The slowdown in the US, although having a significant impact on the world's economy, is unlikely to ...
The slowdown in the US, although having a significant impact on the world's economy, is unlikely to result in an extended period of recession. It is at the turning point of expectation for global growth that emerging markets tend to outperform other asset classes most strongly.
With emerging markets trading on historically low valuations, the scene is set for a sustained re-rating over a 12-month horizon.
In the decade from 1985 to 1995, there were two periods of significant outperformance relative to the US. However, since the mid-1990s, emerging markets have suffered a period of underperformance. This divergence has been down to two main forces: structural imbalances within emerging markets led to a significant slowdown in earnings growth and caused markets to be substantially de-rated and the economic miracle driven by technology associated productivity gains that lifted the US stock market to new highs.
Much of the gap that has opened up between emerging markets and US assets is unwarranted. As the recent bursting of the technology bubble demonstrated, markets can be creatures of sentiment.
In the short-term, hype can drive markets too high, but by a similar token, over-bearishness can drive markets too low. There comes a point when reality sets in and valuations return to reflecting fundamental criteria. Emerging markets with strong current earnings visibility are now overdue an upwards re-rating.
We expect a rally in emerging markets to come through over the next 12 months led by three key drivers: falling interest rates, strong underlying fundamentals and cheap valuations.
Cyclical factors are combining with secular forces, lending support to the idea that we may be close to an upswing in the asset class. Improving liquidity conditions resulting from the easing of monetary policy are helping to reflate the global economy.
It is at this stage that the solid fundamentals and cheap valuations of emerging market equities should come to the fore. These have as their foundation a favourable earnings outlook, particularly when compared with the US market. In the past, superior economic growth at a country level often failed to feed through to higher earnings growth in individual companies. However, more recently these problems have abated. Greater awareness of shareholder value and strengthening standards of corporate governance have set the scene for the improved earnings figures we are currently witnessing.
Low valuations reflect the fact that emerging markets are currently pricing in the worst-case scenario, a hard landing for the US. We believe these fears are overdone. When fears of a global recession depart from the equation, the potential opportunities offered by emerging markets should become apparent.
Jeff Chowdhry is head of the Foreign & Colonial Emerging Markets Investment Trust
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