Much depends on how earnings develop over the next six months and whether the Fed, having switched gears abruptly at the end of 2018, maintains a dovish stance. Earnings revisions and expectations globally were mostly negative at the start of 2019, but seem to have stabilized in the second quarter. Overall, consensus expectations are for higher earnings from the eurozone and emerging markets (EMs) relative to the US.
With volatility flirting with 2018 lows in the face of very real geopolitical risks (e.g., the US-China trade dispute and Brexit), we are cautious on equities overall and are focused on building positions in markets that may offer value. In our view, although emerging markets are more exposed to risk-off sentiment and a stronger US dollar as the trade dispute escalates, we continue to see better value there in aggregate than in Europe or the US, given how far US markets have come and the fact that Europe continues to disappoint. We will seek to take advantage of any increases in short-term volatility around the trade conflict to find attractive entry points into EMs.
Emerging Markets Offer Value
EMs still trade at a deep discount to developed markets (see Figure 3), despite the fact that GDP1 and earnings growth are likely to be stronger in EMs than in developed markets (DMs) (see Figure 4).
Valuations in the MSCI EM index still look attractive relative to the S&P 500 index (see Figure 3). The price-to-book (PB) discount for MSCI EM versus the S&P 500 currently stands at about 51%; the price-to-earnings (PE) discount is about 28%. At the same time, the difference in return-on-equity (ROE) for MSCI EM versus the S&P 500 is only about 15%.2 This is notable because the discount in valuation multiples like PB and PE often roughly corresponds with the ROE gap – valuations, in other words, usually correspond with return on equity. In this case, however, the discount in valuations is much deeper than differences in ROE would ordinarily justify.
Consensus analyst estimates suggest that growth in earnings-per-share (EPS) is currently around 8.2% for EMs and around 6.8% for DMs (see Figure 4). These figures are particularly meaningful when viewed in context with consensus estimates for sales growth, which suggest expected sales growth among EM firms of around 5.3%, compared with expected sales growth for DM companies of only around 2.8%. Unlike EPS, which is a measure of profitability and reflected cost savings and other efficiencies, sales growth focuses exclusively on top-line revenues. Substantially stronger estimates for sales growth in emerging markets therefore suggest that robust demand is a primary driver of EM growth – less so in developed markets.