As we see the US emerge from the winter hibernation (Retail Sales, Industrial Production, Jobless Claims), we are also seeing signs of Emerging Markets recovery on Macro.
One implies the other and while China remains a weak spot, we do not think it’s a headwind anymore, its just not a tailwind. All of this adds up to a view Emerging Markets can begin to make a tactical move on the asset allocation front. We do NOT think this is a quick or easy turnaround, but we do think three years of marginally declining growth in EM has hit an inflection point.
Higher rates throughout the EM world where current account issues and inflation are issues – Brazil (EWZ, quote), Turkey (TUR, quote), Russia (RSX, quote), India (EPI, quote) and South Africa (EZA, quote) will keep growth lower than in places where they do not have to normalize interest rates as quickly – Korea (HCOR, quote), Indonesia (EIDO, quote), Philippines (EPHE, quote), Poland (EPOL, quote) and Chile (ECH, quote).
The implication is that all EM growth is not created equal. G3 acceleration is welcomed in EM and some countries are better positioned than others to share in stronger EU and US growth.
Look for better manufacturing uplift in EM Asia (ex. China). We like Mexico (EWW, quote) to benefit from the US and their own reform agenda but caution that Mexican equities are not cheap. We think CES (Czech, Poland, Hungary) can surprise investors as the EU is growing faster than expected. Some market economists are calling for a small pullback in 2Q in EU and Japan (EWJ, quote), but we think that any pause will be temporary. PMIs in Europe have been in expansion mode for over 27 months and are not falling off in the near term.
On China (FXI, quote), this week’s data points confirmed what we knew: China slowed dramatically in 1Q as the PBoC approach to credit tightening hit its target. China’s pullback was engineered, not the result of economic missteps. Watch for a pickup in exports in the next 3 months, and watch for signs that policy makers are more comfortable with credit conditions and the level of the currency. All of this will play into a long China position that can be approached over the next 3-6 months.