During May, the strategy outperformed the MSCI Emerging Markets index by 1.2%
The main contributors to performance were China and Taiwan. This was partly offset by continued weak performance from Brazil where concerns about delayed Fed rate cuts continued to weigh on the market.
Over the month we have added further to China exposure, leaving us in line with the index weighting. We also added to exposure in Poland while continuing to take profit on Taiwan and further reducing Brazil.
Recent weeks have seen three of the big EM elections scheduled for this year. While the winning parties in all of them were as expected, they nonetheless generated plenty of surprise and market volatility. In both India and South Africa the dominant ruling parties lost their majorities, although will continue in government as expected. In a completely opposite move, Mexico gave its ruling party a super-majority which potentially allows for changes to the constitution.
In our experience elections generate a lot of short-term noise but rarely provides a dramatic impact on the economy and market. Naturally, there are exceptions to this – Modi’s original win set a path for a long period of outperformance for India. In recent years elections in Argentina have had an outsize impact on equity markets too, although they have tended to be subsequently reversed. In these latest elections, certainly short-term volatility has been elevated.
While it is understandable that investors are concerned about the potential for increasingly concentrated power in Mexico, as well as the uncertainty resulting from a South African coalition government, the market reaction in India has been inconsistent to say the least.
Our concern has been that the Indian equity market was highly valued based on very optimistic assumptions. These included an expected strong mandate for Prime Minister Modi to implement much needed economic reforms. Understandably, when exit polls indicated a huge victory for his party on the Monday following elections, the Indian market rallied almost 4% in US$ terms. When actual results on Tuesday showed the opposite, with Modi losing his majority and forcing a reliance on uncertain coalition partners, there was indeed a significant 7% reversal in the market. And yet, over the following days, the market rallied back up to new all-time highs, as if the election outcome that seemed so crucial in the previous days, was actually irrelevant all along.
While it is important not to read too much into short term market movements, this does illustrate that Indian market participants were prepared to buy the market regardless of what new information came to light. Such behaviour suggests a lack of rationality which helps explain the high valuations we are seeing. Famously as John Maynard Keynes said, markets “can remain irrational for longer than you can stay solvent” and we cannot assume a change in behaviour is imminent. At the same time, we need to remain focussed on valuation opportunities and avoid subverting our process.
