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Is now a buying opportunity for emerging market equities?

Is now a buying opportunity for emerging market equities? Mindful Money

While emerging market economies are generally in much better health than their developed market counterparts, the same cannot be said for the region in investment terms. And if we ever needed proof that the state of an economy has little to do with market returns, the divergence in fortunes of emerging vs developed over the last three years or so is just that.

Whilst developed market economies have struggled to recover from the global financial crisis, their equity markets have enjoyed a very strong bull run. Over three years*, the European market is up 28%, Japan is up 35%, the UK is up 42% and the US up 67%. In contrast, emerging markets have continued to enjoy GDP growth of around 7% or higher, but their equity markets have disappointed, with the combined MSCI Emerging Markets index up just 10%.

A significant sell-off in the asset class began in March this year, caused by investors taking flight from riskier assets on the back of the bank bailout in Cyprus and political uncertainty in Italy reviving concerns over Europe’s debt crisis. China’s continued policy tightening measures didn’t help as they raised fears that the economy would slow further. These market falls were then exacerbated by Bernanke letting the ‘tapering genie’ out of the bottle on 22nd May and the MSCI Emerging Markets index lost a further 17% in just over a month, before rebounding slightly.

One of the problems for emerging markets is that while growth levels are still the envy of the developed world, they are slowing and companies which could once attract investors purely by their growth rates are now having to look at other methods – hence the increasing use of dividend payments to return value to shareholders.

Furthermore, a stronger US dollar, typically a sign of economic growth in the US, and which will be further strengthened once QE starts to be tailed off, means capital flows are likely to move away from emerging markets to the US.

All the time we live in an uncertain world, wondering how QE, the biggest financial experiment our generation has seen, will end, emerging markets are likely to remain volatile. We know that every time more QE is announced, markets rise, so it shouldn’t be too much of a surprise that markets fall when they think we will see it come to an end. In this type of ‘risk-off’ reaction, where investors take flight, emerging markets are the first to be sold.

Despite all this, however, the long-term drivers in emerging markets are still in place and therefore so too are the long-term prospects for investors in this asset class. The recent sell-off has left valuations looking very attractive – on a price to book basis they are half those seen before the financial crisis began and a good 25% lower than in 2010. On a price earnings basis valuations are close to those seen in 2001.

So emerging market equities on aggregate are cheap. And some areas, particularly BRIC nations, are cheaper still. This doesn’t mean they won’t get cheaper – indeed in the next few months, while the Fed in particular tos and fros on QE, we may see this asset class fall a bit further – but I do think at this price the area is at least worth some consideration by long-term investors.

This article was written by Darius McDermott and originally published in Mindful Money under the title: Is now a buying opportunity for emerging market equities?

Tags: emerging markets , equities , equities market , investments , opportunities
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