Decade-Low Returns in EM Stocks Are Pushing Investors Into Bonds

(Bloomberg) -- Stocks have become the least attractive in a decade relative to bonds in developing nations, justifying a capital rotation from the former to the latter.

The average earnings yield for companies in the MSCI Emerging Markets Index (projected profits as a percentage of current price) has fallen to about 130 basis points above the yield on a Bloomberg Barclays gauge of dollar bonds. That’s the smallest premium for owning equities rather than debt since January 2010.

Stocks’ promised returns are falling because analysts have cut their estimates for profit at emerging-market companies by 17% in the past three months as they factor in the economic impact of the coronavirus pandemic. A 19% rebound for the equity benchmark has further diminished the ratio of earnings to price.

On the other hand, bond yields are hovering at levels last seen in 2011. Expectations that emerging-market governments will step up borrowing to fund their fiscal-stimulus plans are keeping borrowing costs higher than their 10-year average.

Some investors may already be taking advantage of the narrowing gap between equity and bond returns. While initial public offerings of stocks are fizzling, borrowers are seeing robust demand for new bonds at revised, higher yields.

Investors in exchange-traded funds are showing a similar preference. Outflows from U.S-listed equity funds are accelerating, while bond funds are now getting inflows.

The prospect of a recession, or at any rate a crippling slowdown, in many an emerging market may continue to depress earnings expectations. So bonds may sustain their returns advantage until the pandemic subsides and signs of economic recovery arise.

©2020 Bloomberg L.P.