Emerging market Equities ,,,, Investors have rekindled their love affair with emerging markets this year. Part rush for yield, part hunt for growth, investors have plowed a staggering $80 billion into emerging market portfolios this year according to the Institute of International Finance. Meanwhile, figures from Bank of America Merrill Lynch show record-breaking inflows into emerging market equity mutual funds of almost $24 billion over the ten weeks to September 9. Emerging market debt funds attracted some of the highest inflows ever over the same period.
It looks as if investors are clamoring to get their hands on anything emerging market-related and you could be forgiven for thinking that after this capital influx, emerging market equities are now trading at premium valuations.
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According to analysts at Source, the multi-asset research platform this isn’t the case, in fact, according to a research report issued by the outfit at the beginning of this week emerging market equities are cheap compared to history when valued using cyclically adjusted price to earnings ratios (CAPEs).
Emerging market Equities are still cheap
According to Source’s data, emerging market equities currently trade at a cyclically adjusted P/E ratio of 12.6, which is at the lower end of its 11-year range. In comparison, the US equity market trades at an average CAPE of 25.7 on the global average is 17.8. Further, another reason supporting emerging market equities is the fact that a year ago, emerging market dividends were falling at a year-on-year rate of 20% but dividends are now growing on average and will soon show a positive year-on-year trend according to Source’s forecast.
Despite the uncertainties surrounding emerging market economies, China and the Fed being the two chief risks, Source believes there is a unyielding argument to be made for emerging market outperformance for the next five years. Specifically, the outfits analysts write:
“Some investors may be eager to cash in the excess returns earned on EM assets during 2016 but those gains hardly start to make-up for the massive underperformance in the previous five years. For instance EM equities earned a total loss of 20.5% in the five years to end-2015, versus a return of 80.4% on US equities and 38.0% on MSCI World (all in USD). By the way, at the start of that five year period (end-2010), the CAPE on EM equities was 24.6, versus 21.5 in the US and a global average of 20.7.”
In other words, over the past five years as emerging market equities have underperformed they have become cheap relative to their developed market peers, and right now emerging market equities are trading at one of the lowest cyclically adjusted valuations since 2005.
Going on valuation alone, emerging market equities are attractive, but there are still unknowns on the fundamental side that could make emerging markets even cheaper still.