Chart Of The Week   October 15 2021

When To Turn More Sanguine On EM Equities?

bearish EM equities

China’s money and credit cycles drive Chinese imports and therefore ultimately impact emerging market economies and EM corporate profitability. Thus, the moderation in China’s money and credit cycle is negative for EM risk assets. In particular, the slowdown in China’s M1 money growth indicates that a deceleration in EM EPS is imminent.

Going forward, Chinese policymakers are likely to ease policy and Chinese credit growth will bottom over the coming months. Emerging market equities will probably cheer these developments. However, given that Chinese credit growth is unlikely to accelerate meaningfully, the rally in EM equities should ultimately be faded. Instead, our Emerging Markets strategists recommend that investors await a sharp deterioration in sentiment towards EM and a capitulation in EM stocks before shifting to a more favorable outlook for EM risk assets.

One gauge investors can monitor to time the bottom in emerging market stocks is analysts’ net EPS revisions for EM equities. Net EPS revisions have only recently crossed into negative territory and still have scope to fall further. A significant deterioration in EPS expectations would serve as a positive signal that sentiment is sufficiently depressed – and now reflects the risks to EM corporate profits from weaker Chinese imports. This development would warrant an upgrade to the outlook for EM risk assets. Until then, investors should maintain an underweight allocation to EM stocks relative to DM equities.