- US tech has been the undisputed market king for much of the past decade, but one Wall Street expert says that dominance will shift in 2019.
- Vincent Deluard, macro strategist at INTL FCStone, lays out why an overlooked and underappreciated area of the market is primed to explode higher this year.
If you had to pick the definitive market theme of the decade, the obvious choice is mega-cap US tech and the immense success it’s enjoyed.
The group’s fame has grown to a level where its elite members have their own acronym. At this point, the so-called FANG cohort — consisting ofFacebook,Amazon,Netflix, andGoogle— is easily recognizable to even the most passing follower of markets.
But one market expert says that dominant position will move from tech toemerging marketsin 2019. That would beVincent Deluard, a macro strategist at INTL FCStone. He simultaneously argues that EM concerns are overblown, and that investors are overlooking major potential in the area.
“2019 will be a pivotal year during the growth baton will shift once again from the U.S. tech sector to emerging markets,” Deluard wrote in a recent client note.
Before we get into Deluard’s bullish reasons for favoring EM, it’s first important to lay out his points dispelling what he sees as some inaccuracies swirling around the group. After that, we’ll get into his pro-EM arguments.
Negative misconceptions people have about EM
(1) Growth in China is slowing, so you should sell the entire EM group
Deluard’s first issue with this line of thinking is what he sees as the unreliability of Chinese economic data. He also argues that, despite the nation’s recent struggles, it still possesses the ability to unleash “massive” fiscal stimulus upon the world.
Beyond that, Deluard says China’s contribution to EM performance is frequently overstated. He uses the chart below as evidence. As you can see, India has added $2.1 trillion to its gross domestic product over the past 17 years — a period that saw exports to China climb by just $12 billion.
“Economic growth, and especially emerging markets growth, is primarily an internal matter,” Deluard said. “Demography, domestic investment, and public policies matter a lot more than exports to China.”
(2) There’s a global trade war raging, so you should sell EM
Deluard’s argument here is that people make questionable assumptions when they consider thetrade war‘s impact on EM. He says the biggest misconception they have is that non-China EM will get caught up in a “protectionist spiral,” similar to one they experienced in the 1930s.
“South Korea, Chile, Peru, Malaysia, Indonesia, Thailand, and Vietnam have the industrial base to replace most of China’s exports to the U.S. and the ability to be courted by both superpowers,” Deluard said. “These countries also benefit from growing domestic markets, cheap currencies, and pro-free trade governments.”
(3) The Fed is hiking interest rates, so you should sell EM
For this one, Deluard uses good, old-fashioned historical data. He points out that the period from 2003 to 2007 saw incredible EM returns, even as the Fed hiked interest rates 17 straight times.
Deluard also notes something that many others have already concluded: that the Fed may be done raising rates, at least for the foreseeable future.
Bullish arguments in favor of EM
(1) EM is a good hedge against a weak US dollar
“Nothing is holding the greenback against the growing threat of rising deficits, slowing economic growth, political bickering, rising inflation, and the de-dollarization of Eurasian trade,” Deluard said.
He continued: “Emerging markets’ mountains of US dollar debt, which are still viewed by many as the greatest macro risk, would become a fantastic source of return.”
Deluard concludes that EM economies were right to use cheap US dollar borrowing costs to finance their growth, and that they’re now in a position of relative strength.
(2) EM will be a good source of uncorrelated return
The basis of this argument is simple: EM has been moving independently of macro drivers, which has insulated it from deep losses in other areas of the global market. Combined with the other positive factors outlined in this piece, it adds to the bull case for EM.
“The bulk of recent emerging markets returns came from idiosyncratic factors,” Deluard said. “This performance was achieved despite severe equity losses which usually causes correlations to spike.”
The chart below shows this dynamic in action, with residual alpha returns surging:
(3) EM is ideal for the age of “slowbalisation”
Let’s start with a definition. “Slowbalisation” is a term coined by theEconomistin a recent issue, and it refers to the idea that the “secular increase in trade and cross-border flow reached a peak with the global financial crisis.”
Deluard isn’t buying it. Looking back at history, he points out multiple examples of EM economies thriving amid conditions that forced them to be self-sufficient. He specifically cites the “Mexican growth miracle” of 1940 to 1970 and the post-war industrialization of the Soviet Union.
“I suspect that the positive effects of free trade are routinely over-estimated by mainstream economists, especially when it comes to emerging markets,” Deluard said.
He continued: “China, which broke all the rules, was the big winner of the great globalization of the past two decades. The nascent era of slowbalisation may be an opportunity for other emerging markets to shine.”
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