3 factors supporting emerging markets

Global stocks are testing the fall lows, the VIX is over 25 and oil continues to collapse–not the ideal environment for emerging market (EM) stocks. Yet, while EM equities have traded lower–along with every other risky asset–they are outperforming developed markets (see Chart 1).

In August, I suggested that EM stocks were beginning to look like that rarest of things in an aging bull market: a bargain. My timing, to be generous, was early. From the late July peak to the fall bottom emerging markets equities lost another 15%.

However, more recently EM stocks have been outperforming. Given the litany of concerns, from a trade war to tighter financial conditions, why are EMs outperforming and can it continue? Three factors to consider.

1. Still cheap, getting cheaper.

Emerging market stocks were inexpensive in July; they are cheaper today. Based on trailing earnings, the price-to-earnings (P/E) ratio has dropped from 13.1 to 12, the cheapest since late 2015. On a relative basis, the MSCI Emerging Market Index is still trading at a 30% discount to developed markets, close to the bottom of this cycle’s range.

2. A more range-bound dollar.

After rallying 10% from the February low to the August high, the rally has started to stall. While the Dollar Index (DXY) did make a nominal high in mid-November, more recently the index has been stuck around 96-97. This is important. In the post crisis-world a rising dollar has been associated with weaker EM returns. Since 2010, monthly changes in the dollar have explained roughly 30% of the variation in emerging market equity returns. A flat dollar removes a key headwind.

3. Slower growth and inflation suggest rates may be peaking.

During the spring and summer a stronger dollar coincided with rising interest rates. That has, at least temporarily, come to a halt. Investors are now more concerned about slower growth. This concern is beginning to show up in inflation expectations, which have recently fallen below 2%. Slower growth and decelerating inflation may allow for a quicker end to the Fed’s tightening cycle, another factor that would likely support EM assets.

Can EM rise?

Relative out-performance is one thing, but can EM assets actually start to rally? As others have commented, one way to frame 2018 is as a series of rolling bear markets. The trend was first evident in emerging markets, but quickly spread to commodities, European equities and most recently U.S. tech stocks.

In this light, EM’s biggest advantage may simply be the fact that it got the bear market out of the way early. With the asset class now trading at its lowest valuation since the 2015 bottom and some of the key headwinds abating, any shift in sentiment is likely to be accompanied by a big EM bounce. If or when that occurs, I see best opportunities in Asia.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

Investing involves risks, including possible loss of principal. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of December 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. ©2018 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners. USR1218U-687217-2133632

source https://www.blackrockblog.com/2018/12/18/factors-supporting-emerging-markets/