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Quarterly Liquidity Insights - Q4/2019

Emerging market equities outperformed developed markets in Q4 as global economic data showed signs of stabilisation and the US and China moved towards a trade war truce. Hopes are high that global growth will rebound in 2020, allowing further EM relative gains.

We are, for the moment, cautious. The stabilisation of global data in late 2019 was foreshadowed by an upturn in six-month growth of G7 plus E7 real narrow money at the start of the year – money trends lead the economy by about nine months on average. Real money growth, however, is currently still weak by recent standards: the latest reading of 2.4% compares with a post-GFC average of 3.2%, while rises to 4% occurred before the economic recoveries in 2012-13 and 2016-17 – see first chart.

Chart 1: G7 + E7 Industrial Output & Real Money (% 6M)

Chart of G7 + E7 Industrial Output & Real Money (% 6M)

The monetary recovery, moreover, has been driven by the G7 countries: growth remains lower in the E7 large emerging economies (BRIC plus Korea, Mexico and Taiwan) – second chart. The E7 / G7 real money growth differential is one of the factors we monitor to assess the likelihood of EM equity outperformance.

Chart 2: G7 & E7 Real Narrow Money (% 6M)

Chart of G7 & E7 Real Narrow Money (% 6M)

E7 real money growth has been held back by continued weakness in China despite attempted policy stimulus. Chinese nominal money growth recovered in early 2019 but peaked in Q2 and fell during H2. We attribute this relapse to a credit squeeze caused by a rise in bank funding costs following the first of several regional bank failures in May last year.

Chinese economic data firmed in late 2019, boosting recovery hopes, but we think this improvement reflects the earlier rise in money growth. The monetary slowdown during H2 2019 suggests that economic news will disappoint again from early 2020.

Our caution about Chinese / global growth prospects would normally make us circumspect about adding to “cyclical” markets (i.e. those which have shown greater sensitivity to global activity historically), such as Brazil, Korea, Russia and Taiwan. Money trends, however, are strong in the latter three – third chart. Taiwan and Korea are benefiting from the reorganisation of regional supply chains triggered by the trade war.

Chart 3: Real Narrow Money (% 6M)

Chart of Real Narrow Money (% 6M) - Brazil, China, India, Korea, Russia, Taiwan

Indian GDP growth slowed sharply in 2019 as the economy suffered a credit crunch – the flow of finance to the commercial sector plunged 88% in the first half of the current fiscal year from a year before. The credit “impulse” has almost certainly bottomed but an inflation pick-up in late 2019 depressed real money growth, suggesting soft H1 prospects.

Real money growth is strong in Chile, the Philippines and Greece, among others – fourth chart. Chile is an outlier in Latin America – growth is moderate in Brazil / Peru and weak in Mexico / Colombia – and the recent political protests may have created a buying opportunity.

Chart 4:Real Narrow Money (% 6M)

Chart of Real Narrow Money (% 6M) - Chile, Greece, Mexico, Philippines, South Africa

Chile and the Philippines, on our analysis, are “liquidity-sensitive” markets, i.e. would tend to underperform in the event of a material rise in global bond yields. This seems unlikely in H1 given our soft global growth outlook.

Money trends are most negative in South Africa, suggesting H1 recession risk and supporting our continued underweight.

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