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Alpha, value and risk in emerging markets

The election of Donald Trump led to 14-year high in the US dollar, a spike in the 10-year US Treasury note yield and carnage in emerging markets currencies, local debt and equities. Yet all is not doom and gloom in emerging markets for 2017, despite Trump's campaign promise to scuttle NAFTA/TPP and impose tariffs on China and Mexico. There are multiple reasons why investors can make serious money in selected emerging markets in 2017, as they did in Brazil, Russia, Taiwan, India and Pakistan in 2016. Why?
One, emerging markets earnings momentum and dividend payouts have begun to rise after a brutal, five-year bear market.
Two, emerging market free cash flow yields have begun to rise. Three, some emerging markets currencies are dirt cheap despite King Dollar. Four, valuations discounts relative to a S&P 500 index trading at almost 20 times earnings. Five, China's fiscal and monetary stimulus defuses another 2015 style "Shanghai shock".
Six, the Opec oil output deal stabilises Brent crude and boosts the outlook for petro economies from Russia to West Africa to the GCC. Seven, Trumpflation could nudge inflation expectation higher - and boost industrial commodities. Copper's biggest rise in 30 years after the election is nirvana for markets as diverse as Chile and Zambia. Eight, fund managers are still underweight emerging market equities. Nine, geopolitical black swans are now in France, Britain, Italy and the US. These ten reasons make me a nervous, cautious bull on this asset class.
I concede that even a 50 per cent discount in emerging markets currencies to their purchasing power parity level will not magically make this asset class a money gusher if the Federal Reserve is forced to aggressively tighten in 2017 or the Trump White House ignites a trade war with Mexico or China. Yet some emerging markets currencies now trade at 1998 Asian flu or 2008 post Lehman levels.
In at least a dozen countries, the risk reward calculus is now both compelling and flashes a buy signal. Currencies alone are not a catalyst to go gaga over the embattled asset class. Earnings revisions has gone positive even in Mexico (peso down 11 per cent since Trump's win), South Korea (a nation mired in a Presidential crisis), Taiwan, China and Russia (a nation at war in Syria and Ukraine).
While India is the consensus darling of Wall Street, I believe Modi's crackdown on black money has backfired and will lead to a major hit in economic growth, earnings, margins, supply chains and business confidence. It is no longer prudent to pay 18 times earnings for Indian equities and I expect the rupee to depreciate to 73-74 next year. While single stock ideas do exist, I am not long Indian country indices on Wall Street.
Turkey and Malaysia are also two markets I will not invest in. The Turkish country index fund (symbol TUR) hit new lows last week as Erdogan's 100,000 person purge of alleged "Gulenists", his tirades against international bankers (whom he blames for the end of the Ottoman Empire, as if Enver Pasha's reckless embrace of Wilhelmine German in 1914 meant squat), renewed wars against the Kurdish PKK, tensions with Iraq and Russia just make Turkish equities impossible to value. Malaysia's ringgit has also tanked to 4.45, levels last seen when Mahathir imposed capital control during the 1998 Asian currency meltdown. Prime Minister Najib Razak's refusal to resign despite the sordid 1MDB sovereign wealth scandal has led to an exodus of offshore capital from the Kuala Lumpur Borse - a real shame.
I believe Poland could well be a major winner in 2017 as its stock markets are undervalued. Russia is also in a stellar bull market, despite the 70 per cent rise in its major bank Sberbank, recommended in this column. Pakistan's rupee and stock market has remain unscathed since the election and Trump's lavish praise of Nawaz Sharif is also bullish though I am horrified by the emerging hot war on the Line of Control in Kashmir.
Asian equities have the potential to deliver 20-25 per cent total returns next year, from Singaporean bank to Indonesian conglomerates, from Chinese life insurers and Thai property stocks. South Korea could be the emerging market Cinderella of 2017 if President Park resigns. The Bank of Korea will opt for uber easy money, so the won depreciates faster than the yen and so boost exporter profits. South Korea is Asia's ultimate deep value market, unloved and underowned, ripe for restructuring. So go Gangnam style in the Hermit Kingdom!