Emerging market equities are set to take centre stage in 2013, says HSBC Private Bank’s Dean Turner

Dean Turner, investment strategist at HSBC Private Bank, says emerging markets could be one of the winners from a general rotation into equities, thereby attracting further investor interest this year.

We believe that 2013 will be the year that emerging market equities once again grab the attention of investors. A stabilising global economy with fading tail risks should encourage investors to rotate further out of safe haven assets. In our view, a combination of resilient economies, growing earnings, and attractive valuations should see emerging market equities outperform over coming quarters.

After the early summer sell off, most equity markets recovered to record healthy gains last year, with the MSCI AC world index recording total return (price and dividends) of over 15% in local currency terms. This proved to be a very decent outcome in our view, given the range of macroeconomic and political concerns investors had to grapple with. Interestingly, although the focus of the world’s macro concerns was on the West with the emerging market (EM) economies holding up relatively well, there was little to distinguish between the performances of the equity markets for those blocs.

The broadly similar performance of emerging and developed markets resulted from the far-reaching recovery in risk appetite, in our view. But we believe that this year investors will be more discerning when it comes to rotating further away from safe havens: as we argue below, this should favour emerging market stocks. In our view, the economic outlook, potential for earnings growth, and the capacity for valuations to expand should enable emerging market equities outperform their developed market brethren in 2013.

Growing in influence

One of the key attractions of the emerging market economies is their potential for economic growth. Rates of growth in the emerging markets have outstripped the west for more than a decade, and EM economies are growing their share of global economic activity. This does not mean that EM economies are immune to the cyclical swings that affect the rest of the world – far from it; exports, as opposed to domestic consumption, tend to make up a large share of output for most EM economies.

Nevertheless, we believe that the superior rates of economic growth will be maintained for a few of reasons. The first of these is the ongoing transition towards greater domestic consumption, which should mean that EM economies are less exposed to low growth in the developed markets. The second reason is the superior financial position in terms of lower outstanding government debt and smaller deficits. This should, and already has in some cases, enable governments in the emerging markets to stimulate their economies if growth were to falter. The final reason is that the size of emerging economies as a share of global GDP is much higher today and growing. This increasing importance of emerging economies is stimulating more trade between them, which in itself is another reason why we expect that EM economies can shelter themselves from the sluggish growth in developed markets.

From GDP to earnings

It would be foolish to assume or even suggest that there is a direct relationship between economic growth and stock market earnings, as many other factors have to be considered. Last year the emerging market economies grew at a faster rate than their developed market peers did, but this year we expect that to change.

In our view, corporate earnings growth in the emerging markets should outpace the developed markets this year, as we see a return to earnings growth in Latin America, which had previously been hampered by soft commodity prices. In addition, we expect to see earnings grow again in emerging Europe, as activity on the continent stabilises. As for the largest emerging market block, Asia, here we expect earnings growth to be stronger than last year driven by a recovery in Chinese growth and growing intra-region trade.

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