Quarterly Market Update


Q&A with Anne-Joëlle Viguier-Galley, BBVA Compass’ Chief of Equity and Alternative Investments for the bank’s Global Wealth team. She also doubles as the Chief Investment Strategist for BBVA Wealth Solutions, Inc., the bank’s investment adviser affiliate.

In this edition of the BBVA Compass Market Outlook, Anne-Joëlle examines Emerging Markets and China (all data as of October 3rd, 2018).

1.  What is going on in Emerging Markets?

While the S&P 500® is up 11%, the MSCI World ex USA Index is down around 1.7% and the MSCI Emerging Markets Index is down 8.7%, within which Turkey was off 45%, Brazil 10.4% and China A shares in Shanghai and Shenzhen 18.7%. There are many moving parts and many different issues happening in different countries.  Overall, the current trailing 12-month Price/Earnings (PE) ratio of the MSCI Emerging Markets Index stands at 12.5x; this seems cheap compared to the S&P 500 at 21.1x and the MSCI Europe at 17.1x, yet, compared to its 10-year average of 13.6x, the 12.6x may be fairly valued.

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2.  Why are so many Emerging Market currencies devaluing vs. the US$?

Many individual country situations are complicated and idiosyncratic. Yet, although it may sound simplistic, is it possible that it all comes down to flows and the FED? Let me explain: UST yields continue rising as the Fed tightens policy and unwinds its balance sheet; inflation pressures build on a strong US labor market and resilient US economic expansion, and the US dollar broadly strengthens against a number of global currencies. In August, we saw notable depreciations in the Argentine peso, the Brazilian real and the Turkish Lira. Other countries also followed on the same path, as shown in the graph below.

Many strategists point to the fact that emerging markets are far more distinct and idiosyncratic than they were two decades ago during the Asian financial crisis, which should result in less correlation between disparate economies. Although this is true, it is possible that flows and monetary policy seem to overweight local fundamentals; in other words, the contagion effect takes over. In addition, investors may end up unwinding positions not because they want to but because they have to: sell what you can, as the old adage goes.  

Unlike 2016, when the U.S. Federal Reserve took pressure off emerging markets by slowing its pace of monetary tightening, this time the Fed may not be able or willing to do so. Without the Fed coming to the rescue, this Emerging Markets’ retreat may have to be resolved “the old-fashioned way”1, at least in some countries: that generally means central-bank tightening, currency devaluation, recession, and fiscal/structural adjustments.

3.  What about China?

China is such a key piece of the Emerging Markets’ complex situation that it deserves a question of its own!

Since the onset of the U.S. financial crisis in 2008, China has been a major driver of global economic activity. Part of this has been funneled through the major “Belt and Road” or silk Road Initiative, which has sunk hundreds of billions of dollars outside of China.  

Additionally, China wants to move from being the manufacturer of the world to being a service economy; it also wants to tackle the huge pollution issues it faces.  Within the “Made in China 2025” plan, Beijing identified 10 industries to become globally competitive in by 2025, and globally dominant during this century2: Robotics, new-energy vehicles, biotechnology, aerospace, high-end shipping, advanced rail equipment, electric power equipment, new materials (exp. screens and solar cells), new generation information technology and software (integrated circuits and telecommunications devices), as well as agricultural machinery. Also, in 2017 China published a development strategy for Artificial Intelligence, with a stated goal to lead the world by 2030.  

All these aggressive measures have brought with them overcapacity, local government debt problems, and a major expansion of the national balance sheet. As per Bloomberg, China’s total debt3 now stands at more than 250% of GDP, from an initial level of 141% of GDP in 2008. As per Evan Lorenz of Grant’s Interest Rate Observer, “the sheer size of China’s financial system is hard to grasp. It is literally fantastic. As of December 2017, assets in Chinese commercial banks stood at US$40 Trillion, or 50.5% of total world GDP. There is no precedent for a banking system this great. For perspective, at the end of 2017, US commercial –bank footings came at US$17.4 trillion (22.1% of world GDP) in the context of a US$19.4 trillion American GDP. China’s GDP is around US$13.1 Trillion.”4

As China’s total debt ballooned over the years, the government decided to launch a debt awareness movement, making credit less available and tackle supply side reforms and environmental protection measures. The main drags on China’s economy this year include infrastructure, off-balance sheet financing, exports and some consumption items: “These have been placed under the background of strict fiscal and financial supervision since last year.”5  

Regardless of the trade tariffs, thus, China’s economy is bound to continue to slowdown. The pain of domestic economic restructuring has been combined with a rapid adjustment of its external trade
situation. A very interesting comment from previous central bank chief Mr. Zhou would have stated something like this: “based on statistic model calculation, trade war is expected to push down economic growth by less than half percentage point, but shockwaves wrought by widespread pessimism are impossible to estimate on a precise basis”6.  

Therefore, an uncontrolled unwinding of the Chinese balance sheet would be chaotic and it would send powerful shockwaves through the global economy. President Xi Jinping’s second term was coming to a close, but now he can remain in power for the rest of his life.7 Some people see this as a Russian-like authoritarian move, yet, as per BCP’s Molano Emerging Markets Adviser8 and other strategists, the removal of term limits were done to fully focus on addressing financial stability and continue to watch for potential disruptions.

Trade tensions with the US and the depreciation of the Renminbi this year pose additional risks for the region and Premier Li said that China will cut VAT further and simplify deductions from personal income tax, as a way to support growth via fiscal-easing plans.

4. Why would you still have some Emerging Markets in a diversified asset allocation?

Emerging Markets represents a huge part of world GDP and has growth potential in the long term. Many specific countries and companies are interesting from an earnings and valuation perspective, yet, as always, risk has to be controlled. Global equity markets are US$72 Trillion in size by market capitalization, of this figure 25% are made up by emerging and frontier markets and China represents the largest single country with over US$9 Trillion in market cap. and MSCI is slowly but surely adding the A shares domestic Chinese market into their benchmarks.

BBVA Compass Global Wealth Investment Management Team

Chief Investment Strategist

Dan Davidson, CFP

Directors of Portfolio Management

Mary Lynn Bronner, CFA
James Engelbrecht

Susan Green

Director of Institutional Trust & Investments

Brad Honer, CFA

Fixed Income Specialists

Eric Green
Thomas Joy

Richard Underwood, CFA

Portfolio Managers

Daniel Bush, CFA
Gary Chontos, CAIA
Melissa Diaz

Marc Dobson
Brett Falkenhagen
Antonio Lau

Equity Trader

Valerie Ross


Wilson Boren
Tyler Chapman
Sarah Dolan

Pascal Leduc
Natalie Manning
Allan Ngo

Investment Policy Committee

Dan Davidson, CFP
Mary Lynn Bronner, CFA
Gary Chontos, CAIA
Marc Dobson

James Engelbrecht
Susan Green
Anne-Joëlle Viguier-Galley, CFA
Marc Wenhammar

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Details you need to make a smart decision

1Policy Challenges from Closer International Trade and Financial Integrations: Dealing with Economic Shocks and Spillovers (OECD) - (Amador and Cabral, 2016; Baldwin, 2016)

2 United States. Office of the United States Trade Representative (USTR). Findings of the investigation into China’s Acts, policies and practices related to technology transfer, intellectual property, and innovation under Section 301 of the Trade Act of 1974, 22 March 2018. Section 301 gives the President the right to take action against trade policies that place an unfair burden on American commerce.

3Industry 4.0 is a name for the current trend of automation and data exchange in manufacturing technologies. It includes cyber-physical systems, the Internet of things, cloud computing and cognitive computing referred to as the fourth industrial revolution

 4China has requested consultations with the United States under the WTO’s Dispute Settlement Mechanism regarding the United States’ tariff measures on certain Chinese goods which would allegedly be implemented through Section 301-310 of the US Trade Act of 1974. The request was circulated to WTO members on 5 April. https://www.wto.org.


BBVA Compass is the trade name for Compass Bank, Member FDIC, and a member of the BBVA Group. Securities products are NOT deposits, are NOT FDIC insured, are NOT bank guaranteed, may LOSE value and are NOT insured by any federal government agency.

This material contains forward looking statements and projections. There are no guarantees that these results will be achieved.

Investing involves risk including the potential loss of principal. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio in any given market environment. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.

Indexes are unmanaged and investors are not able to invest directly into any index.

International investing involves special risks not present with U.S. investments due to factors such as increased volatility, currency fluctuation, and differences in auditing and other financial standards. These risks can be accentuated in emerging markets.

Investments in stocks of small companies involve additional risks. Smaller companies typically have a higher risk of failure, and are not as well established as larger blue-chip companies. Historically, smaller-company stocks have experienced a greater degree of market volatility than the overall market average.

Equity investments tend to be volatile and do not involve the guarantees associated with holding a bond to maturity.

In general, the bond market is volatile as prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors.

The investor should note that vehicles that invest in lower-rated debt securities (commonly referred to as junk bonds) involve additional risks because of the lower credit quality of the securities in the portfolio. The investor should be aware of the possible higher level of volatility, and increased risk of default.

Municipal bond offerings are subject to availability and change in price. If sold prior to maturity, municipal bonds may be subject to market and interest risk. An issuer may default on payment of the principal or interest of a bond. Bond values will decline as interest rates rise. Depending upon the municipal bond offered, alternative minimum tax and state/local taxes could apply.

The price of commodities is subject to substantial price fluctuations of short periods of time and may be affected by unpredictable international monetary and political policies. The market for commodities is widely unregulated and concentrated investing may lead to higher price volatility.

Investments in real estate have various risks including possible lack of liquidity and devaluation based on adverse economic and regulatory changes.

Other Sources: Bloomberg; California.gov; Russell.com; First page index returns are calculated on a total return basis using the following indexes: S&P 500 (SPX), MSCI World (MXWO), MSCI Emerging Markets (MXEF), BofA Merrill Lynch U.S. Treasuries 1-10 years, BofA Merrill Lynch U.S. Agencies 1-10 years, BofA Merrill Lynch U.S. Corporates 1-10 years A-AAA, BofA Merrill Lynch U.S. Municipals 1-10 years A-AAA, Russell Top 200 Index, Russell 1000 Index, Russell Midcap Index, Russell 2500 Index, Russell 2000 Index, Credit Suisse High Yield Index (CSHY), MSCI U.S. REIT Index (RMZ Index).