Photographer: Dario Pignatelli/Bloomberg

Buy Emerging-Market Stocks as Pessimism Peaks, Barclays Says

Updated on
  • Outflows signal six-month excess returns over advanced nations
  • Strategist Ian Scott sees similarities to past market rebounds

A buy signal seen only four times in the past 12 years is flashing again in emerging-market stocks, according to Ian Scott of Barclays Capital.

Things got so bad, they’re going to turn around, according to the London-based equity strategist. In the worst quarter for equities in four years, money flows in emerging-market funds are trailing developed nations by a degree unmatched except in 2004, 2005, 2008 and 2014, Scott says, citing EPFR Global data. Yet on every one of those occasions, shares outperformed developed markets by at least 9 percent in the following six months, he says.

A repeat of that performance would come as a relief to markets battered by a $6 trillion meltdown since this year’s high in April amid concern a slowdown in China will apply brakes on global growth and a potential increase in U.S. interest rates will lead to a flight of capital from riskier assets. That spurred investors to withdraw almost $10 billion from emerging-market funds this month through the 23rd, even as they added $15 billion to funds focusing on advanced nations, according to EPFR.

“The degree of selling relative to developed-market equities is about as negative as it gets,” Scott, the head of equity strategy at Barclays, said in an interview Sept. 24. “At this point, emerging-market equities have responded by outperforming over the next six to 12 months. I think this is going to repeat itself.”

In concluding that money flows out of emerging-market funds were the worst relative to developed-country funds, Barclays relied upon a statistical technique called Standard Scores. The model showed the shortfall had widened to two standard deviations from the average, meaning it would occur in about only one out of 10 occasions. When that gap was as wide in February 2014, emerging-market stocks gave 8.8 percent excess returns over six months. In November 2008, it led to a 38 percent outperformance; in May 2005 and July 2004, the surplus was at least 15 percent.

Scott recommended buying emerging-market stocks in June, when Barclays raised its recommendation to overweight, the equivalent of buy. Since then, the MSCI Emerging Markets Index has declined 20 percent. 

Scott said by e-mail Sept. 30 that he stood by his position.

“As for the further underperformance, the flows were not so extreme at the end of June, so with the benefit of hindsight we should have waited until things had deteriorated further,” he said.

The benchmark index has declined 17 percent this year, compared with a seven percent drop in the MSCI World Index. That brought valuation to 10.6 times projected earnings, less than the 11.3 average over the past 10 years and a 28 percent discount to advanced-nation shares. 

Emerging economies are forecast to expand 4 percent this year, their slowest rate of growth since 2009, according to data compiled by Bloomberg.

The slowdown “is more than fully discounted in the price of the stocks,” Scott said. “Investors are being paid to own emerging-market stocks at the moment.”