Colin Graham, global CIO of BNP Paribas Investment Partners, said the forward price-earnings ratio of emerging market equities have jumped sharply.
The MSCI Emerging Markets Index is currently trading at 12 times earnings estimates over the next 12 months, versus 10.4 times in January (The index’s lowest multiple was 6.3 times in October 2008).
He expects the positive economic data of these countries will help drive emerging market equities over the next eight to twelve months.
In particular, Graham likes the ASEAN sub-region of the emerging markets.
Exports in Vietnam and Thailand have done quite well so far this year, which should lend support to market sentiment in these countries, he said. Vietnam’s exports grew 6.4% year-on-year in the first quarter, while Thailand’s exports rose 1.3% in March, after growing 10.3% in February.
However, emerging markets are on sharply divergent paths and he cannot make a blanket statement about the region as a whole. Russia and Brazil continue to be in recession, while China’s credit risks and slowing growth continue to weigh on investor sentiment.
Risks ahead
While the Federal Reserve continues to be dovish, it is hard to tell if there will be a shift in monetary policy direction later in 2016 should the US economic data shows signs of a solid recovery.
A US rate hike could derail an emerging markets equity rally because the US dollar should then strengthen, potentially causing capital outflows from key emerging markets as their currencies come under pressure. Investors then tend to sell their equities to stop losses driven by currency devaluation concerns.
Graham believes that the dollar is probably going to remain a headwind for the emerging markets this year.
“We have seen a retracement in the dollar. We wouldn’t be surprised to see the dollar strengthen,” he said.
China risks are another drag on EM market sentiment, he added.
The country’s credit risks have been brought to attention following a sharp increase in the number of onshore bond defaults this year after the government started to normalise the pricing of bonds issued by state-owned enterprises.
“The Chinese authorities want to keep growing the economy without going back to old policies, and it has created some troubles. If they are not doing anything to reduce debts, it is another worry,” he said.
There are mixed views on China credit risks. Fidelity International believes that China de-leveraging is healthy, but Nikko Asset Management thinks that onshore market volatility could spread to the offshore market.
Emerging market equities remain deep in negative territory, but some analysts believe a rise of nearly 20% off the January lows could signal a rebound.
