Highlights
- We believe emerging markets (EM) fundamental conditions are set for improvement in 2015, based on our outlooks for economic growth, earnings, and policy.
- Valuations are compelling and EM may be situated to recapture some of their relative losses from a technical perspective, particularly in Asian markets.
- However, somewhat mixed fundamental and technical pictures suggest a better opportunity may be forthcoming
Emerging Markets Opportunity Still Emerging
The S&P 500 Index hit another set of fresh record highs last week (November 10–14, 2014) and has achieved the midpoint of our total return forecast (10%–15%) for the year with a 12% return year to date. While we continue to recommend keeping the majority of equity allocations in the United States, as we have for a while, we think it is a good time to look at opportunities that have lagged behind the strong U.S. stock market and may have become attractively valued, possibly setting the stage for a reversal. One such area is emerging markets (EM).
It has been another tough year for emerging markets equities. The MSCI EM Index has returned just 1.4% year to date, far behind the S&P 500 (though MSCI EM Index has outpaced the developed foreign benchmark, the MSCI EAFE Index, which has returned -2.6% year to date) [Figure 1]. EM have struggled for many reasons, including but not limited to lackluster earnings, Federal Reserve (Fed) tapering and the subsequent end of quantitative easing (QE), related concerns about current account deficits due to trade imbalances and borrowing abroad, geopolitical unrest in Ukraine and the Middle East, the drop in commodity prices, a strong U.S. dollar, and growth fears in Europe and China. So with all of those challenges facing investors, is it time to buy EM? To answer that question, let’s look at fundamentals, valuations, and technicals.
Mixed Fundamentals but Poised to Improve
We believe emerging markets fundamental conditions — though somewhat mixed currently — may show improvement in 2015. Key elements to this assessment include our outlooks for economic growth, earnings, and policy:
- Slower growth still outpacing developed world; could pick up in 2015. Growth has slowed significantly in EM countries in aggregate over the past several years, led by the substantial slowdown in China. After growing gross domestic product (GDP) at roughly 8% in 2010, emerging markets economic growth has averaged only about half that amount, or 4%, since 2012, still well above the sub-2% growth for the developed markets overall this year [Figure 2]. But as we discussed in our October 31, 2014, Weekly Economic Commentary, “Gauging Global Growth in 2014 & 2015,” emerging markets overall are expected to grow GDP a bit faster in 2015. Slightly better U.S. growth may help, although Europe (an even bigger export partner for EM) remains a wildcard. The Bloomberg-tracked consensus is currently calling for only a marginal improvement to 4.5% GDP growth in 2015, while the International Monetary Fund (IMF) expects emerging markets growth to improve more substantially, by about a half percent to 4.9%.
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