better days coming for emerging stocks

Shanghai’s primary equity index plummeted into official bear market territory on Monday, but better days are ahead for emerging-market stocks, says Ian Scott, global equity strategist at Barclays Capital Markets.

“EM equities now offer a higher risk premium than DM equities,” Scott said in a note to clients. “In the past, that has meant they have subsequently outperformed.”

The strategist increased his recommended global portfolio weighting in emerging markets to an overweight of 17.8% from a previously neutral 9.8% weight.

Scott said EM equities have suffered from poor demand trends in developed markets, which has hampered exports and earnings, but he believes better global growth in the second half should help reverse this trend.

“Within EM, as with DM, defensive sectors are richly priced, while financials and cyclicals are not,” he said. “In particular, EM banks have been heavily de-rated versus the wider EM universe but also relative to DM banks.”

In order to increase his exposure to emerging markets, Scott is “taking some profits” from Japan’s stock markets (although he remains overweight the country) and cutting his exposure to the rest of the developed Pacific region.

He also remains overweight Europe and underweight North America, including the U.S., where he believes the S&P will continue to trade near 2100.

“We continue to recommend a large overweight position in continental European equities,” he said. “We expect an acceleration in earnings growth this year as the euroarea economy recovers and the lagged effects of the lower currency boost profitability.”