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Emerging Markets

Emerging Markets Equities, Macroeconomics, Idiosyncratic risk

Does macro matter?

August 2018

John Moorhead, Head of Emerging Equities

In a year dominated by macroeconomic and geopolitical events, we delve into how much macro really matters.

So far in 2018 an emerging market investor has seen macroeconomic and geopolitical factors dominate front and centre. The list includes: Fed rate hikes, US China trade war risks, twin deficits and currency devaluations in Turkey and Argentina, economic sanctions on Russia, unpredictable political outcomes in Mexico, Brazil, Malaysia, and the prospect of denuclearizing North Korea. 

Against this backdrop it is easy to forget that the main driver of EM equity returns is typically stock specific factors.

Breaking down emerging market returns

Of course, macro does matter, but as the chart below shows it accounts for no more than half of the story at most, and this is particularly so at market extremes. 
Over the past c.20 years, stock specific risk has accounted for the majority of emerging market returns.
Emerging market returns breakdown
Source: Deutsch Bank, May 2018 

So why is so much discussion centred on macro?

Well, by and large, I would argue it is because for most people talking about macro and geopolitics is easier than in-depth company analysis. For example, discussing the political situation in India or the crisis in Turkey is much more interesting than talking about the supply/demand balance of the Chinese cement market. (Although members in our team would certainly dispute that!). Also, countries and macro considerations are something you can visit and see. If you visit Brazil, you can arguably form an assessment of Brazil as a country and its culture. It is something one can actually experience. The MSCI EM Utilities index is not palpable in the same way and the financial statements of its constituents are not particularly memorable for most observers. Additionally, macro is largely what the media concentrates on. For example, mainstream news channels will focus on Russia’s political interactions with the West, rather than the encouraging shareholder return policies implemented by many Russian oil producers.

Economic growth is not the same as stock market growth

Despite the overinflated extent to which we discuss macro, the reality is that there is only a minor link between GDP growth and stock market returns. GDP growth can drive earnings, but the stock market’s growth is not the same as the economic growth. In particular, this thinking ignores valuations as the starting point, which can be a significant driver of stock prices. It is true, however, that actual GDP growth and market returns display a positive link in most instances (Korea being the exception that proves the rule in the left hand chart below). This however is an ex-post analysis. As investors in the present moment, we only have access to GDP forecasts and unfortunately as the right hand chart below shows these are very poor predictors of stock market returns.

Realised GDP is linked to market returns... but not forecasts, which are often wrong
Source: UBS, May 2018

So if stock markets are mainly driven by stock specific risk, and economic forecasts are largely futile, why bother looking at macro data?  Of course macro matters but as we said already mainly at the extremes. And by extremes, we mean at points of financial and economic crisis. We work closely with Pictet Asset Management’s economics department to monitor 7 key indicators that have preceded previous financial crises.  They are considered relative to their history and relative to other economies. The key benefit of these indicators is they can help us calibrate the conviction of our stock picks and determine critical areas of risk.  For example, over the years Chinese financials, and property names in particular, should have been caught up in some crisis by now if we had listened to the macro headlines. But the reality is that these sectors have outperformed global emerging markets.

Volatility has clearly returned to global markets, and in the emerging world the volatility is often amplified due to the economic and political precariousness of specific countries. More than ever, focusing on what really matters is critical – and most of the time that is stock picking. So to answer my initial headline. Yes, macro matters some of the time when picking EM stocks but never more than stock-specific, ‘microeconomic’ factors.