Buttonwood – Could the vaccine help ailing emerging-market shares?

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    Editor’s note: Some of our covid-19 coverage is free for readers of The Economist Today, our daily newsletter. For more stories and our pandemic tracker, see our hub

    AN INDIAN ECONOMIC official once remarked to Buttonwood that his country’s economy does best when the rest of the world does well—but not too well. India’s exports benefit from global growth. But when the world economy gains too much momentum, interest rates and oil prices can rise uncomfortably high, hobbling a country that is a net importer of both capital and crude.

    His observation came to mind as India’s stockmarket roared to a record high on November 10th, after news that a covid-19 vaccine developed by Pfizer and BioNTech was proving more effective than expected. It will be months before it becomes widely available even in the countries equipped to handle it. But the reproduction number of investors’ exuberance can be very high.

    Another spur to India’s stockmarket—and to emerging-market equities more broadly—was America’s election. The result, when it emerged at last, removed one lingering source of uncertainty. That has made room in investors’ stomachs for other types of risk. The renewed appetite for edginess helped lift MSCI’s benchmark emerging-market equity index by over 6% from November 3rd to 9th. It is now up by more than half from its lowest point in March.

    Though Wall Street has been setting records, the emerging-market index is still far from the all-time high it reached in 2007 or even its peak in 2018. Indeed over the past decade emerging-market shares have made little forward progress, albeit by the most nail-biting route possible. Big gains in 2012, 2016-17 and 2019 were offset by spectacular falls in the intervening years. Overall the index is just 3% higher than ten years ago.

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    That underperformance, however, leaves emerging-market stocks looking much better value than their rich-world counterparts. According to Oxford Economics, a consultancy, the ratio of price to earnings, adjusted for the cycle, for emerging markets lies in the bottom half of its historical distribution. America’s ratio, by contrast, is above the 98th percentile.

    The valuation gap looks even more glaring when compared with immediate growth prospects. The GDP of emerging markets, weighted according to their stockmarket capitalisation, will shrink by less than 2% this year and grow by about 5% in 2021, according to forecasts by the Economist Intelligence Unit, a sister company of The Economist. America is doing better than most of the rich world, but even so its economy will still shrink by 4.6% in 2020 and grow by less than 4% in 2021. Some members of the MSCI’s index, such as China and Taiwan, have handled the pandemic well, allowing for an early return to growth. Others, such as India, have handled it badly. But precisely because their first attempts at lockdowns were so ineffective, they are unlikely to interrupt growth by trying another one.

    These discrepancies have not gone unnoticed. Some strategists think that unloved emerging-market shares might benefit from the kind of “rotation” that in the past few days has propelled investors out of expensive “growth” stocks (such as tech) and into “value” stocks, the revenues of which are more closely tied to the state of the economy.

    They also think that the most beleaguered emerging markets might benefit from a rotation within the rotation. John Lomax of HSBC, for example, recommends increasing holdings of countries like Brazil and South Africa (which are still heavily down on the year) at the expense of Asian ones, like Taiwan.

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    There may be a catch, though. Emerging-market assets may be priced like value stocks. But in another important respect—their sensitivity to bond yields—they more closely resemble growth stocks. When interest rates and bond yields rise, investors become less willing to bear risk or wait for future profits. That hurts growth stocks and emerging markets alike.

    Consider the following scenario. The Pfizer vaccine is approved. But because it must be stored at Antarctic temperatures, it never reaches the emerging markets, such as India, that lack the cold chains needed to distribute it safely. The vaccine might therefore spur an uneven recovery, led by rich countries.

    That rebound could put upward pressure on bond yields: the Pfizer news alone raised yields on ten-year American Treasuries to almost 1% on November 9th. And the tightening of global financial conditions could hurt emerging economies by more than the improvement in rich-world growth helps them. They could do badly, if the rest of the world does too well.

    Editor’s note: Some of our covid-19 coverage is free for readers of The Economist Today, our daily newsletter. For more stories and our pandemic tracker, see our hub

    This article appeared in the Finance & economics section of the print edition under the headline "Coming out of the ultracold"


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