One of the best trades of the year may just be getting started.
Emerging-market stocks have soared in 2017, outperforming other regions and asset classes on the back of improving growth and valuations that are seen as less lofty when compared against markets in the U.S., where dozens of records have been accompanied by concerns that prices have gotten rich. These factors could continue to support the region, analysts said, with one positing that the emerging-market rally was still in its “early innings.”
“A trio of forces offers support for EM equities today: structural reforms that are leading to higher profitability, synchronized global growth fueling improved demand, and stimulative fiscal and monetary policies,” wrote Kate Moore, chief equity strategist for BlackRock, who gives emerging-market stocks an “overweight” rating, the equivalent of a buy rating. The reforms Moore cited include India’s initiatives at fighting tax evasion and corruption, and labor reforms in Brazil.
Moore added, “The underlying fundamentals for EM equities are improving after five years of declining profitability and weak earnings growth. We believe the recent outperformance is the start of a longer trend.”
Thus far this year, the Vanguard FTSE Emerging Markets ETF
an exchange-traded fund decided to the space, is up nearly 26%. Another ETF, the iShares MSCI Emerging Markets ETF
has gained more than 33%. About $9.6 billion has flows into the Vanguard ETF thus far this year, according to FactSet, while another $3.4 billion has gone into the iShares fund. The iShares Core MSCI Emerging Markets ETF
has had $15.1 billion in year-to-date inflows.
The returns for emerging markets outpace gains for the U.S.’s main benchmarks, with the Dow Jones Industrial Average
set to rise more than 19% so far in 2017, the S&P 500 index
on track to gain about 16%, and the Nasdaq Composite Index
looking at a year-to-date advance of more than 26%.
Read: Miss the bull market? Investors say the next one will be overseas
As with the U.S., the region’s gains have been driven by the technology sector, where large-capitalization companies have seen massive year-to-date moves. Stocks focused on the region’s growing consumer base have also outperformed this year, while some commodity plays have lagged behind the overall market.
“Recently there’s been a trend of a rising tide lifting all boats, but that won’t be the case going forward. Individual companies will be very diverse with respect to the risk they offer,” said Robert Marshall-Lee, the investment leader of Newton Investment Management’s emerging and Asian equity team. “We expect China’s GDP to slow to 4-5% going forward, but for companies in consumer services to grow 15%, while individual names within that space grow 30% or more.”
Marshall-Lee said companies related to education or health care in China were trades “that can go for a long time,” and that India offered “huge growth prospects.”
The current forward price-to-earnings ratio for emerging-market equities is 12.6 times, according to data from the Wells Fargo Investment Institute. That’s below the 20-year average of 14.8 times. The forward P/E for developed markets, excluding the U.S., is 14.8 times, compared with the long-term average of 15.7. The S&P 500’s forward P/E is 17.8, in line with its 20-year average.
BlackRock’s Moore said EM valuations were “at their highest since 2010, but 24% below developed markets,” which she said made them “not expensive, on a relative basis.”
Tracie McMillion, head of global asset allocation for Wells Fargo Investment Institute, wrote that the current macroeconomic environment supported broad asset prices “at or near current levels through the end of next year.” She said the U.S. economy would likely avoid a recession in the coming year, but added that “If you have cash to invest, but are wary to do so at such lofty prices, we recommend considering international stocks, an area of the market where more upside potential is possible.”
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