The Economist USA - 26.10.2019

66 Finance & economics The EconomistOctober 26th 2019

2

Buttonwood Away from the crowd

People-pleaser

Source: Datastream from Refinitiv

Price-to-earnings ratio, S&P 500 relative to

MSCI emerging-market index

September 1st 2007=100

1996 2000 05 10 15 19

80

100

120

140

160

180

200

220

B

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 as

msci’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 the

double 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 appeal

Japanese 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 is

activist 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