Earnings will boost emerging stocks

Rising earnings provide the catalyst for emerging-market stocks to start performing better.

"When will emerging markets stop derating?" ask Binky Chadha and the global strategy team at Deutsche Bank. Since 2010, emerging-market (EM) stocks have significantly underperformed US equities, principally because the relative valuations that investors are willing to place on them have declined significantly.

With the US market on a price/earnings (p/e) ratio of around 17, it's close to pre-crisis valuations, but EM stocks are around a third cheaper (the MSCI Emerging Markets index is now on a p/e of 12).

This decline "has brought them into line with our estimate of fair value", say the analysts, but given headwinds such as slower growth and a stronger dollar, they believe things could get worse. "We see relative EM multiples derating a further 15%-20%."

Certainly, any immediate recovery in EM valuations looks unlikely, says Bhanu Baweja of UBS, interviewed by Indian newspaper The Economic Times; the outlook is too cloudy, given factors such as the timing of the Fed's decision to taper quantitative easing.

But earnings are another matter for the last two years they've "been absolutely dismal", but are likely to begin rising modestly in 2014. That could bring an end to the derating trend and provide the catalyst for EM stocks to begin performing better.

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