The danger of lopsidedness in emerging markets

Emerging-market investors chasing consumer-orientated stocks have overlooked other lucrative sectors.

Beware the "thematic bubble" in emerging-market (EM) stocks, says a Bank of America Merrill Lynch report. Investors are chasing EM consumers and their "insatiable appetite for internet services, gaming, calling their families, and eating and drinking".

As fund managers have rushed to scoop up shares of fast-growing firms in such sectors, these growth' stocks have become extremely expensive.

They have a median trailing price/earnings (p/e) ratio of 31. The fastest-growing developed-market stocks, by comparison, are on a p/e of 20.6.

Yet while investors are "egregiously overweight" the EM consumption theme, they are "exceptionally underweight" the cheapest EM stocks: those in the energy, materials and financial sectors, where the state is heavily involved. These firms are usually only as cheap as they are now during recessions or crises.

Also, prospects for privatisation and deregulation in these sectors have improved as many EMs need to raise money. Mexico shows how political change can lead to reform. So there is scope for profits at state-backed firms.

Given these valuation extremes and the likelihood that they will revert to the mean, global investors are taking a big risk with their lopsided EM portfolios.

Recommended

I wish I knew what an emerging market was, but I’m too embarrassed to ask
Too embarrassed to ask

I wish I knew what an emerging market was, but I’m too embarrassed to ask

This week's “too embarrassed to ask” explains what emerging markets are, and why you might want to invest in them.
9 Sep 2020
Bullish investors return to emerging markets
Stockmarkets

Bullish investors return to emerging markets

The ink had barely dried on the US-China trade deal before the bulls began pouring into emerging markets.
27 Jan 2020
Beware the hidden risks when investing in emerging markets
Investment strategy

Beware the hidden risks when investing in emerging markets

Emerging markets look cheap compared with developed countries, but earnings may be less trustworthy.
23 Dec 2019
Emerging markets: buy when the news is bad
Emerging markets

Emerging markets: buy when the news is bad

Emerging markets are being squeezed by local turmoil and by more general factors. But bad news can spell opportunity for investors.
5 Nov 2019

Most Popular

Here’s why you really should own at least some bitcoin
Bitcoin

Here’s why you really should own at least some bitcoin

While bitcoin is having a quiet year – at least in relative terms – its potential to become the default cash system for the internet is undiminished, …
16 Sep 2020
Will a second wave of Covid lead to another stockmarket crash?
Stockmarkets

Will a second wave of Covid lead to another stockmarket crash?

Can we expect to see another lockdown like in March, and what will that mean for your money? John Stepek explains.
18 Sep 2020
James Ferguson: How bad data is driving fear of a second wave of Covid-19
UK Economy

James Ferguson: How bad data is driving fear of a second wave of Covid-19

Merryn and John talk to MoneyWeek regular James Ferguson about the rise in infections in coronavirus and what the data is really telling us.
17 Sep 2020