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UPDATE 1-INVESTMENT FOCUS-Cheap emerging markets: Bargain basement or falling knife?
2013年8月23日 / 下午2点00分 / 4 年前

UPDATE 1-INVESTMENT FOCUS-Cheap emerging markets: Bargain basement or falling knife?

By Sujata Rao

LONDON, Aug 23 (Reuters) - Emerging markets are looking very cheap and the beaten-down prices could be a solid base for future returns, but funds should be prepared for more short-term losses if they take the plunge.

Stocks, bonds and currencies across the developing world are suffering a rout on a scale not seen for years. Asset price valuations look dirt cheap - versus emerging markets’ own history and also possibly against their future prospects.

But on the downside, the impending rollback in Fed money printing will almost certainly drive up U.S. bond yields, the higher global borrowing costs seeping through to hit economic growth across the developing world.

And falls in currencies such as Indian rupee and Brazilian real are a worry, eroding foreign investors’ returns from local stocks and bonds.

Yet, even as such fears feed the selling momentum, cheap valuations are starting to catch the eye of some investors who are looking at the sector from the perspective of a few months or even a few years down the road.

JPMorgan Asset Management, for instance, says it is snapping up cheap emerging market shares to top up its funds.

“As bad as the newsflow is in emerging markets, we would highlight that it is not the grounds for a crisis. However valuations are at crisis levels,” says George Iwanicki, a strategist at JPMorgan Asset Management in New York.

Iwanicki argues that historically, buying emerging equities when they trade at 1.5 times book value or less has delivered positive returns. The sector is now trading 1.45 times.

That compares with a current price-to-book ratio for the U.S. benchmark S&P 500 index of 2.35 and 1.29 for the pan-Europe Euro STOXX 50.

Compared to their own 10-year history, emerging equities are 30-50 percent cheaper on a price-book basis, and valuations have more than halved from their 2007 peaks, data shows.

“Valuations have fallen to levels that historically have almost always provided a positive return,” Iwanicki said.

Similar analysis from HSBC shows that when emerging equities trade at current valuation levels of around 10 times forward earnings, a subsequent market rebound has tended to deliver returns of around 60 percent in the following year.

Rising U.S. yields will be a formidable challenge especially for markets such as India and Turkey that have funding deficits, says John Lomax, HSBC’s head of emerging equity strategy. But valuations suggest much risk is already discounted, he adds.

“Valuations look attractive but headwinds also look severe so there is no point in being unnecessarily brave,” Lomax said. “But you shouldn’t throw out the whole emerging markets baby with the bath water.”


Bonds may have further to go. Not only are they hyper-sensitive to Treasury moves, emerging debt, unlike stocks, has been an investor favourite for months. Segments of the market, arguably, were in bubble territory.

Still, average yields on bonds in emerging market currencies have risen 150 basis points this year on JPMorgan’s GBI-EM index, and the worst-hit currencies have lost 15-18 percent to the dollar, reversing some of their overvaluation.

Werner Gey van Pittius, co-head of emerging debt at Investec Asset Management says emerging economies’ growth gloom will eventually lift, dragged up by the brightening picture in the United States, Japan and the euro zone.

“We see value in the market and we are adding risk,” van Pittius says. “We find it hard to believe that (correlations)between emerging and developed markets have completely broken down. Our base case is EM data will catch up...that’s not priced in.”

Meanwhile there could be plenty of money to be made.

Real interest rates - the difference between interest rates and inflation - have risen as central banks tighten policy. And implied yields on emerging currencies, derived from the gap between spot and forward rates, are also rising.

The implied 1-year yield on the Indonesian rupiah, for example, is around 15 percent.

And even in a world of rising yields and falling currencies, investors can make a killing by receiving coupons on short-duration bonds and reinvesting the proceeds, van Pittius says.

Even factoring in a 100 bps rise in emerging bond yields and 1 percentage point currency loss from current levels, he reckons on an annualised 5.5 percent return from emerging debt.


Of course some of those assets are cheap for a reason and will stay cheap for years to come. Bears will also note that slumping profit margins remain a problem for stock markets.

John-Paul Smith, head of emerging equity strategy at Deutsche Bank says companies from the developing world can sustain return-on-equity (ROE) levels only by taking more debt. ROE measures how much profit a firm makes with shareholder’s money.

“It would be inaccurate to perceive EM equities as cheap relative to returns they generate because their quality of RoE is deteriorating more rapidly than developed markets,” he says.

The biggest hurdle to the valuation trade is market momentum that could saddle funds with big short-term losses.

“Investors will start looking at valuations again and see there is lot of value. The time frame? 6 months? 12 months? Not less than that,” said Marcelo Assalin, lead portfolio manager at ING Investment Management for emerging local debt strategies.

“I am not looking at valuations but technicals and fundamentals,” he said. “Valuation wise you would want to be long but no one wants to grab a falling knife.”

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