Challenged EMs present long term opportunity

Richard Titherington, Chief Investment Officer, Emerging Market and Asia Pacific Equities, JP Morgan Asset Management

Emerging market equity valuations are unusually attractive because the asset class is burdened by sluggish global growth, a rising US dollar and falling commodity prices. As a result of bearish sentiment, emerging markets have only been as cheap as they currently are 5% of the time since 1989, suggesting that investors with a long-term focus have an attractive entry point. Meanwhile, the outlook for Japan remains positive and that market is also inexpensive relative to the developed markets.

Fundamental challenges for emerging markets

The cumulative headwind effect of lower global economic growth, a strengthening dollar and lower commodity prices has prompted slow EM growth, a disappearance of earnings growth (in the aggregate), and complications arising from currency weakness. Meanwhile, concerns about China’s cycle have intensified fears of either an intra-Asian currency war or a further breakdown in Chinese growth that exacerbates the three headwinds that the emerging markets have already been navigating.

In order to for bearish sentiment in emerging markets to reverse, we’ll need to see changes in the real economy. There are three catalysts for investors to watch.

First, we’ll need to see currency stabilisation, arguably the most important factor.  If the Chinese government is able to stabilise the Renminbi, that may help other EM currencies and commodity prices.  Secondly, we’ll need to see some improvement in the economic picture and the final catalyst will be a corporate earnings recovery.

The long term investment opportunity

Despite the disappointing performance of emerging markets since 2011, they are still expected to recover to higher growth rates than developed markets over the longer term and the asset class overall has become too big to ignore.

For example, emerging markets are home to 85% of the world’s population and more than 50% of its global GDP growth. Although they are still only 12% of global equity market capitalisation, this is changing quickly, particularly with the increasing liberalisation of China’s equity market.

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