A period of adverse sentiment towards emerging markets could create opportunities for investors to get on board at attractive valuations, the author of this article says.
Investors should be able to see that the risks, both macroeconomic and geopolitical, facing emerging market stocks are priced in, thus valuations already take account of such potential hazards as the “normalisation” of US monetary policy, the chances of a further slowing of the Chinese economy and the downward trend in commodity prices.
But because too many investors do not appear to see this, emerging market stocks overall trade at a substantial discount to where history suggests they ought to be. This should not, however, be taken as a signal to pile indiscriminately into this market. Yes, there are early signs of improvements in earnings and profitability, which ought to support valuations, but just as there are some stock markets in this sector offering significantly better returns than others, so there is a wide gap between the expensive and the cheap when it comes to individual shares.
Successful investment requires identifying those companies whose shares have been mispriced and investing accordingly.
Different sectors, too, have seen their performances diverge. For example, in the eight months to August, consumer goods companies, financial services firms and materials businesses did well while telecommunications companies and utilities did less so.
Overall, however, we firmly believe that the backdrop for emerging market equities has improved and is continuing to do so, and that this will drive a change in investor sentiment.
The developed world economies are gathering pace, led by the US, and while good news from the eurozone is harder to come by, Germany and Spain, to take two examples, are leading the way for the single-currency bloc.
This adds up to a more positive climate for emerging market equities, as does the tenacity of the Chinese authorities both in stimulating activity through loose credit conditions and in sticking to their programme of rebalancing the economy away from over-reliance on exports and investment and towards a greater emphasis on domestic consumption.
As we saw earlier, the Chinese market rallied in August.
To sum up, we are already seeing significant assets flowing into emerging market equities, and we expect prices to continue to rally. Successful investing in this new climate will call for a discerning approach that seeks value and avoids overpriced stocks.