Emerging markets bounce back after a miserable few months

Balinese women carrying offerings © Alamy
Indonesia’s large domestic market provides shelter from global storms

Investors in emerging markets have been enjoying some long-awaited relief after a miserable few months, says Robert Burgess on Bloomberg. The MSCI Emerging Markets index jumped by almost 2% on Wednesday last week, its biggest one-day gain since January. Perhaps some money managers “sense all the doom and gloom… is overdone”. The trade war and a strong US dollar have seen the index shed 8% since a high mid-April.

Sagging global trade is a big problem for many developing economies: they are highly geared to global growth. For example, exports represent 44% of South Korean GDP and 39% of Mexican output. Many firms borrow in dollars, but make sales in the local currency. Ongoing dollar strength means more hefty debt-servicing costs, says John Authers on Bloomberg. Emerging market currencies are also proving to be closely correlated to China’s yuan. That leaves them at the mercy of trade-war negotiators and Chinese monetary decisions.

A chance to buy low

Still, where there’s gloom there is also opportunity. On a price-to-earnings basis, emerging market stocks trade on a 20%-30% discount to their developed counterparts, James Donald of Lazard Asset Management told Karen Hube in Barron’s. Lower valuations mean higher potential returns. Research by asset management group GMO suggests that emerging market companies are poised to deliver superior returns over the coming years, says Jennifer Thompson in the Financial Times. Based on current valuations, the sector should serve up an average annual real return of 5.2% over seven years, with the cheapest set to return 9.8% over the same period. Richly valued US large caps, by contrast, look set to “fall 3.7% annually over seven years”.

Another plus point is the superior growth performance of emerging nations. Expansion in emerging markets is the “linchpin holding up the global economy”, former World Bank vice president Ian Goldin tells CNBC. Average growth of over 4.5% is “pulling up” more sluggish developed economies. “The centre of gravity is clearly moving to Asia.”

Emerging market investors have endured a long period of disappointment, says Hube. The asset class has “been underperforming for almost a decade”. Yet that is a reason for optimism, argues Donald. “If you look at history, you don’t have constant underperformance. You have periods of underperformance followed by periods of outperformance.” Such a shift could now be in the works.

Not all emerging markets are equally enticing, however. MoneyWeek prefers economies such as India, the Philippines and Indonesia, where large domestic markets provide shelter from global trade woes.