Invesco Canada blog

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Steve Cao | August 1, 2017

Emerging from the shadows – the case for emerging markets

After an extended period of weakness, emerging market equities have rebounded nicely year-to-date – outperforming developed market stocks by a sizeable margin, as measured by the MSCI Emerging Markets Index and MSCI EAFE Index.1 In my view, this strong performance has been driven by better macroeconomic conditions, strong earnings growth and discounted valuations relative to developed market equities.1

Let’s take a closer look at these emerging market catalysts:

Improving macro conditions

  • China posted better-than-expected gross domestic product (GDP) numbers for the first and second quarters of the year, and the structure of the Chinese economy continues to improve
  • In India, important tax reforms have been enacted in the form of a national “goods and services tax,” which was implemented on July 1. This was watershed legislation – one of the most important reforms ever passed in India, in my view. The new tax makes India a common market, which eases the movement of goods across states, and should boost economic efficiency. I believe the tax will eventually have a positive long-term impact on productivity and economic growth
  • In Brazil, political malfeasance has made headlines, but economic fundamentals continue to improve. Real wage growth has turned positive, unemployment has begun to fall, corporate balance sheets are being deleveraged and inflation has been kept in check. Despite political uncertainty, Brazil has also made progress enacting various reforms, with labour bills passed by both houses of the National Congress. On balance, I believe positive economic forces in Brazil outweigh the country’s political uncertainties
  • In Russia, economic growth has accelerated after two years of recessions, while inflation has slowed even amid monetary easing. These are positive signs for an energy-dependent economy hurt by low crude oil prices

Corporate earnings on the upswing

Corporate earnings are also on the upswing in many emerging markets. Consensus analyst estimates for earnings growth have been revised upward for both 2017 and 2018. In fact, some analysts are expecting 20% higher year-over-year corporate earnings growth from emerging markets equities for 2017.2

Valuations remain compelling

Despite these positive trends, emerging market stocks are still remarkably affordable – especially relative to developed market issues.

  • On a trailing price-to-book value basis, emerging-market equities are trading in line with historical valuations. Relative to developed markets, however, emerging markets equities remain at a roughly 26% discount.3
  • On a forward price-to-earnings basis, emerging-market equities are trading at a 12% premium to their historical valuations, but remain at a discount to developed market stocks.4

While conditions appear to be improving for emerging markets as a whole, individual stock selection remains critical. The Invesco International and Global Growth team uses a fundamental, bottom-up approach to selecting stocks. We believe focusing on companies’ earnings, quality and valuation (EQV) characteristics can reward investors over the long term.

 

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1 Source: FactSet Research Systems as of June 30, 2017. MSCI Emerging Markets Index year-to-date performance is 18.43%, compared to MSCI EAFE Index year-to-date performance of 13.81%, as of July 25, 2017.

2 Source: HSBC GEMS Equities Wrap Up, June 2017

3 Source: Invesco, Compustat and MSCI. Data as of June 30, 2017. Emerging markets represented by the MSCI Emerging Markets Index. Developed markets represented by the MSCI EAFE Index. Price-to-book data date back to December 1995; data as of July 16, 2017.

4 Source: Invesco, Compustat and MSCI. Data as of June 30, 2017. Emerging markets represented by the MSCI Emerging Markets Index. Developed markets represented by the MSCI EAFE Index. Price-to-earnings data date back to December 2002; data as of July 16, 2017.

Past performance is not indicative of future results.

An investment cannot be made into an index.

Forward price-to-earnings ratio is a variant of a company’s price-to-earnings ratio, and is calculated by dividing the company’s current share price by its expected earnings, usually for the next 12 months or next full fiscal year.

Price-to-book ratio is calculated by dividing the market price of a stock by the book value per share.

The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

An investment in emerging market countries carries greater risks compared to more developed economies.

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