“Headlines would have you believe that a US rate hike spells the death knell for emerging market equities,” Sohn wrote in a research note, adding that historically, emerging market equities have performed well following a rate hike.
In addition, the reason why the US Federal Reserve will likely hike in 2016 is a positive one: the economy is recovering well, which should benefit the smaller and open economies of emerging market countries.
Another big concern about the Donald Trump presidency, if he sticks to his previous statements, is the increase in trade protectionism, with much of it directed toward China and Mexico.
“While undoubtedly negative for key trading partners, one mitigating factor is that emerging markets have steadily closed their current account deficits, which leaves them less vulnerable to trade shocks,” according to Sohn.
Nonetheless, “investors remain overly bearish, and the majority of global portfolios are still underweight EM equities”.
Cheap valuations
In spite of the 2016 rally, emerging market equities continue to look cheap on both an absolute and relative basis. Equities are still trading below their 10 year price-to-book average and at a significant discount to developed markets, according to the report.
In addition, fundamentals of emerging market companies are beginning to stabilise, which could act as a tailwind for the rally in emerging markets to continue.
M&G doesn’t take macro calls on sectors or geographies, but its portfolio exposure can highlight certain preferences. Sohn likes select information technology stocks, which represent its largest absolute exposure and largest overweight, according to the report. The financial sector, partiuclarly from “market leading” life insurers and banks is also atttractive.
“Within the bank space there is a whole spectrum of different macro backdrops and banking fundamentals across emerging markets, but we like underpenetrated markets — where interest rates are not as low as in developed markets — in countries such as Peru and Indonesia.”
Meanwhile, from a country perspective, the firm continues to see value in North Asia, with China, South Korea and Taiwan amongst the cheapest markets because China’s slowdown has “clouded” their macro outlook, the firm said.
It also continues to be overweight Brazil, but acknowledged that the country’s stock market has rallied “too far and too fast” ahead of actual reforms and the firm has been taking some profits pre-election.
On the flipside, the firm is avoiding expensive markets that it used to favour, such as India, Mexico and Thailand.
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Despite a rally in 2016, the MSCI Emerging Markets Index fell after the US presidential election while the S&P 500 rose. A sustainable rally in emerging markets remains in doubt because no one knows the actual policies that the new US administration will be able to implement.
