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A Broadening Rally in the EM Bull Market
The MSCI Emerging Markets Index rose 27.8% for the year through September, outpacing its index counterparts for Europe (+22.8%, MSCI Europe Index), the United States (+14.2%, S&P 500 Index), and non-US developed markets (+20.0%, MSCI EAFE Index). Good earnings momentum, expectations of rebounding export growth, and strengthening balance sheets helped attract $19 billion in emerging markets equity inflows in the third quarter for total inflows of $65 billion year to date. While the record of net inflows was $84 billion reached in 2010, approximately $155 billion flowed out of the asset class from early 2013 to mid-2016.
The second quarter was notable because the market’s gains were concentrated on a small cross-section of Chinese, Taiwanese, and Korean technology companies. Leadership could be changing. In the third quarter, market interest in energy and materials companies picked up amid more stable oil prices, and better economic data from Russia and Brazil, which are home to large oil, gas, and mining companies.
Earnings growth is strong and rising for the majority of sectors and this supports rising emerging markets equity valuations. This has been a tailwind for stocks with growth attributes and has resulted in a much wider returns gap than we would expect between large cap growth and large cap value.
The tech sector’s trailing price earnings multiple reached 19.7x in September 2017 from 12.4x in January 2016, near the market’s bottom. Returns have risen nearly 50% since January as investors responded to transformational themes including online retail and gaming, and cloud computing. Earnings growth has also been the strongest of any sector outside of energy - where earnings are coming back from lows. China-based Alibaba, JD.com and Baidu are among the year’s best-performing stocks. Year-to-date through September month-end, Alibaba is up 97%, JD.com is up 50%, and Baidu is up 51% in dollar terms. Notably, these companies were only added to the MSCI Emerging Markets Index in November 2015.
The tech sector’s relatively asset-light models have translated into stronger earnings and free cash flow. This earnings momentum is one example of the current tailwind to emerging markets growth investors, who can tolerate a higher valuation in exchange for strong earnings growth. Value investing continues to be effective in the large cap space, but significantly less so than growth at this time. In the small cap universe, however, growth attributes were rewarded but to a lesser degree.
Energy and Materials
Valuations have been slower to rise among economically sensitive companies, including those in the energy and materials sectors, which declined 4.8% and 0.4% in the second quarter relative to the index’s 6.3% gain. But they began to pique the market’s interest in the third quarter, rising 13.4% and 10.2%, respectively, and outperforming the index’s 7.9% gain. Disruptive technologies such as fracking and deep-water exploration and drilling have had a deflationary effect on crude oil prices; however, oil demand has been better than expected this year and the Brent crude oil rose by more than 20% in the third quarter.
We believe emerging markets still offer attractive value opportunities, especially if earnings expectations continue to sustainably reset higher. Relative to developed markets, emerging markets equities trade at a 25% discount with comparable or higher return on equity. Although it is too early to tell whether the investment environment (currently favoring growth and momentum stocks) has shifted, we have historically witnessed very strong performance in valuation-sensitive strategies once market leadership changes.
The views and opinions expressed at the date of publication are those of the Lazard Emerging Markets Equity team and not those of Lazard as a firm. These may not be those currently held by the author or by any Lazard company, and are subject to change at any time. Data used in this article is used in good faith but no reliance may be placed on it. All data contained herein is sourced by Lazard Asset Management unless otherwise noted.
In the UK this document, which is supplied for information only, is for distribution only to professional investors and advisers authorised to carry out business under the Financial Services and Markets Act 2000. This is a financial promotion.
Past performance is not a reliable indicator of future results. Fluctuations in the rate of exchange between the currency in which shares are denominated and the currency of investment may have the effect of causing the value of your investment to diminish or increase. Investors are reminded that the value of investments and the income from them is not guaranteed and can fall as well as rise due to market and currency movements. When you sell your investment you may get back less than you originally invested. Securities identified in this document should not be considered as a recommendation or solicitation to purchase, sell or hold these securities. It should not be assumed that any investment in these securities were, or will be, profitable. Investments in emerging markets carry an above-average degree of risk due to the undeveloped nature of the securities markets in those countries. Investors should consider carefully whether or not investment in emerging markets stocks is suitable for them and, if so, how substantial a part of their portfolio such investments should be.
Issued and approved by Lazard Asset Management Limited, 50 Stratton Street, London W1J 8LL Lazard Asset Management Limited is incorporated in England and Wales with registered number 525667. It is authorised and regulated by the Financial Conduct Authority. The contents of this article are confidential and should not be disclosed other than to the person or persons for whom it is intended.
Emerging and developing markets can face significant political, economic or structural challenges. The fund may experience delays in buying, selling and claiming ownership of investments and there is an increased risk that the fund may not get back the money invested.
Lazard Asset Management (Deutschland) GmbH
Lazard Fund Managers is the distribution effort of Lazard Frères Gestion and Lazard Asset Management, offering UCITS funds to clients across Continental Europe.
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