EM equities have the potential to go further

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Despite many portfolios still underweight EM equities, investors are turning more positive as sentiment and fundamentals improve. Against a backdrop of five months of outperformance versus their DM counterparts, Stephen Cohen, Chief Investment Strategist at iShares EMEA, looks at why emerging market equities have the potential to go further.

“EM equities’ out performance in the past five months has left broad EM and China testing recent year highs. Since mid-March, EM has outperformed developed markets, with the MSCI EM up 15%, China H Shares 24% and China A Shares 13%. Despite these gains, we think there could be more to go in the EM trade.

“While still underweight EM equities in many portfolios, investors are turning significantly more positive. This has been driven by a broad improvement in sentiment and fundamentals, led by China, positive speculative impact from elections such as India, Indonesia and Brazil, a shift from the tightening stance across EM CBs earlier this year, and markets pricing out – for now – developed market policy normalisation.

EM data upward trend intact despite European growth tailing off

“The upward trend of EM data has stayed intact even as growth has tailed off in Europe. On a corporate level consensus, EM earnings growth for this year has been revised upwards steadily, albeit incrementally. This contrasts with Europe where consensus earnings growth has almost halved compared to the start of the year. A change in the developed market policy outlook could undermine EM momentum but a lack of wage growth in the US and the UK, and fast falling inflation expectations in Europe are currently providing a renewed benign rate environment.

Reiterate call on China, Korea and Taiwan

“For China, headline easing is not likely but Chinese authorities should continue to ease on the margin in order to meet the year-end growth target, especially since recent data is starting to plateau. We also reiterate our call on Korea, which has recently delivered a rate cut and announced plans for reform, and Taiwan.

“Nonetheless, investing in EM does not come without its risks. Geopolitical risks continue, giving a safe haven bid to the US dollar and a headwind for EM currencies. On a country level we are watching the upcoming October election in Brazil. BOVESPA has rallied 25% during the EM recovery on hopes for a market-friendly election outcome while fundamentals have deteriorated sharply.”

 

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