Emerging-Market Stocks Become a Smart Bet in a Post-Brexit World

  • Earnings growth in emerging stocks will be positive in 2016
  • Valuation gap to developed equities near widest since 2006

Emerging-market stocks are looking like a smart buy as investors begin to view the developed world, from frequent terror attacks to a troubled European Union, as the sometimes riskier proposition.

This year, emerging-nation equities have outperformed their developed peers as concern over a hard landing in China subsided and a rebound in commodity prices propped up export-dependent economies. The U.K. vote to quit the world’s biggest trading bloc against a backdrop of rising violence further diminishes the appeal of regions once considered safe bets.

Money managers at Neuberger Berman Group LLC and AllianceBernstein Holding LP are sensing an opportunity. The prospect for higher earnings among developing-nation companies coincides with a murkier profit outlook in developed markets where interest rates at near zero are failing to revive sluggish economic growth.

“Emerging markets have gone through a fair bit of crises with a massive currency shakeout, hampered growth and skyrocketing inflation, and now you’re seeing the reverse of that,” Conrad Saldanha, who helps oversee $5 billion in dedicated emerging-market equity at Neuberger Berman, said in a telephone interview. “A lot of political, economic and regulatory risks are more skewed to developed than emerging markets.”

Sixty-one percent of companies included in the MSCI Emerging Markets Index that have reported quarterly earnings have outperformed analysts’ expectations, data compiled by Bloomberg show. This comes after two years of negative earnings growth amid geopolitical tension from Russia to Brazil and a slowing economy in China. Earnings for companies on MSCI’s benchmark gauge will probably expand by 10 percent this year followed by 13 percent in 2017, the data show.

“Sentiment is turning around for emerging equities, while valuations remain very low, and if you’re selective enough, this could be a good buying opportunity,” Morgan Harting, a senior portfolio manager at AllianceBernstein, said by phone from New York.

Stocks have perked up in some of the beaten-up markets -- Brazil’s benchmark equity index has added more than half of its capitalization in dollar terms this year, Russian equities have rallied 21 percent and China is calm after last year’s currency panic. 

Mind the Gap

Analysts expect developing stocks to rise 10 percent over the next year, data compiled by Bloomberg show. That compares with a 7.8 percent increase for developed stocks. Developing equities are trading at 12.3 times projected earnings, compared with 16.3 times earnings for developed countries, according to data compiled by Bloomberg. While the valuation gap narrowed in the past months, it’s still near the widest since 2006.

The Brexit referendum in June has boosted bets central banks will keep flooding the global financial system with cash to ward off an economic slowdown, giving investors confidence to put money into riskier assets. Traders have pulled money from developed equity funds at the fastest pace since 2011, while outflows from developing equity funds have been the smallest since 2012, data from EPFR Global show.

“In developed markets the growth outlook is getting more uncertain, so the growth premium EM is offering could start to widen again,” said Hertta Alava, the head of emerging markets at FIM Asset Management Ltd. in Helsinki.

Not So Fast

Many fund managers remain skeptical, citing a soaring debt level in China, a risk of a retrenchment in oil prices and geopolitical uncertainty in countries from Russia to South Africa. An attempted coup in Turkey is a reminder of surprises that lie in wait.

Paul Christopher, who invests in both emerging and developed equities as head global market strategist for Well Fargo Investment Institute, is underweight emerging equities and neutral on developed stocks.

“I don’t think that emerging economies have finished correcting the debt problems which have troubled them since 2012,” Christopher said by phone last week.

His advice? Give it another year.

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