This year has seen a big divergence between performance of developed and emerging market stock markets, and a fund manager says the gap doesn't square with underlying economic reality.
Emerging market equities have been hammered by rising US interest rates, a stronger dollar and fears that escalating US-China tariffs will blunt growth, but valuations are reaching the level where they are a screaming “buy”, a fund manager argues.
EM valuations have been approaching crisis levels due to substantially weakened confidence (and performance), yet cash flows and earnings generally remain resilient. These conditions, when paired with improving corporate governance that includes dividend pay-outs and buybacks, present an increasingly attractive long-term buying opportunity for us,” Chetan Sehgal, lead portfolio manager, Templeton Emerging Markets Investment Trust, said.
“Many currencies have been cheap, and as value-oriented, long-term investors, we continue to invest in companies that demonstrate sustainable earnings power and trade at a discount relative to their intrinsic value and other investments available in the market,” Sehgal said in a note.
The MSCI Emerging Markets index of equities has fallen by 13.85 per cent since the start of this year. By comparison, the MSCI World Index of developed countries’ index is down by 3.3 per cent (both percentages are in dollars, and include the impact of reinvested dividends).
“Longer-term buying opportunities for us are developing given continued underlying fundamental strengths,” Sehgal continued.
“We are witnessing the global supply chains and trading relationships that have been integral to growing global prosperity come under increasing pressure. Thus far, emerging markets appear to have borne the brunt of the fallout: an asymmetric - and, in our view, excessive - market reaction that has contributed to valuations at near crisis levels by November 2018. However, these are valuations that to us represent increasingly attractive buying opportunities, given where fundamentals stand,” Sehgal said.
The OECD and other organisations see global economic growth decelerating next year. The Paris-based body said that global gross domestic product is likely to expand by 3.5 per cent in 2019, compared with the 3.7 per cent forecast in last May’s OECD outlook, and by 3.5 per cent in 2020. The International Monetary Fund sees emerging market economic growth in 2019 holding steady at 4.7 per cent, while it has forecasted growth in advanced economies to slow from 2.4 per cent in 2018 to 2.1 per cent in 2019.
Sehgal said: “Estimated EM earnings growth of 10.5 per cent in 2019, while below projections of 15.4 per cent for 2018, would nonetheless compare favourably with estimated US earnings growth of 9.5 per cent for 2019, down from 21.2 per cent for 2018."
The fund manager added that looking forward, the underlying business and economic situation does not justify the scale of the emerging market equity drop this year.