Emerging markets still underperforming

It’s been seven days since the largest single devaluation in the Chinese yuan on record, and the fall out on emerging markets (EMs) and commodity base economies remain high.

Source: Bloomberg

EMs in the past seven days have lost 2.6%, while developed markets (DMs) are down 0.6%.

If you look at the moves in the commodities markets, the fall out is even starker:

  • 2009 lows in oil - it’s a long way off the 2009 lows of US $33.89 in WTI and US $38.43 in Brent. However, the demand dilemma on weaker-than-forecasted growth in China, coupled with the USD appreciation will see crude prices even lower in the foreseeable few months
  • 2009 lows in copper, nickel and zinc – again, China growth fears are pushing industrial metals to these lows
  • 2009 lows in CRB commodities index – the link with the AUD here is still very much intact, and a correlation to watch if the CRB continues to slide at alarming rates

The collapse in commodity prices in 2009 was based on the fear that there would be an absolute collapse in global liquidity, and therefore cause a grinding halt in demand for industrial metals.

Now however, with the sustained ramp up in supply coupled with sluggish demand from the world’s second largest economy, a price collapse is imminent – the difference between 2009 and 2015 is that 2015 is a fundamental change in the supply/demand equation rather than the event-driven change in 2009.

China’s trade balances are seeing exports to its second and third largest trading partners, Europe and Japan, grind to a standstill. This will only move the supply and demand equation further to the right, meaning lower prices in the foreseeable future. 

The effect on EMs from the China story is easy to track if you compare the MSCI world index to the MSCI emerging markets index – there is a 20% downside divergence over the past 52 weeks for EMs.

The worst performers in the EM space year-to-date makes for interesting reading:

  • Indonesia down 12.3%
  • Taiwan down 10.8%
  • Malaysia down 9.3%
  • Thailand down 5.4%

These emerging markets have high levels of US-denominated debt and will find it difficult to withstand increases in the Fed funds rate – the possible run-on in EM currencies is also high, with the INR and IND the most likely pair to see the downside in the beginning.

What is also interesting around the fall in EMs is the flow-on-effect to markets with high trade exposure to these markets.

Singapore is down 7.5% year-to-date, Canada is down 1.5%, and Australia is off 1%. There is an element of being oversold in the short-term in Canada and Australia. However, the fundamental shift in the commodities story cannot be denied and will likely see these indices underperforming in comparison to their developed market peers over the coming year.

Ahead of the open

Australia’s earning season rolls on; today sees the likes of QBE, Monadelphous and Sonic Healthcare.

Australian earnings season so far has been relatively positive, with 58% of the 51 companies that have reported so far surprising on the upside on the EPS line, and with 56% surprising on the revenue line. Expectations for domestic-facing industrials was very low leading into report season, at 1% growth in FY15. So in hindsight, it may not be so surprising that over half have beaten estimates.

This week is the one that matters most, as cyclical energy and mining companies report ones that may surprise - including BHP, FMG, WPL and CTX. The ones that may disappoint include STO and ARI.

We are calling the ASX down 13 points to 5354. The data to watch today is the minutes from the RBA; however, it may be obsolete as the China yuan story did not eventuate on 4 August.

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