66 Finance & economics The EconomistOctober 26th 2019
2Buttonwood Away from the crowd
People-pleaserSource:DatastreamfromRefinitivPrice-to-earningsratio,S&P 500 relativeto
MSCIemerging-marketindex
September1st2007=1001996 2000 05 10 15 1980100120140160180200220B
ill hicks,a much-mourned comedi-
an, would pause in the middle of his
act as if a thought had just occurred to
him. He would ask that anyone in the
audience who worked in advertising or
marketing kill themselves. This was the
only path to redemption now left open.
No one took up his invitation. I know
what the marketing people are thinking,
he would then say. The anti-marketing
dollar, that’s a good market. Look at our
research! Bill is smart to tap into it.
Such next-level thinking comes to
mind whenever the case for emerging
markets is considered. For professional
investors, diverting capital from Ameri-
ca’s stockmarket to other less-blessed
places seems like an invitation to career
suicide. The dollar’s continued strength
is kryptonite to emerging markets. They
feel the damage from the trade war most
keenly. Sure, emerging markets look
cheap. But there is no law saying they
cannot become even cheaper.
Cheapness aside, though, there is
another, less appreciated, side to emerg-
ing markets. As capital rushes into an
ever narrower set of favoured rich-coun-
try assets, there is growing anxiety that it
might all suddenly unwind. At least
emerging markets are an uncrowded
trade. This is a paradox that tricksy mar-
keting types should appreciate: the
unloved asset class, that’s a good market.
You might be wise to tap into it.
But why are emerging markets out of
favour in the first place? The perennial
fear is they are crisis-prone. Look at
Argentina. It has moved with breathtak-
ing speed from default to emerging-
market darling and then—unhindered by
a $57bn imfsupport package—back to
the brink of default. But fear of crises is
not the only reason for caution. Indices
of emerging-market stocks, such asmsci’s benchmark, lean heavily towards
Factory Asia, and thus to China’s supply
chain. This puts investors on the front line
of the trade war. Even away from the
trenches, there is plenty to fret about.
India has failed to fix its broken banks. The
fractious politics of the ancin South
Africa get in the way of much-needed
reforms. Russia lacks a convincing eco-
nomic-growth story. The list goes on.
Emerging-market crises follow a pat-
tern. Foreign investors head for the exit,
and there are not enough domestic buyers
to replace them. Some factors can make
this kind of liquidity-driven crisis more
likely: a bloated current-account deficit;
an overvalued currency; lots of short-term
debt; or runaway inflation. But these days,
such vulnerabilities have become rare.
The bigger emerging markets tend to
have freely floating currencies. This mil-
itates against the build-up of external
debts and internal pressures. Their in-
dependent central banks aim for low
inflation. Most of the 25 emerging markets
listed on the indicators page of The Econo-
misthave inflation below 4%. It is in thedouble digits in only two—Argentina and
Pakistan. Low and stable inflation has
allowed the local market for government
bonds to deepen. Debt burdens financed
at short maturities make countries more
crisis-prone. Long-term debt makes
them more stable. According to the imf,
the average emerging market has public
debt of 54% of gdp, around half the
rich-country norm. The average maturity
of debt is similar, at around seven years.
All this has made emerging markets
much less brittle. Yet assets trade at a
discount. The price-to-earnings ratio for
the msci index of emerging-market
stocks is below its average since the
mid-1990s. It looks even better value
when compared to that in the rich world.
The s&p500 share-price index has only
rarely been dearer relative to emerging-
market stocks than it is now (see chart).
You should expect out-of-favour
markets to be cheap. But they also have a
less appreciated appeal. They tend to be
uncrowded, and so less at risk of a sud-
den surfeit of sellers over buyers. If
liquidity risk has fallen in emerging
markets, it has probably risen in devel-
oped ones. The worry is that investors are
chasing the same assets: the safest gov-
ernment bonds; investment-grade cor-
porate bonds; technology stocks; and
dollar assets in general. The more in-
vestors cram into these markets, the
greater the risk of a rush to the exit.
An allocation to unloved assets in-
sures against such herding. It is hard to
drum up much enthusiasm for the lead-
ership or growth trajectories of China,
India, Russia and the rest. There are few
if any captivating stories of reform and
renewal. But the appeal of emerging
markets is in their very lack of superficial
appeal. Some bright marketing spark
should put that on a billboard.The deep appeal of emerging markets is in their very lack of surface appealJapanese firm, say, be considered an at-
tempt to influence management? The up-
shot is that investing becomes more con-
voluted and time-consuming. One analysis
concludes that the new rules mean an
eight-fold increase in applications to the
government.
Officials say they are just playing
catch-up. The European Union tightened
its screening of inward investment in
April. America has expanded its regime,
and even prodded Japan to reduce Chinese
access to sensitive technology. But a for-
eign banker in Tokyo says the real target isactivist investors. “The wording in Japa-
nese is very specific about targeting inves-
tors who want a say on boards.”
Activists have long fought for Japanese
companies to sell non-core assets and stop
hoarding cash. In recent years they have
clashed with some of the nation’s cor-
porate giants. They have been leaning on
Nissan to sack its managers and draw a line
under the era of Carlos Ghosn, the carmak-
er’s former boss. Earlier in the year a New
York investment fund tried to force Kyushu
Railway, a regional transport firm, to boost
stingy returns to shareholders.Ironically, Mr Abe can take some credit
for this flurry of activism. By badgering
bosses to change crusty boardroom prac-
tices, he has emboldened investors. The
number of big listed firms with two or
more external directors, for instance, has
tripled since a corporate-governance code
was introduced in 2015.
But many foreign investors already
seem to be questioning the sincerity of the
government’s reforms. Last year they
dumped ¥5trn ($48bn) of Japanese stocks.
Overseas investors once bought Abenom-
ics. Now they want to sell. 7