latamen
Emerging stocks could make a comeback in 2019

Emerging stocks could make a comeback in 2019

10-01-2019 | Monthly outlook

A number of factors bode well for emerging market equities this year, says investor Jeroen Blokland.

  • Jeroen Blokland
    Jeroen
    Blokland
    Portfolio Manager

Speed read

  • US rate policy and widening growth gap support EM stocks
  • Low valuations from 2018 sell-off are a potential springboard
  • Risks though include threat of US recession or China downturn 

A pause in US monetary tightening, a widening gap in GDP growth rates between emerging and developed markets, and stocks trading at cheap valuations could all be positive for the much-maligned asset class.

However, the threat of declining US growth – or even a long-overdue recession – or risks to Chinese growth due to the ongoing trade war continue to pose a threat to an emerging recovery, according to Blokland, Senior Portfolio Manager with Robeco Investment Solutions.

“2018 wasn’t a pretty year for equity markets in general, and for emerging markets in particular,” he says. “Global stocks fell 4.1% in euros, whereas emerging market equities realized a negative return of more than 10% in euros.”

“But given the recent developments in markets, the odds for a solid emerging market performance from here on are pretty decent. Gradually, the pieces of the puzzle are falling into place.”

Stay informed on our latest insights with monthly mail updates
Stay informed on our latest insights with monthly mail updates
Subscribe

Emerging stocks suffered last year. Source: Bloomberg

The Fed at the forefront

The first thing working in their favor is the path of the Fed’s monetary tightening. “Contrary to the messages of just a few months ago, the end of, or at least a pause in, US monetary tightening is now on the table,” says Blokland. “After a period of three years, during which the Fed has made nine rate hikes, Chairman Jerome Powell has changed direction in his recent speeches to embracing a more neutral policy.”

“As current market circumstances aren’t particularly favorable, it seems likely that the Fed will take a break from further raising rates. This means that the difference between interest rates in the US and, for example, the Eurozone will not widen further.”

“And that means the US dollar – which is already overvalued – won’t necessarily strengthen, as the attractiveness of a currency largely depends on interest rate differences between two regions. This is an important development for emerging markets, as a stronger US dollar often coincides with lackluster emerging market performance.”

Mind the gap

Then there is the gap between GDP growth in emerging and developed countries, which is seen widening this year for the first time since 2016. “Historically, the gap between growth rates in emerging and developed markets has been one of the strongest drivers of emerging market equity performance relative to developed market equities,” says Blokland.

“In the latest IMF growth forecasts (see chart below), growth in emerging countries is expected to accelerate somewhat, while growth in developed markets is seen easing in the coming years. While the divergence will be slow at first, the gap will likely widen to above 3% in 2020, the biggest differential since 2013.”

Diverging growth rates: the bigger the better for emerging equities. Source: Bloomberg, IMF

Trade tantrums

But what about the effect of the ongoing trade war between China and the US? “Emerging markets are particularly vulnerable to a slowing of global trade,” admits Blokland. “This is probably why they started to decouple from global equities from June onwards as the dispute escalated, although the effect of the currency crises in Argentina and Turkey should not be ruled out.”

“In recent months, however, both parties seem to have refocused on de-escalation. A temporarily truce was declared: China lowered tariffs on some US imports, and President Trump offered some willingness to come to an agreement.”

“While that doesn’t necessarily mean the dispute is fully solved, it does mean that the marginal effect on trade and GDP growth will decrease. When this happens, we expect emerging market stocks to be among the main beneficiaries.”

Valuation catalyst

Finally, valuation could provide a catalyst. “The average price/earnings ratio of emerging market equities has dropped by as much as 30% as a result of the sell-off last year,” says Blokland. “As a result, the valuation for emerging stocks has fallen significantly below its long-term average.”

“And even though the pattern in the valuation of developed market stocks is similar to those in emerging countries, especially outside the US, emerging equities also remain mildly cheap on a relative basis. Although it is rarely the trigger for market reversals, we believe that the current level of valuation can become an important tailwind when things start to turn around.” 

Recession risks remain

So, what are the risks? “If we do get a US recession this year – which we don’t expect at this point in time – emerging market equities are likely to fall further before they bottom out,” Blokland warns. “In that case, earnings will probably decrease, removing the potential valuation catalyst as well.”

“The same scenario is true if Chinese GDP growth slows further, meaning current stimulus is insufficient to accelerate growth. For many emerging countries, and not just in Asia, trade with China is far more important than with the US.”

“The Fed also poses a risk if the US jobs market and wage growth forces the central bank to continue raising rates, putting renewed upward pressure on the US dollar. Still, recent developments make us believe that the odds of these risks materializing have decreased and not increased recently.”

“A pause in the Fed hiking cycle, and/or any progress in the trade dispute between China and the US, would further substantiate this observation, and pave the way for a solid return on emerging market equities going forward.”

Subjects related to this article are:

Important information

The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).

This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.

This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.

I Disagree