Overweight emerging markets

Find out why we think that EMs currently offer some of the most attractive investment opportunities globally.

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At a glance

While the coronavirus has added to risks to the global economy, we continue to like emerging market stocks. This is predicated on our view that China succeeds in containing the outbreak there in the coming weeks.

Economic and social changes in emerging markets

The economic and social changes in emerging markets (EMs) over the past two decades have been extraordinary. EMs now account for over 60% of total global economic output and over 70% of GDP growth. Since 2000, over one billion people in emerging economies have moved out of poverty, while the number of billionaires has increased more than three times faster in EMs than in the developed world.

Investors exposed to these developments have been well rewarded. In recent years, however, the EM story has changed. EMs failed to shine between 2014 and 2019 as their aggregate growth advantage over developed markets (DMs) shrank. Investors, tired of the underperformance, have voted with their feet. Meanwhile, the coronavirus outbreak has added to risks in the region, leading to a sell-off in stocks.

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EMs currently offer some of the most attractive investment opportunities globally

We continue to overweight EM equities. This positioning is predicated on our view that China succeeds in containing the outbreak there in the coming weeks, allowing supply chain disruptions to resolve, consumer confidence to revive, and the economic and market impact from COVID-19 to be confined to the first quarter of the year. Assuming this is the case, we expect earnings growth of near 12% in Asia ex-Japan this year. We also view valuations in Asia ex-Japan as reasonable at 1.6 times book value, a near 35% discount to global peers. Meanwhile, the forward P/E discount of EM equities to developed market equities increased recently to 28%, above five- and 10-year averages.

Among the EMs, we see a strong case for Brazil, a rare early cycle story in a world of maturing growth, as the country transitions from a state-led to a market-driven economy. The recovery should drive superior earnings growth (20% vs. 13% for EMs based on our estimates). Record low real interest rates are also supporting domestic and international funds’ allocation to equities, while potential BRL appreciation could also provide an additional source of upside.

In addition, we see a compelling investment opportunity in EMs through incorporating environmental, social, and governance (ESG) factors. Although ESG regulation in EMs is often less robust than in DMs, this also means investors are likely to place a greater premium on those EM companies with higher ESG standards. The MSCI EM ESG Leaders index has already outperformed the broader MSCI EM index by more than 3% annualized from inception at end-September 2007 to end-September 2019.

Over the next decade, we expect much lower DM equity returns—about 4%–6% nominal returns per year in local currency terms. But in EMs, we expect roughly 9% annual returns in USD terms, largely thanks to better potential for long-term profit growth.

Key takeaways

  • We are overweight emerging market equities, which look poised to accelerate versus their developed market peers.
  • Investors can also seek exposure to emerging market stocks incorporating ESG factors.
  • Brazil offers a compelling early cycle story in a late cycle environment.

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