Global Investing

Emerging stocks: when will there be gain after pain?

June 14, 2012

Emerging equities’ amazing  first quarter rally now seems a distant memory. In fact MSCI’s main emerging markets index recently spent 11 straight weeks in the red, the longest lossmaking stretch in the history of the index.  The reasons are clear — the euro zone is in danger of breakup, growth is dire in the West and stuttering in the East. Weaker oil and metals prices are hitting commodity exporting countries.

But there may be grounds for optimism. According to this graphic from HSBC analyst John Lomax, sharp falls in emerging equity valuations have always in the past been followed by a robust market bounce.

What might swing things? First, the valuation. The  2008 crisis took emerging  equity prices to an average of 8 times forward earnings for the MSCI index, down from almost 14 times before the Lehman crisis. The subsequent rebound from April 2009 saw the MSCI emerging index jump 90 percent. Emerging equities are not quite so cheap today, trading at around 9 times forward 12-month earnings but that is still well below developed peers and their own long-term average.

Lomax says:

Macro headwinds are strong but emerging markets are looking very cheap. On a price/earnings basis they are 15 percent below historical lows which guards against further falls. In the past, whenever you bought emerging markets at such levels, you made money.

Crucially however, that bounce back in 2009 came after a March G20 leaders’ meeting announced a massive stimulus package estimated at around $1 trillion to prevent a global economic and banking collapse. Investors are betting that global central banks will react to the current financial market distress via more money-printing or cheap loans to banks. According to Bank of America/Merrill Lynch’s monthly fund manager survey, investors are firm in their belief  that global central banks, led by the euro zone and the Fed, will soon embark on stimulus.

The survey showed in June that fund managers slashed exposure to equities right across the board, halving their weighting to emerging markets to just 17 percent. If the expected stimulus materialises, the oversold market could rally quite spectacularly.

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/