By Jeffrey Sacks, Capital Markets Strategist - Europe, Middle East and Africa
July 14, 2016
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While we continue to prefer developed market equities to those from emerging markets (EMs), we do see some selective tactical opportunities in EMs.
Emerging market (EM) equities have had a tough few years. Since early 2011, the MSCI Emerging Markets index has fallen by 30 per cent. By contrast, developed market (DM) equities – as represented by the MSCI World Index – have risen by 30 per cent.
Among other things, EMs have suffered from the effects of a sharp slowdown in China as well as from softening global trade and a variety of political tensions. As a result, EMs as a whole now look lowly-valued compared to DMs. So is it time to switch our longstanding preference for DMs over EMs?
On a long-term view, EMs’ prospects may indeed now be brighter than those of DMs. That is certainly the message from Citi Private Bank’s own strategic asset allocation methodology. Its estimated return for EM equities is an annualized 10.4 per cent over the next decade. By contrast, its estimate for developed market equities is 6 per cent a year for the same period.[i] However, these estimates do not necessarily tell us much about what will happen over the shorter tactical horizon of 12 to 18 months that our Global Investment Committee addresses.
DM equities are less attractively valued than EM equities over this shorter-term horizon, trading on 19 times prospective earnings compared to 14 times for the latter. However, we believe that DM could sustain these valuations for a while especially with the ongoing assistance from central banks’ monetary easing. DM earnings could benefit from the firmness of the US economy, which is one of the main engines of global growth. DM equities also look attractively-valued compared to DM sovereign bonds, which is another source of support.
Despite our ongoing preference for DMs over EMs, we do see some selective tactical opportunities in EMs. One bright spot that we identify for certain EMs is the early-stage recovery in the oil price. Latin American equities had suffered as a result of the decline in crude oil since 2014 – and of commodities more generally over the past five years. However, its oil-exporting economies stand to experience some relief from oil’s rebound. Despite Latin American equities’ gains in 2016 so far, we believe their lowly valuations leave scope for further upside.
More broadly, though, EMs remain weighed down by sluggish global trade and ongoing weakness in general commodity prices. The structural slowdown in China’s economy has dented demand for many industrial commodities, such as copper. In some emerging countries like Turkey and South Africa, challenging domestic economic and political environments are compounding the problems caused by trade and commodity softness.
Within EM, the risks have shifted away from Latin America and towards Asia where China has unresolved structural weakness. We have therefore cut our overweight in Asian equities to neutral and reduced our underweight in Brazil equities. We stress that all of this is in context of our gradually reducing overweight to global equities, with DMs still overweight.[ii]
A version of this article appeared in the July 2016 edition of Professional Wealth Management.
[i] Adaptive Valuation Strategies – 2016, Citi Private Bank.
[ii] Details of Citi Private Bank’s current tactical asset positioning are presented monthly in Global Strategy: Quadrant
Opinions expressed herein may differ from the opinions expressed by other businesses or affiliates of Citigroup, Inc., and are not intended to be a forecast of future events, a guarantee of future results or investment advice, and are subject to change based on market and other conditions. In any case, past performance is no guarantee of future results, and future results may not meet our expectations due to a variety of economic, market and other factors.
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