Emerging Stocks `Catalysts' Align, Signal More Gains, Morgan Stanley Says

Emerging-market equities are poised to extend their outperformance against developed-nation stocks amid higher corporate profits, according to Morgan Stanley.

The MSCI Emerging Markets Index has gained 13 percent since reaching this year’s low on May 25, trimming its losses this year to 2.4 percent. The MSCI World Index, tracking developed- nation stocks, has dropped 7.9 percent in 2010 and bottomed later, on July 5.

Further gains may be driven by the “superior” outlook for economic and earnings growth in developing nations, a peak in Asian inflation, China’s decision to de-peg its currency and the “resilience” of commodity prices, according to Jonathan Garner, Morgan Stanley’s London-based chief Asian and emerging-markets strategist. The return of foreign funds “heavily favor” emerging-market stocks relative to developed nations, he said.

“A number of catalysts are falling into place for emerging-market equities at this juncture,” Garner wrote in a report yesterday. On May 26 he advised investors to boost holdings of emerging-market equities and local-currency debt, given the prospects of a “strong year” for the global economy.

Global equity funds have cut their “underweight” in emerging markets relative to benchmark indexes to 70 basis points, compared with 210 basis points at the start of the year, according to Garner.

Fund Flows

Individual investors are also buying more developing-nation stocks, the strategist said, citing data by Cambridge, Massachusetts-based EPFR Global showing that emerging-market equity funds have attracted a cumulative $91 billion since January 2009. That compares with net withdrawals of $71 billion from developed-nation stock funds, according to the report.

The MSCI index of 21 developing nations offers investors a return on equity of 14 percent, topping the 10.2 percent for the MSCI World Index, Garner said. The valuation premium of emerging markets to developed stocks is lower than in late 2007, the strategist said, citing price-to-book value multiples.

“In conclusion, both fundamentals and flows appear to be aligning to deliver another year of emerging-market equity outperformance relative to developed-market equities, the ninth in the last 10 years,” Garner said.

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

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