EM equities face “hostile” short-term environment
While emerging markets (EM) equities are currently not expensive and have become under-owned, the macroeconomic environment remains hostile for the asset class in the short term, according to Eaton Vance Management affiliate Hexavest.
After delivering exceptional returns in 2017 and in January 2018, EM equities as measured by the MSCI Emerging Markets Index have corrected by 12.6 per cent from their peak through 30 September, the Montreal-based manager said.
Jean-Pierre Couture, chief economist and portfolio manager at Hexavest, said valuation and contrarian sentiment indicators are currently pointing to an overweight positioning in equities.
“In a nutshell, EM equities are not expensive and have become under-owned. However, the macroeconomic environment remains hostile in the short term for EM equities,” he said.
Couture said the global synchronised growth of 2017 has vanished in 2018, with all regions except the US now in a slower-growth regime. He said Hexavest's base-case scenario is that the US economy will also decelerate in coming quarters.
“Increasing trade tensions come on top of an ongoing slowdown in China and disappointments over the strength of the recovery in Brazil, Russia, and South Africa,” he said.
“Growing imbalances in several countries also need to be monitored. This could result in further negative revisions to forecasted GDP growth and expected earnings for EMs.”
But Couture pointed out that the picture is brighter for EM equities from a valuation perspective, with the current valuation well-aligned with its historical norm.
“Hence, long-term EM equity returns, in our view, should be close to their historical standards (above 12 per cent per year in total returns),” he said.
In contrast, Couture said Hexavest is seeing the complete opposite for US equities, believing them to be “extremely expensive,” implying lacklustre expected returns.
“At current valuation levels, we believe the entry point to increase EM exposure and reduce US exposure is very appealing to long-term investors,” he said.
“Investor sentiment, from our contrarian perspective, also supports an overweighting to EM. Bearish sentiment by investors is reflected in the relative performance of the MSCI USA Index versus the MSCI Emerging Markets Index this year.
“While the MSCI Emerging Markets Index has tumbled 12.6 per cent from its January 2018 peak through September 30, the MSCI USA Index has advanced 5.7 per cent - a differential of more than 18 percentage points.
“So, despite the improvement in EM valuation and investor sentiment, the macroeconomic outlook remains challenging. We are waiting for an improvement in the macroeconomic environment before increasing the allocation to the sector.”
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