Reasons to back EM stocks despite tough outlook

Firms such as Ashmore, GMO and Northern Trust see equities in emerging markets outperforming those in developed countries in the next few years.
Reasons to back EM stocks despite tough outlook

The US stock market has been on a tear for a decade, far outstripping global equities, but is widely seen as due a potentially prolonged downturn. And some investment experts are tipping emerging market equities for a multi-year period of outperformance, despite a challenging environment.

The S&P500 has returned around 300% as of September 6 since its post-global financial trough in March 2009. In the year to end-August, meanwhile, the MSCI World has gained 99% and the MSCI Emerging Markets index just 47%.

But if the economic cycle is at a late stage – as per the general consensus – are things set for a turnaround?

Northern Trust forecast a five-year annualised return of 6.1% for emerging market equities in its 2019 capital market assumptions report, released yesterday. That is even after the Chicago-based asset manager and custodian lowered its prediction from 8.3% in last year’s report. 

However, in light of concerns such as those over the prevailing US-China tensions, the firm forecasts that Asia will be worst-performing emerging market region in the period, with 5.5%.

Northern Trust expects both developed market and US stocks to return 5.7% a year over the same time.

Jan Dehn, Ashmore

Despite the fact it sees emerging market equities as the likely strongest performing regional stocks in the next half-decade, that is in spite of problems they still face.

“Valuations [of emerging market stocks], though inexpensive, are not expected to move higher given greater uncertainties surrounding current economic models – particularly China’s,” the report noted.

Northern Trust also said that while corporate revenue growth in emerging markets is “superior” to that elsewhere, it will be “muted by continued (and well documented) share issuance”.

Similarly, US fund house GMO is another backer of emerging market equities for the coming period. It has tipped them to gain 5.2% annualised over the next seven years, as against negative -1.5% for US small-caps and -3.7% for US large-caps. It set out the data in its latest real return forecasts on July 31.

Jan Dehn, head of research at emerging market-focused fund house Ashmore, explained why he too was relatively optimistic for equities from those markets.

“I think emerging market stocks will see steady, albeit not spectacular, growth from here,” he told AsianInvestor yesterday.

By contrast, developed markets are coming to the end of a 10-year QE [quantitative easing] party; the US and Germany look to be heading for a recession; the Brexit situation is harming UK growth too.”

Over the next few years Dehn sees a lot of dollar positions being unwound.

“The US is heading into a slowdown, the Federal Reserve will cut rates, so neither stocks nor bonds will be attractive,” he said. “Hence people will take money out of the US, and the weaker dollar will make emerging market debt more attractive.”

When money flows back into emerging market debt as a result, that should result in a positive cycle in those markets that should be good for EM equities, which have been lingering in misery for quite a while, Dehn argued.

The flip side to this is that a US recession and the related decline in earnings will be bad for US equities, which would have a knock-on effect on emerging market equities, he added. “That will be a bit of short-term panic, but investors are likely to look through that.”

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