Emerging Markets poised for ‘quadruple whammy’ to lift them out of doldrums

Emerging market equities could be lifted by a ‘quadruple whammy’ of factors in 2019 which takes them out of a near year-long decline, River and Mercantile’s Al Bryant has said.
Rising oil prices and higher US interest rates combined to deliver financial stress on emerging markets (EM) early in 2018.  A US-Sino trade war, and rising fears of a global slowdown, added to these pressures in the latter part of the year, leaving emerging market equities in bear market territory.
“There have been a lot of headwinds for emerging markets in the last 12 months, but the primary one was the strong economic growth of the US and the corollary normalisation of interest rates,” he said.  “This caused losses to mount for EM equities; a good portion was based on EM fx declines against the rising Dollar.”
However, Bryant, said there are four key drivers that can potentially power emerging markets this year following such events.
“You now have a combination of factors which includes cheap equity valuations, beaten down currencies, attractive dividend yields, and improving profitability,” he said.
“A large cross-section of EM companies have improved balance-sheets and have been showing an improvement in profit margins. Dividend yields also now average above 3% for emerging market stocks which has been a decent historical signal for subsequent gains.
“Of course, the risk with EM is always that stocks are cheap for a reason, but in the absence of further global turmoil, these positive factors could be very powerful for emerging markets.”
Below Bryant, who joined River and Mercantile in 2017 from Credit Suisse with the Industrial Life Cycle (ILC) team which he heads up, highlights the four factors in more detail.

• Cheap valuations

Data from consultancy Yardeni Research shows that emerging market shares are relatively inexpensive at present. With a forward P/E of 11, emerging markets are considerably cheaper than the US (15.4) and also less expensive than the UK (11.7), Japan (11.7) and EU (11.8)[1].

• Beaten down currency – The J.P Morgan Emerging Market Currency Index (FXJPEMCS Index) is down 28% versus the US Dollar from medium term highs in the summer of 2014, and 11% off from most recent highs in early 2018. (source Bloomberg).
• Attractive dividend yields

MSCI data shows emerging markets currently offer a dividend yield of 2.91%, much higher than that of the S&P500 (2.09%) and the same as the UK (2.91%)[2].

• Improving profitability – The Return on Equity (ROE) for the MSCI Emerging Market index rose to 13% for 2018, a rise from lows of 10.7 in 2015. This improvement is expected to be maintained in 2019. (Source Bloomberg, MSCI).

[1] https://www.yardeni.com/pub/mscipe.pdf
[2] https://www.msci.com/documents/10199/24a51f40-c88e-4dd4-8b60-f7fcc15c6282