Emerging Markets

Re-emerging markets – Explaining our overweight

By: Rob Bush | April 18, 2017

In the romantic whirlwind of global investing, no lover, it seems, is more alternately courted and then spurned than the emerging markets (EM). At times, investors are besotted, showering the asset markets of developing nations with capital as their infatuation with higher yields and stronger growth blinds them to all faults. But, before we know it, there’s an indiscretion – a capital control here, a debt crisis there. The once beautiful prospect of a lifelong partnership dissolves as investors and markets part ways, in search of their next paramours.

However, here at Deutsche Asset Management, we believe that the time is ripe for investors to rekindle their relationship with emerging markets. At our most recent Chief Investment Office (CIO) day, we moved to an overweight on the region and, fortunately, we allowed our heads to rule our hearts. Here are the main reasons why we think EM should again warrant your affection:

Macro Stabilization – After a tough 2016 for one or two of the emerging markets, notably Brazil and Russia, we think that Gross domestic product (GDP) growth and commodity prices have stabilized. Indeed, when it comes to growth, China may even surprise on the upside with encouraging signs of improving industrial production, steady infrastructure spending, and a Yuan that has been remarkably stable since its jitters in the summer of 2015 and at the beginning of 2016.

Export Pick Up – Although our view is that many emerging economies are actually a little less reliant on net exports than may generally be assumed, we nevertheless see outbound trade growing faster than imports in a number of the larger exporters, including Korea, Taiwan, Thailand and Russia.

Earnings Growth – Our view is that earnings will likely grow at more than 10% over the course of the next year in the MSCI Emerging Markets Index, and that should help to drive our forecast for 1,000 in the benchmark by March 2018.

Discounted Valuations – We wouldn’t categorize emerging market valuations as distressed but rather as attractive relative to the US. Even after a strong start to 2017, the current Price-to-earnings (PE) ratio of MSCI EM is around 15.1 versus 22.2 for MSCI USA Index, a discount of more than 30%.

Monetary Policy – More emerging market central banks are loosening monetary policy than tightening. All things equal that ought to provide a boost to stocks by encouraging relatively underinvested local money to seek out riskier assets. Additionally, to the extent that lower rates in EM, coupled with a hiking The U.S. Federal Reserve (Fed), cause EM currencies to weaken that could provide a boost to corporate profitability. Furthermore, one of the classic risks that investors are concerned with in EM, that of too rapid a currency devaluation causing problems in meeting dollar liabilities, does not seem to have materialized post Trump’s election.

Furthermore, these reasons aside, there are two more that we have blogged on before that we think are worth reiterating.

The first is the surprisingly low volatility that emerging markets have exhibited over the last 16 years or so. Figure One shows the rolling one year volatility of the MSCI EM Hedged and USA equity indices. It certainly came as a surprise to us that the emerging markets index has actually been less risky than the US more than 75% of the time. We attribute this to the relatively low inter correlation of many of these markets. After all, the emerging market label includes a basket of some very disparate markets, which, though individually may be quite risky, apparently diversify well when pooled.

Source: Bloomberg as of 06/1/2001 to 3/30/2017. Past performance may not be indicative of future results.

The other potentially appealing feature is the relatively low correlation that the emerging markets have exhibited to U.S. stocks over time. The average of the rolling one year correlations between these markets over the same period was 0.42 and the highest that it ever climbed to was 0.62 during the latter part of the financial crisis. This, don’t forget, at a time when correlations across asset classes generally were spiking and investors were clamoring for diversifiers.

So there you have it. Not perhaps, reasons enough to fall head over heels in love with emerging markets, but sufficient, we hope, to at least get your pulses racing.

Rob Bush
ETF Strategist
 
For general inquiries:
(844) 851-4255

 

We believe that the time isripe for investors to rekindle
their relationship with emerging markets.

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