On Monday 9 March, rising fear over the coronavirus pandemic and panic in oil markets prompted indices to record their largest one-day fall since the financial crisis. Emerging-market equities have particularly suffered, as poor liquidity, a strengthening US dollar and heightened risk aversion mean investors have shunned the asset class. The MSCI Emerging Markets Index fell by more than 30% from its peak in the middle of February to its trough a month later.
There are also concerns that emerging-market countries – unlike their developed market counterparts – do not have the fiscal or monetary levers to support their economies, while a global recession invariably means a reduction in US dollar funding to EMs (and so hurts their ability to repay debt).
In it for the long term: a good time to buy?
While the widespread market turmoil has created significant stress for emerging-market investors, there are also opportunities for those with a long-term mindset. Bear markets are generally characterised by low valuations and, in the words of Sir John Templeton, “The time of maximum pessimism is the best time to buy.”
As investors sell assets that they deem to be riskier, emerging-market equities are discounting the negative impact of the market sell-off to a much greater degree than developed-market stocks. The price/earnings ratio for emerging markets is currently trading at a 20% discount to that of developed markets.
Emerging markets: booking in the discount
However, companies are struggling to adjust their earnings forecasts to account for the impact of the coronavirus pandemic and oil-price shock. This means that price/book (PB) valuations offer a much better assessment of how cheap emerging-market stocks are on a historical basis. PB ratios compare the price of the stock to its book (or net asset) value, with a low reading indicating that the company is cheap relative to the value of its assets.
The PB ratio for emerging markets is currently 1.23 times, which is close to a ten-year low. This is a 38% discount to developed markets, compared to the long-term average of 16%. The discount is now two standard deviations below its ten-year median and is close to the levels seen during the financial crisis (see figure 1).
Figure 1. Emerging markets are trading at a discount to developed markets
Source: Bloomberg, as at April 2020. Best price/book and best return on equity is calculated as blended forward 12 months.
This is a notable discount, given that emerging-market companies are delivering a return on equity in line with developed-market firms (see figure 2).
Figure 2. Developed and emerging markets offer a similar return on equity
Source: Bloomberg, as at April 2020.
Importantly, history shows that periods when PB multiples are at these low levels tend to be followed by positive returns over the next 12 months. An additional benefit for emerging-market Asian firms is the fact that the assets reflected in their book values are considerably more tangible than that of US companies.
Currency and oil: another boost?
In addition to being very cheap, emerging-market equities should also be supported by currency movements. There is a strong correlation between emerging-market stock returns and the performance of their currencies, which has remained in place during the current crisis. Emerging-market foreign-exchange indices are at all-time lows, which means there is a good chance of a rally – and potentially higher equity returns.
Developments in oil markets should also support this. The price of US oil for delivery in May recently fell below zero, as the market struggled with oversupply and producers started to pay buyers to take the commodity off their hands. Meanwhile, Brent crude, the international benchmark, sank below $20 a barrel. When the oil price last fell below $20 in 2001, emerging-market equities outperformed US stocks over the following five years.
While low oil prices will hurt commodity-sensitive economies, they are a boon to net energy importers – such as India and Indonesia – which make up 70% of emerging-market economies.
Samsonite: extremely cheap
We are currently invested in Samsonite, an Asian luggage manufacturer, which is a good example of an emerging-market company that is trading at historical lows. Its PB ratio stands at 0.63, which indicates that its market price is less than the value of its assets (see figure 3). These valuations seem to suggest it faces imminent risks, which – even with a prolonged coronavirus impact – do not seem likely over the next two years.
Figure 3. Taking a tumble: Samsonite’s PB ratio
Source: Bloomberg, as at April 2020.
The firm has $400m in cash and $1.2bn-worth of liquidity, while it has successfully refinanced with no major debt obligations until 2025 and is conservatively managing its dividends and investments. Samsonite has a 20% market share in the luggage industry and should benefit from the pick-up in travel as the impact of the coronavirus eases. While sales are likely to fall by 28% this year, they could rebound by 25% in 2021.
Drawdown discount: looking beyond the noise
For those with a long-term horizon, widespread pessimism and low valuations offer an opportunity. However, investors must weigh the possibility of a permanent economic damage if the coronavirus lockdown continues.
As a result, it is necessary to undertake a critical assessment of current and potential investments. This involves considering whether a company can survive the turmoil, emerge stronger relative to its competitors and benefit from the consolidation that will eventually take place.
We believe that the emerging-market structural-growth story remains intact, driven by an aspiring, growing middle class, rising digitisation, reforms and infrastructure development. As industries consolidate, companies with strong balance sheets and capabilities will benefit from these structural drivers of growth.
Although challenges remain, we do not view the current environment as a threat. Instead, we see it as an opportunity to increase our exposure to excellent, quality companies that are now available at discounted prices.