By Richard Titherington
In my three decades of investment experience in emerging markets, it has become clear to me that panic selling always creates opportunities for disciplined long-term managers. In my view, emerging market equity valuations are unusually attractive for long-term investors 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 have an attractive entry point.
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 for bearish sentiment in emerging markets to reverse, I believe that we’ll need to see changes in the real economy. I think there are three catalysts for investors to watch. First, we’ll need to see currency stabilisation. 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 single most important catalyst for our markets.
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.
Current valuations present an attractive opportunity for long-term investors. Historical analysis from the past 20 years shows that investors can potentially enjoy reasonable upside when entering the markets at such low valuations. We can judge this based on the price-to-book ration of the EM index, as that metric tends to be a good proxy for investor sentiment.
For the MSCI Asia Pacific ex Japan, the 12-month average return subsequent to entering the market at 1.3x price to book is 64%. For the MSCI Emerging Markets, the 12-month average return subsequent to entering the market at 1.3x price to book is 49%.
Emerging market currencies on average are also back to levels last seen during the crisis period in the late 1990s. It’s important for investors to maintain a focus on the long-term opportunity that remains in emerging markets, throughout what are sure to be continued short-term fluctuations.
Richard Titherington is chief investment officer for emerging market and Asia Pacific equities at JP Morgan Asset Management
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