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Opportunities in Emerging Market Equities

Since 2010, emerging markets equities have underperformed due to a stronger dollar and declining commodity prices. But that trend could be reversing.

Fundamentally, growth around the world is on the upswing. The G10 Economic Surprise Index, the Morgan Stanley Global Trade Leading Indicator, and the JPMorgan Global Composite Purchasing Managers’ Index have all suggested higher growth since February 2016. Commodity demand is likely to pick up as global growth increases, keeping commodity prices stable. In China for example, manufacturing has already accelerated, exporting inflation to the rest of the world. Emerging Markets are poised to be the primary beneficiary of this global rebound, with MS & Co. forecasting GDP growth in emerging markets at double the rate of the United States.

FactSet consensus estimates are for 20% earnings growth in emerging markets for 2017 compared to 10% in the United States and 17% in developed international countries.  But what makes Emerging Markets particularly attractive compared to the rest of the world are valuations.  Based on market expectations for earnings, emerging markets are trading at a 24% price-earnings discount from developed markets, according to Bloomberg).

Many of the risks that once held back EM equities now appear contained. In 2013, the Fed signaled that it was looking to taper Quantitative Easing.  The rising US interest rates strengthened the U.S. dollar and squeezed emerging market debtors, many of whom needed US dollars to pay back debt.  Emerging markets fell into a recession that was made worse by plummeting commodity prices, capital outflows, and falling currencies.

Today, emerging market economies appear much more resilient. Their real interest rates have risen while US rates have remained relatively stable, allowing real rate differentials to widen. The yield advantage is attracting capital, helping to support local currencies. This, in turn, would increase returns for US dollar investors and make it easier for emerging market companies to pay back dollar-denominated debt.

On the political front, with uncertainty around trade policy, we prefer an active approach to emerging market equities, focusing on domestically oriented companies in countries such as Indonesia, India, Taiwan, Korea, and China. Overall, synchronous global growth, a stable dollar, and reviving commodity demand could support a multi-year bull market in emerging market equities. Because they are currently cheap relative to other equities, the Global Investment Committee believes now is a good time to consider adding exposure to Emerging Markets.

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