It makes sense that quantitative easing is good for emerging markets, given the fund flows that it creates, out of the U.S. and into markets where growth is stronger and interest rates are higher. Yet has the emerging markets (EM) rally been nothing more than this? How dependent is it on the U.S. Fed, rather than domestic drivers in each nation?
Credit Suisse thinks there’s far more to the strength in EM than U.S. monetary policy alone. Don’t forget that earnings are indeed soaring:
Credit Suisse’s Sakthi Siva:
MXEF (MSCI Emerging) is up 20% so far in 2H10. One of the most frequently asked questions in our recent round of client visits in the US, Singapore and Hong Kong is whether the current 20% rally in MXEF (MSCI Emerging) is driven by just expectations of QE 2 (Quantitative Easing). The concern is whether GEM corrects when we get QE 2 (FOMC is on 3 November), particularly if QE 2 is smaller than expected. While there is a -0.74% correlation coefficient between the DXY (trade-weighted dollar) and MXEF, we attribute more of the rally to solid fundamentals – earnings, soft landing, and potentially a bottoming in global IP.
Don’t forget earnings as GEM earnings are now 39% above 2007. If we index EPS to 100 on 31 December 2007, GEM earnings at end-2010E are 39% above 2007, and at end-2011E potentially 60% above 2007.
So earnings are surging, and it’s worth noting that despite the excitement for emerging markets thus far post-crisis, if you look at the MSCI index for emerging and frontier markets (Bberg: MXGME IND), then you’ll see that it hasn’t yet reached its pre-crisis highs.
So while there’s always room for quantitative easing to disappoint markets, as this has surely been one key driver, emerging markets have an earnings-growth engine to run on as well, so they can likely weather the storm. The real threat isn’t a disappointment when it comes to U.S. QE, but rather the potential for some sort of sharp crisis out of China as that nation threats the needle between growth and excess. Luckily, thus far China seems to be managing its soft landing rather well.
(Excerpt above via Credit Suisse, GEM Strategy, Sakthi Siva, 29 October 2010)