Emerging market equities  have been on a tear this year with the MSCI Emerging Market Index rising 17%, outperforming the S&P 500 by around 11.8%. This performance is set to continue according to a new research note from HSBC’s head of global emerging market equity strategy John Lomax.

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Emerging Market Equities – further gains?

There are four main drivers of emerging markets. The outlook for China’s economy, oil prices, US monetary policy and US dollar strength all influence emerging market returns by modelling return assumptions of each of these factors, Lomax and team believes emerging market equities have further upside of 6% ahead as oil prices rise, China’s stock market pushes higher the US ten-year yield depreciates, and the dollar continues to devalue. In the base case, the team models the following scenario:

“EUR-USD depreciates to 1.20, the US ten-year Treasury yield falls to 1.65%, oil prices rise to average USD60/bbl and MSCI China rises by 3% – all by the year-end.”

In this case, the model shows a 6% upside for emerging market equities through year-end with commodity markets, particularly Brazil and South Africa are favored over Asian markets. Turkey could also benefit in this scenario. Within Asia, although the regions a whole is not preferred, South Korea is set to be the region’s best performer in the base case, outperforming emerging markets in aggregate. India is the least liked market. On a sector-by-sector basis, the models like materials stocks, utilities and consumer discretionary. In the above scenario, it’s estimated the Brazilian market will return 16% through year-end with South Africa, Turkey and Poland returning 14% and 12% respectively.

The team at HSBC also consider a bull case scenario, which assumes a slightly more aggressive return for Chinese equities:

“We also consider an alternative scenario, which highlights our sense of the risks around the base case – here Chinese equities return 15%, but oil prices remain flat through to the end of this year.”

In this scenario, the entire emerging market index is projected to return 12% by year-end, almost double the base case expected return. Turkey is expected to reap the greatest benefits from this although Brazil and South Africa will follow closely. All three of these equity markets could return a little more than 20% through year-end according to HSBC’s model. Unfortunately, even in this most optimistic scenario, Middle Eastern economies which are most dependent on the price of oil will continue to struggle. Returns from UAE, Egypt, and Qatar are expected to be negligible, and Russia could return less than 5% through year-end.

HSBC: Emerging Market Equities Could Gain 20% Through Year-End HSBC: Emerging Market Equities Could Gain 20% Through Year-End