Emerging Markets Equities: The Tide Has Turned

by: , Director, Product Management, New York Life Investments

After trailing U.S. equities for four consecutive years (2013 – 2016), emerging markets equities, as measured by the MSCI Emerging Markets Index, have staged an impressive rally that may continue over the next several years on a backdrop of stronger economic and corporate fundamentals.

For further insight, we spoke with Portfolio Manager, Jan Boudewijns, who is also the Head of Emerging Equity Management for Candriam Investors Group. Candriam is a leading European asset management firm and a sub-advisor for MainStay Investments.

Emerging Opportunities within a Synchronized Global Recovery

At current levels, emerging markets (“EM”) equities present an attractive opportunity for long-term investors. While much of the developed world is in the latter stages of an expansionary cycle, EM economies are still early cycle and supported by robust economic and earnings growth.

According to the International Monetary Fund (IMF), emerging markets economies are projected to expand at nearly twice the pace of developed markets, or close to 5.0% gross domestic product (GDP) growth in 2018. Not surprisingly, China and India are key components, with estimated growth rates of 6.6% and 7.4%, respectively. The average debt-to-GDP ratio across emerging markets is also still healthy. What’s more, inflation risk is largely contained as a result of disruptive technological innovations that continue to suppress wage growth.

Figure 1 – Global Growth Dominated by Emerging Markets

Sources: Bloomberg LLC and International Monetary Fund’s “World Economic Outlook” (WEO), January 2018.

Solid Earnings Growth with Attractive Valuations

Favorable economic conditions and earnings growth are key determinants of equity returns. As we navigate a new market cycle, EM equity returns are expected to benefit from secular demographic trends, lower corporate debt levels, currency strength and stronger intra-EM trade.

According to MSCI, earnings and revenue growth for EM equities are expected to outpace foreign developed markets well into 20191. Candriam estimates the strongest earnings growth to come from Asia (primarily China and South Korea) and within the following sectors: information technology, materials, and energy. A recovery in commodity prices (partially the result of a weaker U.S. dollar) are also positive tailwinds for Brazil and Russia exporters.

Further supporting the case for EM equities are attractive valuations relative to both historical average and to developed markets (as measured by price-to-earnings (P/E) ratio).

Figure 2 – Emerging Markets’ Equity Valuations are Attractive

MSCI EM Index – P/E relative to Historical Average

Sources: Thomson Reuters Datastream, New York Life Investments, 12/31/17. It is not possible to invest in an index. Past performance is no guarantee of future results.

Exploiting Market Inefficiencies with an Eye on Risk

For several years, the risks, rather than the opportunities, of investing in EM equities dominated headlines and investor sentiment. However, as we reached an inflection point in 2016, the prospects for emerging markets investing has clearly improved. Despite the promising outlook, investors need to be mindful of the risks associated with emerging markets. Central bank policy and geopolitical risks to include U.S. protectionism and trade tariffs, remain. At this time, Candriam is cautious on regulatory reforms and political developments, particularly within India and South Africa.

At the company level, fundamental stock selection with the flexibility to exploit market inefficiencies and manage risk will become increasingly important. Candriam believes investors can achieve greater success through a thematic approach that favors companies with competitive advantages and strong, sustainable organic growth.

[1] Source: Thomson Reuters I/B/E/S. MSCI Earnings and Revenues Growth, March 7, 2018.

The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report, are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in this material will be realized.

About Risk

All investments are subject to market risk, including possible loss of principal. Stocks and bonds can decline due to adverse issuer, market, regulatory, or economic developments. Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner, or that negative perception of the issuer’s ability to make such payments may cause the price of that bond to decline. A bond’s prices are inversely affected by interest rates. The price will go up when interest rates fall and go down as interest rates rise.

Foreign securities can be subject to greater risks than U.S. investments, including currency fluctuations, less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in tax or currency laws or monetary policy. These risks are likely to be greater for emerging markets than in developed markets.

Index performance is shown for illustrative purposes only and does not predict or depict the performance of the Funds. Indices are unmanaged, include the reinvestment of dividends, and cannot be purchased directly by investors. Past performance does not guarantee future results.

Commodity refers to investments in instruments and companies that are susceptible to fluctuations in certain commodity markets. Any negative changes in commodity markets (that may be due to changes in supply and demand for commodities, market S-4 events, regulatory developments or other factors) could have an adverse impact on those companies.

International Monetary Fund – an international organization that promotes the stabilization of the world’s currencies and maintains a monetary pool from which member nations can draw in order to correct a deficit in their balance of payments: a specialized agency of the United Nations.

The MSCI Emerging Markets Index is an index created by Morgan Stanley Capital International (MSCI) designed to measure equity market performance in global emerging markets.

The S&P 500 Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock-market performance. Index results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index.

Candriam Investors Group is a New York Life Company.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302.

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Kevin Kloski, CFA

Director, Product Management, New York Life Investments

Kevin recently worked as a Portfolio Specialist at Voya Investment Management, serving as a subject matter expert on fundamental and quantitative equity strategies.

Full Bio

2 Comments

  1. 2017 proved to be one of the best years for emerging markets equity since 2009. Equity returns were driven by synchronized global growth and strong emerging markets earnings recovery, less aggressive central banks, a weaker U.S. Dollar and a stable and relatively benign macro environment in China – despite commodity price volatility and geopolitical issues. Looking ahead, Candriam believes these key drivers will continue to support the asset class, and will also be the main risk factors to be closely monitored. But with many global investors still largely underweight, we remain supportive for emerging markets equity, despite the possibility of some periods of profit-taking, as we have seen within the technology sector. On a regional basis, Candriam estimates the strongest earnings growth to come from Asia this year (primarily China and South Korea) and within the following sectors: information technology, materials, and energy. Additional commentary (positioning and outlook) will be available within the next week or two.

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