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Emerging equities are on their way back

Emerging equities are on their way back

02-08-2016 | Insight | Dimitri Chatzoudis, Fabiana Fedeli, Jaap van der Hart, Wim-Hein Pals The Emerging Markets Equity team has turned tactically bullish on emerging markets equities. This means that we expect emerging equities to outperform developed equities both in the short and in the long term. In our outlook we explain why, addressing the concerns investors have about this asset class.

Speed read:
  • Short- and long-term prospects for emerging equities look good
  • Reforms, valuations, earnings and monetary policies are in favor
  • Concerns on China, US rates and politics are put into perspective
Over the last six years we have witnessed a lot of negativism towards emerging markets. Fears of a Chinese economic hard landing, Brazilian political and corporate corruption scandals, Russian geopolitical issues and an African collapse at the end of the commodity boom era are just a few of the events that made the headlines and have created negative sentiment towards the asset class. All the events mentioned have led to a disappointing performance in emerging equity markets and a lot of investors have withdrawn from the asset class over the last couple of years.

Resilience

After the UK referendum on Brexit, however, emerging equity markets have proven to be resilient, both in absolute terms and compared with developed equity markets. The Brexit vote is obviously predominantly a European issue and from a fundamental point of view the longer term effect on emerging markets is limited. Among all the global trading blocs it is Europe that will face the most uncertainty in terms of future political and macroeconomic developments. Also important, since most emerging currencies are far more correlated to the US dollar than the euro, emerging currencies should remain relatively immune to potential turmoil in Europe.

Expected pick-up in earnings expectations bodes well for EM performance

The main cause of the underperformance of the emerging equities asset class from late 2010 to late 2015 was that earnings were weak compared with developed markets. We expect better earnings ahead on the back of more favorable monetary policies and less pressure on emerging currencies. The reforms in China, India, Korea and Indonesia are also positive, both from a macroeconomic perspective and for financial markets.

Investors tend to focus on short-term macroeconomic indicators. In the short term China has its debt issues and challenges with regards to opening the country’s financial markets to the world, resulting in currency volatility. From a long-term perspective though, the Chinese are world champions when it comes to long-term strategic plans. China is in transition: from the world’s production hub supported by low wages, to a knowledge-based service economy. In order to achieve this goal, they are more and more open towards foreign capital, entrepreneurship and private capital. And the Chinese really think in terms of decades.

Indeed, looking at the longer term, the Chinese economy is in a strong position, with a large emerging consumer class, vast amounts of foreign exchange reserves, a huge current account surplus and still the largest production hub in the world. For the long term we worry about the debt levels in the Chinese economy, but so does the government. For the time being, we foresee an increase in debt-to-GDP ratios, but for now the levels are below the levels of many other countries, both developed and emerging.

After six consecutive years of underperformance of emerging versus developed equity markets (measured from June 30, 2010 onwards, see Figure 1) current rock bottom valuations offer interesting buying opportunities.

Performance emerging versus developed markets

emerging-equities-are-on-their-way-back-graph1.jpg 
Source: Bloomberg

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