In a previous post, I explained that while a few key risks could cause significant headwinds in emerging markets, on balance, our outlook for emerging markets in 2017 is optimistic. A few factors support that view. Valuations are attractive and corporate earnings have improved. Emerging market financial positions are stronger. Resources are stabilizing. And, secular growth potential is intact.
Valuations Are Attractive
Emerging market equities are attractively valued relative to both developed markets and their historical averages, as the chart below illustrates.
Corporate Earnings Have Improved
Emerging market earnings forecasts were consistently revised downward in 2012, 2013, 2014, and 2015, but were stable in 2016 after a market sell-off in early 2016 over Chinese fears. Thus far in 2017, earnings forecasts have improved.
Moreover, since the global market sell-off in early 2016, U.S. earnings revisions have bounced back strongly, and earnings revisions in other developed markets have improved, accelerating at the end of the year due to a stronger U.S. dollar relative to the Japanese yen, euro, and British pound. Emerging market earnings revisions have lagged those of developed markets, but have shown clear signs of improvement in the latter part of the year.
As the chart below illustrates, emerging market earnings recovered in the second half of 2016 after years of decline. This was mainly driven by China’s earnings improvement.
Financial Positions Are Stronger
Emerging markets weakened after the surprising U.S. election results as the U.S. dollar appreciated sharply and U.S. yields spiked, just as they did in 2013 after the U.S. Federal Reserve announced its intention to reduce its quantitative easing. However, we believe we are unlikely to see a repeat of the 2013 “taper tantrum,” and after an initial wobble, emerging markets have outperformed developed markets.
As a matter of fact, current account balances are in better shape in emerging markets now than they were in 2013, during the taper tantrum and in previous financial crises, and economic activity is stronger, with purchasing managers’ indices (PMIs) rising.
Resources Are Stabilizing
There has been a dramatic reversal in China’s stimulus policy. After nine months of contraction, credit increased in January 2016, focusing on heavy industry and infrastructure-related sectors.
The credit slowdown had engendered a real economic slowdown that the Chinese government feared might spiral out of control, which is why it promptly reversed course, rolling out the old playbook and expanding credit. It should come as no surprise that commodities bottomed simultaneously with credit, and began to rally as it became clear China had reversed its policy.
Secular Growth Potential Is Intact
Emerging market consumer-related investment themes remain very attractive. In our opinion, there is significant growth potential in a range of consumer products and services. Low mortgage penetration, for example, offers scope for growth. So, too, do cars. We are seeing increased spending in education, online services, and tourism. And, there has been a structural shift to modern trade in emerging market food retailers. This is why the emerging market consumer is so well represented across our portfolios.