Value in emerging-market stocks

Some sort of Indian army motorcycle formation display pyramid thing © Alamy
Emerging markets are structurally stronger these days

While the pain for global stocks was spread far and wide in October, “emerging market equities have been under the heaviest fire so far this year”, says Steve Johnson in the Financial Times. In October, fund managers said they were the most “underweight” (allocating less money than usual to the asset class) emerging markets that they’ve been in two years, according to the latest survey from Bank of America Merrill Lynch. Just six months ago they were heavily “overweight” in the region.

A tough year combined with October’s sharp sell-off means emerging markets now look significantly cheaper than most other markets. The average emerging market trades at 14 times earnings, compared with the UK on 16 times, Europe at 17, and the US at 23.

“If the past is any guide to the future, it could be time to fill your boots,” says Johnson. Measured by price-to-book ratio (which compares the price of shares with the assets on their balance sheet), emerging market equities trade at a 36% discount to the developed world. A gap like this “has historically been a strong buy signal”, Ewan Thompson of Neptune Investment Management’s Emerging Markets fund tells the FT. Since 2001, a gap this wide has seen emerging market stocks outperforming their developed counterparts over the subsequent five years.

Positive structural change

And while emerging markets have lagged in recent years, their long-term performance is appealing. Since the turn of the century, emerging markets have returned an average of 7.9% a year, compared with 5.4% for US shares and 3.5% for Europe, says Mark Atherton in The Times. What’s more, Jan Dehn of investment manager Ashmore tells The Times, most emerging markets are in a structurally-stronger position today than they were in the early 2000s. Their share of global GDP has risen, their foreign currency reserves have quadrupled and they are far less dependent on foreign capital. Many countries have also brought inflation under control, trimmed spending and brought down public debt.

The long-term outlook is auspicious, too – 70% of global growth is expected to come from emerging markets in the next five years, according to Adrian Lowcock of financial services company Willis Owen. And while they currently account for 45% of global GDP, their stockmarkets only make up 29% of global equity markets, Atherton notes. So the sector should also benefit from a “catch-up” element over time.