May 2020
Global equity markets experienced a dramatic and sharp sell-off in March, followed by a sharp rebound in April. We are all being bombarded by a plethora of data, emails and news articles, but it can be tough to parse the information from the noise. Here at Nipun, we have received a number of questions from institutional allocators on the current state of Emerging Markets and the opportunity set these markets present. This note synthesizes our responses to some of the commonly asked questions.
Where do you see value in Emerging Markets currently?
We, at Nipun, are long term believers in value investing, but to us, value does not equal cheapness. We evaluate valuation in the context of future fundamentals. For example, based on standard value metrics like P/B, P/E and dividend yield, Latin America as a region appears cheapest. However, these metrics can be deceiving. Latin America has had to deal with a host of economic challenges over the last few years. Regional GDP growth was only 0.6% in 2019, well below expectations. The region also faces significant macro issues including high levels of public debt and large current account deficits. The arrival of COVID-19 has unfortunately worsened the outlook for the region.
By comparison, North Asia has held up better year-to-date, and appears to be more fairly valued on the basis of expected earnings and fiscal stimuli. This region has been more effective in controlling the virus, and therefore firms in this region offer better earnings visibility than many countries in South Asia where the full extent of the damage from the virus is still unknown.
At this juncture, when future fundamentals are uncertain, there is a heightened risk to value investing. Higher risk can also lead to higher returns. We are reminded of our experience in March 2009 when the recovery after the Global Financial Crisis led to large returns to value strategies.
Momentum has been effective as a stock selection factor. What is your view on momentum?
Within Emerging Markets, stocks that currently rank well on momentum are generally beneficiaries in the COVID-19 environment. A case in point are healthcare related stocks or stocks that benefit from a “stay-at-home” theme. Some “safe” assets like gold-related stocks also have a reasonable a degree of momentum. Our proprietary metrics currently show a high degree of crowding in the momentum trade. Looking back historically, a crowded momentum trade portends a heightened risk of a sharp draw-down. Instead of price momentum, we prefer to use sharper and less crowded measures of investor sentiment. For example, we evaluate different investor flows in each major market to decipher the sentiment of key market participants. Our goal is to identify early stage momentum stocks and avoid late stage crowded momentum trades.
What opportunities has this crisis created in Asia and Emerging Market equities?
There is currently a big disconnect between the impact that the virus is having on economic activities, and the still relatively high consensus earnings’ expectations. We believe that the upcoming earning season will bring significant surprises. Market reaction to earnings will also be larger than usual, similar to what we observed during the time of the Global Financial Crisis. Referring back to our GFC playbook, we have added a number of relevant signals to predict near term earnings surprises, which can generate significant alpha for our investors. We are focused on near term earnings rather than on style tilts like momentum or value as we see better risk adjusted opportunities in this trade.
Given the uncertainty in earnings, how can you predict future fundamentals effectively?
Historical fundamentals can be less relevant during periods of sharp economic inflection, like the one we are currently experiencing. Further, many earnings estimates for companies become less reliable. Our research shows that analysts are slow to revise estimates downwards, especially when there is a lack of clarity. Recognizing this, we have adapted our models and added new signals that better predict near-term fundamentals. In addition, to assess longer-term fundamentals, we have added new measures that reward companies with strong balance sheets and an ability to shore up their balance sheet.
We utilize several data points that are timelier than earnings. Examples include news, company press releases and announcements, as well as information from globally related stocks. A good case in point is our favorable view on food retail and hypermarkets. While apparel retail stores have struggled in this sell-off, our analysis across global food retailers suggest strong near term earnings. Predicting earnings surprises effectively has always been a winning strategy and we believe the rewards to this are likely to be outsized when Q1/Q2 2020 earnings are announced.
Disclaimer:
While many of the thoughts expressed in the attached materials are stated in a factual manner, the discussion reflects only Nipun’s beliefs about these investments and the related markets. These materials may contain forward-looking statements based on Nipun’s expectations and projections about these investments. Those statements are sometimes indicated by words such as “expects,” “believes,” “will” and similar expressions. In addition, any statements that refer to expectations, projections or characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Such statements are not guaranties of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual returns could differ materially and adversely from those expressed or implied in any forward-looking statements as a result of various factors. The attached information was prepared as of the date hereof, and may be different as of the date you review it. Nipun and its affiliates undertake no obligation to revise or update any statement in these materials for any reason.
