Reflation paves way for further upside in emerging markets

Emerging markets eq- uities have returned more than 10% year-todate, outperforming US and European markets by more than 6 percentage points. We think they will continue to shine amid a vaccine-driven global economic recovery.

More sensitive to growth global than economic most stock markets in the developed world, emerging markets are well positioned to take advantage of the ongoing cyclical recovery. They are also set to benefit from continued abundant liquidity conditions, higher commodity prices, and a weaker US dollar. We like China, South Korea, Singapore, Latin America and Russia. Overall, earnings we forecast growth 32% for emerging markets this year, and we are positioning for a high-single-digit upside in the MSCI EM index for the next 6–12 months.

• Valuations not cheap, but relatively attractive. We acknowledge that valuations are no longer appealing compared with EM equities’ own history, but they remain attractive relative to developed markets. On a price-to-book basis, emerging markets’ valuation discount to US equities is still below the long-term average, and we expect the gap to shrink further. In addition, we now anticipate earnings growth will take the reins in driving performance, and believe earnings upgrades could offset valuation normalization. With more investors reallocating their equity exposure to EM stocks, we think the asset class will see support in both absolute and relative terms.

• EM value stocks have scope for further outperformance. Despite the recent setbacks of EM value stocks due to the uncertain coronavirus outlook, we think the value rotation is still on track. With vaccine rollouts well underway globally, including in large emerging economies, we believe the rotation should lead the MSCI EM value index to outperform the broad MSCI EM index by 7–10 percentage points over the next 6–12 months. We recommend exposure to financials, materials, energy, and industrials, and see select opportunities in real estate.

• EM currencies to remain supported as recovery broadens. Part of our optimism about EM equities reflects our positive view on EM currencies, in addition to recuperating commodity prices. While the recent rises in the long end of the US yield curve and real yields have put emerging market currencies on the back foot, we expect a broadening recovery will support pro-cyclical currencies, such as those in emerging markets. Support will also come from accommodative liquidity conditions and a gradual easing of mobility restrictions. Our view remains that the Federal Reserve will be very cautious about tapering asset purchases, and we think it will keep communicating that tightening is far off, which should dampen pro-dollar sentiment. We like the Russian ruble, the Turkish lira, and select Asian currencies (CNY, SGD, INR, IDR).