Why Valuations Don’t Matter Much in Emerging Markets

(Bloomberg Opinion) -- Like the Nasdaq, emerging markets are no strangers to booms and busts. Unlike the U.S. market, valuations no longer matter much outside the developed world. 

That’s because sell-side analysts’ earnings estimates are unreliable.

The 10 percent correction in the Nasdaq 100 Index in October shouldn’t have surprised U.S. analysts – they’ve been revising down earnings estimates since April, when trade tensions started to brew.

Aggregating estimates for all companies in the Nasdaq, the implied Ebitda growth rate for the next three fiscal years tumbled from a high of 24.3 percent in February to 12.9 percent recently. So the sell-off is a catch-up with analysts’ wisdom.

The same can’t be said of emerging markets. Using that approach, implied future earnings growth for companies in the MSCI Emerging Markets Index has been eerily stable this year, even though the benchmark has lost one-third of its value from a January high.

The picture looks even stranger for the MSCI Asia ex-Japan. Sell-side analysts have actually revised expectations up – as if companies from China to South Korea won’t be touched by the trade war.

One obvious explanation is that developing-nation analysts need to hone their analytical skills. Perhaps out of laziness, or fear of losing access to companies, they’re reluctant to be bearish. As my colleague Nisha Gopalan notes, more than 60 percent of the stocks on China’s CSI 300 Index have no “sell” rating; the ratio is 40 percent for the S&P 500 Index. 

Another is that emerging markets are vulnerable to so many known unknowns – from the Federal Reserve’s rate increases to oil shocks – that forecasting earnings growth (even on a three-year view) may be too challenging.

Regardless, unreliable bottom-up earnings estimates make life difficult for investors and strategists. The MSCI EM index is now trading at 10.6 times forward earnings – one standard deviation away from its 10-year average. Does this mean it’s time to buy into dips?

Goldman Sachs Group Inc., for one, isn’t going along with earnings estimates. In its 2019 outlook, the bank reckons Asian equities will have a challenging year and sees EPS growth slowing to 5 percent, about half the consensus forecast. 

Morgan Stanley, on the other hand, went bullish in its 2019 global outlook, double-upgrading emerging markets from underweight to overweight. The firm cites mean reversion: What goes down must come up.

There’s a lesson from the 2008 global financial crisis. The MSCI Emerging Markets and MSCI China indexes were among the world’s worst performers, only to come out on top in 2009. Last year, China’s stock market had a bull run after Beijing struggled to contain capital outflows and in the wake of the ill-conceived 2016 circuit breakers.

This year is shaping up to be a “rolling bear market” like that of 2008, Morgan Stanley says, noting that global investors now have  nowhere to hide: From the S&P 500 to U.S. high-yield corporate debt, none of the major asset classes is returning more than the rate of inflation. But for next year, “the lower an asset is on the 2018 rankings, the better we feel about its prospects for 2019.” 

Bonus season is almost upon us, and equity analysts surely are jostling for more pay. With their estimates diverging so sharply with the market, your guess on emerging markets might be better than theirs.

To contact the editor responsible for this story: Paul Sillitoe at psillitoe@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

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