Turning point for lagging emerging stock returns?

April 27, 2012

Over the past year emerging markets have broadly lagged an upswing in global equity markets, yielding cumulative returns of 4.5 percent since last August. That’s less than half the return developed markets have provided (see graphic below).

But there are two reasons why a  turning point may be approaching. First the positioning. Foreign holdings of emerging equities have plunged in the past six months and according to research by HSBC they are at the lowest in four years. That’s especially the case in Asia, where fund managers have been jittery about China’s growth slowdown.

International funds appear to have responded aggressively to signs of a slowdown in emerging market economies, the bank observes, adding:

This could be a positive signal for emerging equities if economic conditions subside…particularly for Asian markets where holdings are lowest.

Valuations are the other attraction. Emerging equities are trading around 10 times forward earnings —a fifth below developed market peers. In China, which comprises about 18 percent of the main MSCI emerging equity index, valuations are near record lows. EM valuations have been “sustainably lower” only back in 2002 or during the depths of the 2008 crisis, notes James Bristow, who runs a global equity portfolio at U.S. asset manager Blackrock in London.

Bristow likes emerging markets, which account for up to half his revenues. But at the moment only about 5 percent of his fund is invested directly into emerging securities as he has opted to receive EM exposure via  international companies that sell to the developing world. That can mean all sorts of firms — from cereal and yogurt-maker Nestle to car manufacturer Daimler Benz. But now he is starting to add some EM positions, including India’s ICICI Bank and China Construction Bank:  the latter’s 22 percent price slump last year means it is trading at 1.3 times book value, well under the long-term P/B levels. To fund these purchases, Bristow has sold some U.S. tech firms where he reckons there is limited room for additional gains.

The price performance of EM recently is showing why we need to shift back..Valuations are pricing a lot of fear so you are being paid to take that risk.  Every day I’m finding more and more opportunities to invest directly in EM and that’s a theme for the rest of this year.

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