Emerging market equities have set a stellar pace among asset classes this year thanks to a standout performance by Asian technology shares as the earnings outlook for many companies brightens.
The MSCI EM equities index has risen more than 17 per cent in local currency terms, considerably outpacing the S&P 500’s rise of 9 per cent which has repeatedly set record highs recently, driven by a handful of tech behemoths including Google and Apple.
IT companies have handily outperformed other sectors in the EM index, returning 31 per cent so far in 2017.
Jan Dehn, head of research at EM-focused asset manager Ashmore Group, said companies in emerging markets were coming out of “one of the longest earnings recessions in their history”.
He is optimistic that the favourable conditions will continue, arguing that “the switch in global capital back to EM provides a supportive macro environment” while “in price-to-earnings [ratio] terms we are still well below where we have been in normal market conditions, valuations are not stretched”.
A weaker dollar has helped EM equities as fears that an accelerated policy tightening by the US Federal Reserve would pressure the dollar-denominated debt of Asian companies — as previewed in 2013’s so-called taper tantrum — has receded.
Ben Laidler, global head of equity research for HSBC, said corporate valuations are “still very low, with a 30-40 per cent discount to developed markets on a price-to-earnings ratio basis” while many investors had not yet stepped back into the market.
Investors have added nearly $30bn to dedicated emerging market stock funds, according to flows tracked by EPFR.
The prospect of fast economic growth and stability in commodity markets has helped attract investors.
Ashmore has seen net inflows to its EM debt flows for the first time in three years, indicating renewed investor confidence, it said recently.
Substantial markets such as Russia and Brazil have returned to growth after experiencing painful recessions, helping to boost demand. An uptick in China’s appetite for imports has also helped many emerging economies.
However, Mr Dehn cautions that EM stocks are correlated with US stocks, which represents a risk factor. “If we get a US stock market correction we would expect EM fixed income to do better than EM stocks,” he added.
Mr Laidler said while EM tech stocks are benefiting from the same investor appetite that has pushed US equity indices to record highs, they are less consumer-focused as the sector is dominated by hardware manufacturers.
John Normand, a JPMorgan analyst, said that, although the bank was positive about the medium-term outlook for EM equities, a “more pronounced downshifting in the Chinese shadow banking system” was a notable potential risk for the sector over the short run.
Emerging market governments’ bonds have also performed well, generating nearly a 10 per cent total return in the year to date according to Bloomberg Barclays indices.
Commodities were the only major asset class to generate negative returns so far in 2017, down more than 10 per cent.
Additional reporting by Eric Platt