Emerging Stocks Face Significant Correction, JPMorgan Says

Emerging-market stocks may enter a “significant correction” after they trailed developed-nation shares this year, according to JPMorgan & Chase Co.

“Fundamentals and technicals are weakening,” Adrian Mowat, the chief Asia and emerging-market strategist at JPMorgan, wrote in a report dated yesterday. He recommended options that protect against stock losses and advised selling equities that are most sensitive to market swings.

The MSCI Emerging Markets Index fell 1.4 percent to 1,053.14 in New York, the biggest drop in seven months, erasing its gain for the year. About 62 percent of companies in the gauge that reported earnings for the quarter ended Dec. 31 missed analysts’ estimates, compared with 34 percent for the MSCI World Index, which has climbed 4.4 percent this year, according to data compiled by Bloomberg.

Concern that Chinese policy makers will pare back monetary stimulus is weighing on the country’s bank stocks, while South Korean exporters are getting hurt by the won’s strength and South African shares have slipped amid mining-related disputes, Mowat said. At the same time, Japanese equities are surging on Prime Minister Shinzo Abe’s stimulus efforts and U.S. shares are benefiting from takeovers.

Country Recommendations

“We see no near-term changes to these conditions, hence we fear emerging markets may continue to underperform and be a funding source for Japan,” Mowat wrote.

Shrinking liquidity in China, heavier state intervention in key emerging-market economies and a dearth of good stock ideas are the main reasons for being bearish, according to John-Paul Smith, an emerging-markets strategist at Deutsche Bank AG in London.

“I am forecasting a 10 to 15 percent decline in absolute terms for emerging markets this year and more in terms of relative performance against the U.S.,” Smith said. “This is the year when people finally realize that actually the sustainable rate of growth in China going forward is much lower than they currently think.”

Hong Kong-based Mowat’s outlook contrasts with that of Bank of America Corp., which said on Feb. 19 that investors should buy emerging-market equities and bonds as economic growth improves in the so-called BRIC countries of Brazil, Russia, India and China. Price targets for shares in the MSCI emerging-market index suggest the gauge will advance about 13 percent in the next 12 months to 1,195, according to analyst estimates compiled by Bloomberg.

Earnings Valuation

The measure trades for 10.5 times projected 12-month earnings, compared with a multiple of 13.7 for the MSCI World, data compiled by Bloomberg show.

Japan’s Nikkei 225 Stock Average climbed 10 percent in 2013 through yesterday amid optimism that a weaker yen and increased government spending will lead the country out of deflation. The Standard & Poor’s 500 Index rose 6 percent in the period as Warren Buffett’s Berkshire Hathaway Inc. and 3G Capital agreed to buy H.J. Heinz Co. for about $23 billion.

Emerging-market investors should favor “quality” companies with high return on equity, Mowat said. He has overweight recommendations on shares in Turkey, India, Mexico, Indonesia, Thailand, the Philippines and Peru, meaning positions should exceed the nations’ representation in benchmark indexes.

Mowat predicted in November 2011 that the MSCI emerging index would reach 1,150 by the end of 2012. The gauge touched 1,085 in February 2012 and ended the year at 1,055.20.

China, India

The Hang Seng China Enterprises Index retreated 2.2 percent today, erasing its 2013 advance, after China’s government told local authorities to curb real estate speculation and the central bank drained cash from the financial system. The S&P BSE India Index also turned negative for the year after a 1.6 percent drop today.

Developing-nation shares fell today after Federal Reserve meeting minutes sparked concern the U.S. may curtail stimulus and Belle International Holdings Ltd., China’s biggest footwear retailer, lead a tumble in retailers. Hong Kong-based Belle plunged a record 17 percent to HK$15.28 after saying in a filing last night that its 2012 net income will “fall within the lower end” of analysts’ estimates.

The MSCI emerging market index gained 15 percent in 2012, compared with 13 percent in the S&P benchmark, as the Fed’s increase in asset purchases and the European Central Bank’s pledge to keep the euro intact boosted investors’ confidence in holding developing countries stocks.

Global Stimulus

A withdrawal of the global stimulus may lead to losses in emerging-market stocks as earnings growth has yet to show signs of recovery, according to Lewis Kaufman, a fund manager at Thornburg Investment Management, which oversees $85 billion.

“By and large, many companies are struggling to meet earnings expectation,” Kaufman said in a telephone interview from Santa Fe, New Mexico. “There’s probably a bit of disconnection between the extent of the rally and the underlying fundamentals.”

Kaufman said he favors stocks in Southeast Asia and the Philippines as economic growth “surprises positively.” His $213 million Thornburg Developing World Fund returned 14 percent over the past three years, beating 98 percent of its peers, according to data compiled by Bloomberg.