Photographer: Martin Leissl/Bloomberg

Why This Stock Bear Sees No Hope for Emerging Markets

Updated on
  • Smith says few attractive bets in authoritarian regimes
  • Ecstrat favors nations with low exposure to commodities, China

John-Paul Smith won’t give up on his bearish bet against developing nations. 

The founder of research firm Ecstrat Ltd., renowned for his early warning of Russia’s equity-market plunge in 1998 while at Morgan Stanley, is finding plenty of places to direct his pessimism. Among his latest concerns: authoritarian regimes in China and Russia as well as governments in Thailand, Turkey and the Philippines shifting in that direction.

Smith’s caution runs counter to recent history, in which the world’s autocratic nations have rewarded bond traders with larger returns than democratic countries. While that may be true in the early stages of a regime, he says an authoritarian rule eventually hurts productivity with the value of debt and equity assets taking a hit.

“I’m struggling to identify any attractive bets for emerging markets under authoritarian regimes,” Smith said in an interview from London. “The notion that both sovereign and corporate governance throughout the world will gradually converge towards some supposed liberal norm is now well and truly dead.”

Stocks in particular are adversely affected under authoritarianism because states typically redistribute resources away from minority capital to fit their social and political agenda, according to Smith. He says this could crush the decade-long bets some funds are making on emerging markets. While Smith is bearish across developing-nation stocks, his equity strategy consultancy is less pessimistic on Thailand and the Philippines near-term given their lower exposure to commodity prices, contagion risks with China and moral hazards.

The MSCI’s gauge of developing-nation equities fell 0.2 percent as of 9:05 a.m. in New York on Tuesday, trimming its year-to-date advance to 29 percent.

COUNTRYSMITH’S DIAGNOSISEQUITY RETURN YTD
ChinaWe expect the gap between Beijing’s policy rhetoric and the actual implementation of reforms to become even wider. The fundamental question is the same: how to engage with a regime which adheres to a completely different set of rules?16.4%
RussiaRussia has moved away from market-driven reforms toward authoritarian governance with greater state control over the corporate sector.3.7%
South AfricaThere’s a Manichean struggle for the heart and soul of the ANC with the integrity of the nation’s most important institutions under attack.18.2%
PolandThe government has weakened constitutional safeguards and sparked a confrontation with the EU.50.2%
HungaryThe shift under Viktor Orban has taken the form of de facto expropriation of foreign direct and portfolio investment.37.3%
ThailandThailand’s military-led junta threatens to become an all-out authoritarian regime.22.1%
TurkeyErdogan has borrowed from the Putin playbook, establishing a “managed democracy” and redistributing property to his supporters.42.5%
PhilippinesRodrigo Duterte’s use of extra-judicial methods in his war on drugs also underscores a nation shifting towards autocracy.20.2%
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