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Pimco Adviser Re-Ups Its ‘Trade of a Decade’ in Emerging Markets

(Bloomberg) -- As emerging-market stocks spiral toward a bear market, one of the asset class’s longtime bulls says now is the time to buy.

Research Affiliates, a sub-adviser to money managers such as Pacific Investment Management Co., is reiterating its recommendation to buy developing-nation equities, countering warnings from Harvard economist Carmen Reinhart, Allianz SE chief economic adviser Mohamed El-Erian and others about fragility in the developing world. The firm first said in February 2016 that emerging markets would be the “trade of a decade,” and the MSCI Emerging Markets Index has returned 52 percent since then.

External debt, foreign-exchange reserves and current account balances show developing nations at low risk of a widespread funding crisis, analysts Chris Brightman, Michele Mazzoleni and Jonathan Treussard wrote in a report.

“When fear reigns supreme, it’s time to buy, not sell," they said.

The benchmark index is now down 18 percent from a bull-market peak reached in January, and emerging-market equities look “cheap” by almost every measure -- from CAPE to price-to-book ratio, price-to-sales ratio and market cap to gross domestic product, according to Research Affiliates. The Newport Beach, California-based firm predicts annual average real returns of 6.3 percent over the next decade, the best of any asset class.

Research Affiliates cites five positive signs for emerging-market stocks:

  • 1) The global economy has become more stable as inflation has trended into the low single digits from double digits in decades past.
  • 2) Emerging-market countries are wealthier and financially healthier. The average reserve level is near 25 percent of GDP, more than triple the level from 1960.
  • 3) The most vulnerable countries, such as Turkey and Argentina, represent just a small fraction of the value of developing-nation stock markets.
  • 4) Relative valuations discount a great deal of bad news.
  • 5) Investors often respond with fear to market corrections in emerging markets when the same move in the U.S. would lead to buying the dip.

Here are a few of their other key takeaways:

  • China, South Korea, Taiwan, India and Russia, which compose about three-fifths of the MSCI EM Index, have little to no risk of a funding crisis given their low external-debt-to-GDP ratios and ample reserves. Most also run current account surpluses.
  • Less than 20 percent of the MSCI EM Index looks to be at elevated risk (notably Turkey and Indonesia) of a funding crisis, while another 20 percent (including Brazil, Mexico and South Africa) faces moderate risk.
  • By these same three measures, the U.S. fares poorly with external debt to GDP higher than the worst EM countries and a persistent current account deficit. Still, it’s in no immediate danger of a funding crisis.

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