Emerging-Market Valuations Signal Returns of Up to 42%, Deutsche Bank Says

Investors buying emerging-market stocks at current valuations may reap gains of as much as 42 percent over the next 12 months, according to Deutsche Bank AG, citing historical returns.

Emerging-market shares are trading at about 9.9 times estimated earnings, compared with their average</a> of about 12.1 times, Hong Kong-based strategist Brad Jones said. On an equity risk premium basis that takes into account the “unusually low level of real U.S. interest rates,” developing nations are also 1.1 standard deviations cheaper, he also said.

At these levels, developing-nation stocks have historically yielded returns of between 19 percent and 42 percent, according to Deutsche Bank. Valuations have shrunk this year as the MSCI Emerging Markets Index dropped 6.6 percent, giving up some of last year’s record 75 percent rally, as Europe’s sovereign-debt crisis spreads and concerns that China’s efforts to curb speculation in its real estate market will cool the nation’s economic growth.

Emerging markets are “converging toward, but not quite at, a valuation floor,” Jones wrote in a June 11 report. “Though valuations are still shy of a ‘boundary condition’ low, Asia excluding Japan and emerging-market stocks have been cheaper than today on just 10 to 20 percent of months since 1995.”

Current multiples for developing nations are at least as low as those of 1998, the strategist said. That’s when the Asian financial crisis drove the region’s economies into recession and Russia defaulted on $40 billion of domestic debt.

‘Negligible’ Inflows

The “negligible” inflows to emerging-market stocks and the worst monthly performance for developing-nation hedge funds in May since September and October of 2008 also suggest signs of “distress” within the markets, according to Jones.

Emerging-market stock funds posted a second straight week of inflows in the week ended June 9, taking year-to-date investments to $11.9 billion, according to EPFR Global. That compares with record inflows of about $83 billion last year.

Within Asia markets outside of Japan, valuations have become 1 standard deviation cheaper than its historical average, after having been 1.5 standard deviations more expensive last July, according to the strategist. At these levels, markets have posted average one-year returns of between 9 percent and 36 percent, he said.

To contact the reporter on this story: Shiyin Chen in Singapore at schen37@bloomberg.net

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