Emerging markets emerge again

It's been a nasty year for emerging markets, but valuations are starting to look appealing.

It's been a nasty year for investors in emerging markets. The MSCI Emerging Markets index, a key benchmark, hit a six-year low this summer. In the past five years, it has slid by 15%; developed-world stocks have gained 35%.

China's slowdown and the commodities downturn have all hit growth, which is now running at an annual pace of around 3% a sharp drop on the average of about 6% seen in the last decade. The prospect of higher US interest rates, which would draw investment away from traditionally risky assets such as emerging markets, is another headwind.

Still, "a little bit of good news goes a long way when an asset class is this out of favour", as Ben Laidler of HSBC points out in the Financial Times. The worst appears to be over. The macroeconomic backdrop is improving, says Capital Economics. The big deceleration in emerging-market growth occurred earlier this year, "and conditions have since stabilised".

Activity in China looks set to rebound following recent interest-rate cuts, with further monetary easing also likely. Credit growth is accelerating, and commodities could stabilise as Chinese demand firms and supply is cut following the previous price slump.

Meanwhile, according to Capital Economics, valuations are starting to look appealing. Emerging markets are on a price/earnings (p/e) ratio of 11, compared to 15.6 for developed markets, the widest gap in almost a decade. Given all this, "we suspect a sustained outperformance of emerging-market equities will begin sooner rather than later".

Asset management group GMO estimates that emerging markets are now cheap enough to return 4.6% a year over the next seven years, compared to 1.1% for top-quality US equities, says the Financial Times in short, emerging markets are due a comeback.

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