EM stocks may make a comeback in 2019

Emerging market (EM) equities might make a comeback in the coming months, supported by the US rate policy and a widening growth gap in GDP between emerging and developed markets, according to Robeco Investment Solutions’ senior portfolio manager, Jeroen Blokland.

On the other hand, the threat of declining US growth and risks to Chinese growth due to the ongoing trade war could pose a threat to EM recovery.

According to Blokland, last year was pretty tough for emerging markets, which saw a negative return of more than 10 per cent in euros compared to only a 4.1 per cent fall in euros in the case of global stocks.

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“But given the recent developments in markets, the odds for a solid emerging market performance from here on are pretty decent,” he noted.

One of the things which would work into EM’s favour was the path of the Fed’s monetary tightening, which would mean that the US dollar would not strengthen further, and a stronger US dollar often coincided with lacklustre performance for the emerging markets, Blokland reminded.

The gap between growth rates in emerging and developed markets was also typically one of the strongest drivers of EM equity performance relative to developed market equities, but Robeco’s analyst warned of the risks that the ongoing war between China and the US might pose for the emerging markets, which were particularly vulnerable to a slowing of global trade.

Additionally, a drop in the average price/earnings ratio of EM equities by 30 per cent, as a result of the last year’s sell-off, meant that valuations for EM stocks had fallen below their long-term average.

Asked about the potential risks, Blokland said that if we got a US recession this year then EM equities would follow and fall further and in that case, earnings would also decrease, removing the potential valuation catalyst as well.

“The same scenario is true if Chinese GDP growth slows further, meaning current stimulus is insufficient to accelerate growth. For many emerging countries, and not just in Asia, trade with China is far more important than with the US,” he said.

“Recent developments make us believe that the odds of these risks materialising have decreased and not increased recently.

“A pause in the Fed hiking cycle, and/or any progress in the trade dispute between China and the US, would further substantiate this observation, and pave the way for a solid return on emerging market equities going forward.”

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