Tailwinds to Emerging Markets Resurgence?
By Jack Rosovsky, CFA and Charles Roth
Emerging markets have shot out of the gate in early 2017, even as the Fed is hiking rates. Renewed global growth, earnings cycle and valuations bode well.
Busan, South Korea
In contrast to last year’s volatility in the first quarter, global equity markets showed strong returns during the first three months of 2017. Economic indicators and earnings around the world are beating expectations, moving global stock markets higher. International equity markets outperformed U.S. stock markets in the first leg of this year, with emerging markets almost doubling the U.S. large-cap stock performance. Perhaps valuations and earnings cycles are starting to be reflected in index returns.
If U.S. blue-chip earnings are at cycle peaks, developed market ex-U.S. and emerging market earnings are far from it. And valuation differentials—forward price/earnings ratios of 12.2x and 14.7x in the MSCI Emerging Markets and EAFE Indexes, respectively—are considerably less demanding than the S&P 500 Index’s 17.5x forward P/E. These two factors, along with accelerating global economic growth, go some way in explaining why the MSCI EM Index climbed 11.5% in the first quarter and the MSCI EAFE Index gained 7.3%, outpacing the S&P 500 Index’s 6.1% advance. The valuation differentials suggest that emerging market and advanced market stocks outside the U.S. may still have considerable upside.
Take emerging markets. Within the MSCI EM Index, all sectors showed positive returns, indicating that the advance is broad-based. From a country perspective, returns in Mexico, South Korea, and India were up mid- to high-teens in U.S. dollar terms, as the peso, won, and rupee appreciated meaningfully against the dollar. This is a reversal from the fourth quarter of last year, when these local markets had negative returns and their currencies depreciated against the dollar.
Interestingly, this performance came at a time when the U.S. Federal Reserve has raised its benchmark interest rate twice in four months, and somehow suggested dovishly that more hikes are on the way. Historically, U.S. rate hikes pull flows out of emerging markets in pursuit of higher dollar-based returns in U.S. assets. That may still play out. But faster emerging markets economic growth, earnings far from cycle peak and much cheaper valuations are proving to be a tailwind in the first leg of 2017.
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Originally Published at: Tailwinds to Emerging Markets Resurgence?