Emerging-Market Stocks in Pole Position to Gain as World Reopens

(Bloomberg) -- A bullish case is building for emerging-market stocks, which have trailed their developed-nation peers this year, with strategists saying the asset class is better positioned to benefit from a global reopening.

There are already signs the gap is narrowing, with the MSCI Emerging Markets Index last month outperforming the MSCI World Index for the first time since January.

Relatively attractive valuations, a weaker dollar and expectations that global supply chains will whir back into high gear are burnishing the appeal of developing-nation equities. The surge in global commodity prices is adding to optimism that improving growth will help boost cyclical shares in these markets.

“Investors who missed out on the strong U.S. and EU consumer and cyclical equity bull run so far this year should consider investing in EM stocks,” said David Chao, a global market strategist in Hong Kong at Invesco Ltd., which oversees about $1.4 trillion. “Rising inflation expectations and bond yields should drive continued investor rotation from growth to cyclical assets –- EM economies are more cyclical in nature.”

Analysts see the MSCI EM index, which is trading at 14 times forward earnings, rallying about 20% over the next 12 months, according to data compiled by Bloomberg. That’s almost double the advance seen for the developed-nations’ gauge, which has a valuation multiple of about 20.

At the same time, 12-month forward earnings estimates for EM shares have jumped by about 40% from a June 2020 low.

“Expectations for the year ahead remain high,” said Emily Whiting, an investment specialist for emerging markets & Asia Pacific equities at JPMorgan Asset Management in London. “A successful vaccine rollout leading to a resumption of normalcy in the developed world and parts of EM. With that, comes optimism for corporate earnings and equity markets.”

Not everyone is convinced emerging markets will outperform.

Risks include a vulnerability to escalating inflation, and a potential pullback in commodity prices, said Mathieu Racheter, an emerging-market strategist at Julius Baer Group Ltd. in Zurich. Investors looking for EM exposure may want to consider sticking to value stocks in Asia, particularly in like China, India and South Korea, Racheter said.

The MSCI EM gauge is trailing the developed-nations index by about four percentage points so far this year.

Developing-nation stocks are also seen benefiting relatively more from expectations that commodities will extend gains as vaccine rollouts help economies rebound after grinding to a halt due to the pandemic. Materials and energy shares carry a weightage of almost 14% in the MSCI EM Index, versus about 8% for the MSCI World gauge, data compiled by Bloomberg show.

An index of global commodities has surged about 20% this year as prospects for the global recovery have improved. Cyclical stocks, which include sectors such as auto makers, clothing stores and restaurants, are seen getting a boost as growth gathers momentum and inflation concerns dim the appeal of technology shares.

“Emerging markets are still one of the better ways to get exposure to the global-growth story,” said Marija Veitmane, senior multi-asset strategist at State Street Global Markets in London.

Boston-based State Street favors metals and miners in Latin American countries such as Brazil and Chile over Eastern Europe. Invesco’s Chao said he prefers emerging markets in Europe, and Brazil.

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