Citing research from Verdad's Dan Rasmussen, the speaker notes that EM assets perform best when purchased during a crisis that originates in developed markets (e.g., the GFC or COVID). Panicked selling creates widespread mispricing in EM, even though the region is not the source of the crisis, offering a prime buying opportunity.
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For traders, the defining characteristic of an emerging market isn't GDP but how its sovereign bonds behave during risk-off events. If bonds sell off alongside equities when volatility rises, it's an EM. If they rally as a safe haven, it's a developed market, regardless of economic metrics.
After being 'shunned by the world for 10 to 15 years,' emerging market assets are benefiting from a slow-moving, structural diversification away from heavily-owned U.S. assets. This long-term trend provides a background source of demand and support, contributing to the asset class's current resilience against short-term volatility.
A powerful EM strategy involves identifying businesses with proven, powerful models from developed markets, like American Tower. Local EM investor bases may not be familiar with the model's potential, creating an opportunity to buy these companies at a displaced valuation before their predictable results drive multiple expansion.
During a crisis, equity and loan portfolios can become completely illiquid. However, currency liquidity almost never disappears. Therefore, a deep capability in FX instruments is the most critical risk management tool for an EM investor, allowing them to hedge when other markets are closed.
During periods of country-specific fear or uncertainty, investors sell off all assets indiscriminately. High-quality companies are discarded along with low-quality ones, making country-level risk analysis more critical for investors than sector or individual company analysis.
Emerging vs. developed market outperformance typically runs in 7-10 year cycles. The current 14-year cycle of EM underperformance is historically long, suggesting markets are approaching a key inflection point driven by a weakening dollar, cheaper currencies, and accelerating earnings growth off a low base.
Despite alarming geopolitical headlines concerning Venezuela, Iran, and US-NATO relations, emerging markets are showing resilience. Investors are largely ignoring this "noise," focusing on the strong cyclical backdrop: upward growth revisions, loose financial conditions, and supportive commodity prices. Markets are prioritizing the global economic outlook over political shocks unless those shocks directly threaten growth.
Stronger US growth isn't hurting EM currencies because growth is also being revised up globally in places like China and Europe. This prevents a repeat of the 'US exceptionalism' theme that typically strengthens the dollar and pressures EM assets, making the current environment less problematic for EMFX.
Despite being at historically tight levels, EM sovereign credit spreads are unlikely to widen significantly from an EM-specific slowdown. The catalyst for a major sell-off would have to be a 'beta move' originating from a crisis in core US markets, such as equities or corporate credit, given the current strength of EM fundamentals.
EM assets show resilience to headline volatility because investors learned from past "on-off" tariff threats not to overreact to U.S. statements. This hesitancy to respond to policy that can be reversed in a tweet creates a buffer against short-term swings, contrasting with more reactive markets like U.S. equities.