Emerging Markets Equities: The Tide Has Turned
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.
 Source: Thomson Reuters I/B/E/S. MSCI Earnings and Revenues Growth, March 7, 2018.
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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.
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