Blog

Emerging Market Equities: Looking Beyond Near‑Term Fear

We see two overarching reasons for long-term investors to consider continuing to hold a strategic allocation to EM equities: fundamentals and valuations.

Over the past year, emerging market (EM) equities have been one of the most volatile segments of the global market. With news headlines dominated by the International Monetary Fund’s bailout of Argentina and Turkey’s sudden interest rate increase and currency depreciation, EM equities dramatically sold off in 2018 – down 14.6% for the year (source: MSCI Emerging Markets Index). Investors sold billions of dollars of EM equities and market pundits raced to declare an EM crisis, one worse than 2014 and perhaps on par with 1997–1998. The fear has been palpable.

However, at Research Affiliates and PIMCO, we see two overarching reasons for long-term investors to consider continuing to hold a strategic allocation to EM equities: fundamentals and valuations.

Fundamentals don’t justify the fear

In our view, the biggest risk when investing in an EM equity market is a funding crisis, when a company or government borrows in U.S. dollars and investors lose trust in its ability to cover interest payments. We think the risk of a broad-based funding crisis in EM, especially the kind that affects the largest EM equity markets, is low.

First, the global economy, although decelerating, remains in many ways more stable than it has been in decades: Poverty has declined, inflation has trended downward and crises in banking, currency or sovereign debt have been less frequent. Second, since 2000, major EM countries have become wealthier and financially healthier as measured by cumulative GDP growth: China is up 60%, India 41%, South Korea 24% and Taiwan 22%. And as wealth has increased, foreign exchange (FX) reserves have grown – the average EM reserve level is approaching 25% of GDP today. (All data is from Research Affiliates and the World Bank.)

Finally, the largest constituents of the EM equity universe have the best fundamentals. China, South Korea, Taiwan, India and Russia make up nearly 70% of the MSCI EM Index. All have low external-debt-to-GDP ratios, ample FX reserves and current account surpluses (India has a tiny deficit). Another 17% of the market consists of Brazil, Mexico and South Africa, countries with current account deficits but low debt ratios and ample FX reserves. The countries driving the “EM funding crisis” headlines over the past year – Argentina, Turkey and Indonesia – make up less than 3% of the EM equity market. In fact, Argentina isn’t even an MSCI EM Index constituent. In short: We believe the largest EM equity markets are not at risk of a funding crisis.

Valuations appear attractive for the long-term investor

Before the 1997–1998 EM funding crisis, the EM equity CAPE (cyclically adjusted price-to-earnings ratio), a valuation metric useful over long periods of time, traded at a premium to the U.S. equity CAPE. Today, the EM equity market is priced at a CAPE of 14.5, at the bottom quintile of its historical valuation range and less than half the U.S CAPE of 29.6 (source: Research Affiliates). PIMCO’s five-year capital market assumptions forecast higher annualized returns in the EM equity market versus U.S. equities.

When the risks and the bad news are well-known to the market and fear reigns supreme, we believe opportunity abounds for the long-term investor. However, while we see favorable fundamentals and valuations, investors should not dismiss the risks – which can be sudden and severe – associated with the EM equity market, which has both rewarded and bewildered many investors.

For detailed insights into our views on equities, fixed income and other asset classes, please read our latest Asset Allocation Outlook.

READ HERE

The Author

Chris Brightman

Chief Executive Officer and Chief Investment Officer, Research Affiliates

Raji O. Manasseh

Equity Strategist

Related

Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Dublin
PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

Munich
PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Milan
PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

Smart Charts in Focus
XDismiss Next Article