stocks (the JANTS) – “We think they are now trading at extreme levels”, Donald says
  • This has affected the relative performance of Lazard’s value strategy, with the most expensive stocks leading the market higher
  • Lazard expects this to reverse, as it has done in previous cycles. But the firm is very enthusiastic about the prospects for the undervalued segments of the markets going forward, and
  • Lazard sees value in companies in some unloved corners of EM Brazil, Russia, Indonesia, Turkey. In terms of sectors, Lazard likes the banks and some IT stocks.

In a recent paper Lazard details three major areas of risk for emerging markets over the next couple of years. The paper says: “We believe the single largest risk facing emerging markets today is whether the improved growth dynamics of 2017 can persist into 2018 and 2019. Perhaps surprisingly, this is also the risk we are most sanguine about. e bottom-up risks that directly affect emerging markets are low on our list of worries, while risks emanating from developed markets are what keep us up at night. Unlike a decade ago, when there were few strong leading economic growth indicators, today measures such as PMI diffusion indices can quite reliably describe near term growth prospects…”

Lazard says: “The second largest risk for markets is the potential for the Trump reflation trade to return. Recall the aftermath of the US election in November 2016, when investors rushed to sell US Treasury bonds and buy US dollars on the view that significant US stimulus would result in higher growth and, hence, less monetary stimulus. The market’s reaction was swift as 10-year US Treasury yields rose more than 80 basis points to 2.60 per cent and the US dollar appreciated more than 7 per cent in roughly two months. e dollar move sent the greenback soaring past its first-quarter 2016 level, when investors were panicking over falling growth in emerging markets, to its most expensive level in 14 years. Over the next several quarters, however, hopes of significant US stimulus dwindled, US inflation fell, the Federal Reserve took a dovish posture, and the US dollar returned to its pre-election levels.”

And, thirdly: “The largest binary risk, and one that could certainly change the narrative in 2018, emanates from the US Federal Reserve. Fixed income investors, in many ways, have been privileged to invest under the leadership of Fed Chairs Ben Bernanke and Janet Yellen. We believe both have shown extraordinary dovishness in their decision-making and have made large strides to create better transparency around the Fed’s decision-making process.

“Dot plots, early releases of Fed minutes, and speeches by voting members have all helped to develop a clearer narrative around how the Fed intends to withdraw stimulus as the US economy emerges from the global financial crisis. In many ways, that transparency has resulted in lower overall volatility across fixed income asset classes. Glaringly, the one time that the Fed lost control of its forward guidance resulted in the taper tantrum of 2013. Subsequently, the Fed has been extremely cautious in its policy guidance to investors.”