2023-04-20 23:43:37 ET
Summary
- EWX offers good value and earnings growth.
- EWX is strongly exposed to a high-growth terrain although political risks in Taiwan should be monitored.
- The dollar could make a comeback and small-cap themes tend to be vulnerable in risk-off environments.
Asia is rich in people, rich in culture, and rich in resources. It is also rich in trouble. - Hubert Humphrey
Introduction
In last week’s ‘global view’ section of The Lead-Lag Report, I noted how emerging markets were looking interesting again. Within this broad EM space, I thought it would be a good time to review the prospects of the SPDR S&P Emerging Markets Small Cap ETF (EWX). EWX focuses on over 2,800 EM stocks with market-cap of less than $2bn. If you’re contemplating some exposure to this product, here are some important guidelines that may abet your decision.
Good alternative to pricey US stocks
Last week I published a macro piece in my subscription service highlighting how those pursuing domestic stocks were doing so wearing the hood of complacency. It’s one thing to be overly bullish when valuations are cheap but the S&P 500 currently trades at 18.6x ; this is around 25% higher than the long-term median multiple of 15x. The S&P 500 is on course to deliver long-term earnings growth of 11.6% but do consider that the majority of earnings revisions are yet to come through and that growth number may likely be brought down. Conversely, the most popular EM ETF - The Vanguard FTSE Emerging Markets ETF ( VWO ) - offers a similar level of earnings growth of 11% but is priced at a much lower multiple of 11.8x.
Interestingly enough, our focus ETF - EWX - offers the best trade-off out of the lot. On a forward P/E basis, it trades at just 9.58x, yet offers superior long-term earnings potential of 14%!
Heavily exposed to EM-Asia
Prima facie, even if EWX is expected to fish for small-cap opportunities across the globe, it still tilts very heavily towards names in Asia. This region accounts for a whopping 74% of the total holdings. If growth prospects here were to turn sour, that would reflect poorly on EWX, but interestingly enough, based on the latest WEO report by the IMF, investors ought to feel relatively sanguine. Over the next two years, the IMF expects EM-Asia to offer the best growth prospects (incidentally the only terrain to offer 5% plus growth levels).
In yesterday's 'macro view' section of The Lead-Lag Report, I've also noted how a few EM-Asia banks such as the Reserve Bank of India ((RBI)), and the Bank Indonesia (BI) are doing their bit to preserve the growth narrative, without overtightening too much. Earlier this month, contrary to market expectations of a 25 bps hike, the RBI maintained its repo rate at 6.5%. BI has been maintaining the status quo for 3 straight months now. These developments should help support sentiment for equities in those shores.
However, as noted in a tweet on the timeline of The Lead-Lag Report, if EM-Asia is to truly flourish, you'd want China to step up its game. One can't have too many complaints about the China re-opening trade, particularly as the recent GDP growth number came in at 4.5% , above Street estimates of 4%, but there’s still room for improvement as it is still below the Chinese government’s target.
Be mindful of political developments in Taiwan
More than China, investors would also need to watch out for political developments in Taiwan, as holdings from that nation currently account for 28% of the portfolio (the largest share). This part of the portfolio could likely produce a lot of volatility as we are currently less than 9 months away from an election. If William Lai, the Democratic People’s Party ends up winning the election, it would be taken negatively by China, as he is someone who is very keen to assert Taiwan’s independence. This may prompt China to exert greater pressure on Taiwan, and who knows how the US could react to that. One thing is for sure, Taiwan does not have the luxury of losing China as a trade partner as the latter currently contributes 23% of overall trade.
Other risks
As pointed out in a tweet from The Lead-Lag Report Twitter account, I suspect the dollar could be due a bout of mean-reversion, as it looks quite oversold. Needless to say, this doesn't bode well for EM-themed assets. We have also seen previously how it rebounded quickly once it dropped to the 101 level.
Besides, I also suspect it could once again start exhibiting its safe-haven qualities (just like treasuries) as risk-off conditions gather pace.
I recently published an Instagram post noting how conditions for a market top and another bout of correction have been picking up pace. If risk sentiment toward the broader markets goes out of the window, EWX could remain particularly susceptible given its strong exposure to the small-cap cohort.
For further details see:
EWX: The Onus Is On Asia