The emerging markets streak continues

Fundamentals of emerging equities remain attractive but a slowdown in China may wipe out gains.
While the fundamentals of emerging equities remain attractive, caution must be exercised as a 'black swan' event may negatively impact markets. Picture: Shutterstock

Emerging market (EM) stocks outperformed their developed market counterparts for the sixth consecutive month in June, with the MSCI EM Index returning 1.1%, compared with a 0.4% gain in the MCSI World Index. (1) 

For the quarter as a whole, the MSCI EM Index was up 6.4%, while the MSCI World Index was up 4.2%. Key drivers of emerging market performance included encouraging economic data in China, investor inflows and corporate earnings growth.

Frontier markets outperformed developed markets and performed in line with their emerging-market counterparts. The MSCI Frontier Index gained 6.3% in US dollar terms over the quarter. (2) Nigeria, Sri Lanka and Kenya were among the top-performing frontier markets. An improvement in foreign-exchange liquidity coupled with undemanding valuations drove stock prices in Nigeria.

Emerging markets continue to offer superior growth potential compared with developed markets. The long-term trend of increased consumer penetration and improving affluence, leading to a shift to more premium products and services, should continue to bode well for these markets in the future.

Consumer demand growth is a prominent investment thesis within our portfolios. We look for opportunities in areas relating to consumer products. These include consumer staples, retailing and discretionary purchases such as automobiles. We also look for opportunities in services such as consumer finance where companies can achieve high growth rates and sustainable profits.

Technology is another major investment theme. Many emerging-market companies have become leading players in the adoption and development of technology and IT has outperformed other emerging-market sectors in the second quarter and first half of 2017. Although we are cautious of the share-price advances in some Internet stocks, we continue to see value in the sector across emerging markets as a whole. Our focus is on earnings sustainability as a result of innovation, dominant platforms or technology.

In addition to internet companies, which stand to benefit from the move toward more online transactions, we see potential for attractive long-term investment opportunities in many other areas. These include: shopping, targeted advertising, gaming and other services, graphic processing units for data centers and artificial intelligence applications and connectivity and processor integrated circuits for autonomous cars and devices related to the “Internet-of-Things.”

In the memory segment, smartphones have been upgrading memory content for better performance, which has helped drive demand for and pricing of dynamic random access memory (Dram) chips. Demand for Dram chips from data centres is also picking up, which we think should further support prices.

Valuations remain attractive

In terms of valuations, as of the end of June, the MSCI EM Index had a trailing price-to-earnings ratio (P/E) of 14.9x, a price-to-book value (P/B) of 1.7x and dividend yield of 2.4%. That compares with a P/E of 21.5x, P/B of 2.3x and dividend yield of 2.4% for the MSCI World Index. (3)

The fundamentals of emerging equities remain attractive. However, caution must be exercised when it comes to certain developments that may generally emanate from any possible “black swan” event — that is, a major shock that can’t be predicted.

China is a dominant country within emerging markets, both as a market and a demand-driver for many industrial commodities. Any slowdown in China and derailment of its structural adjustment process could have short-term implications for sentiment toward emerging markets as a whole.

On a broader level, the world is still imbalanced. Many countries have high debt levels, and concerns surrounding that and other macroeconomic factors could lead to short-term volatility.

Mark Mobius is the executive chairman of Franklin Templeton Emerging Markets Group.

1. Based on the MSCI Emerging Markets Index versus the MSCI World Index, US dollar terms. The MSCI Emerging Markets Index captures large- and mid-cap representation across 23 emerging-market countries. The MSCI World Index captures large- and mid-cap performance across 23 developed markets. Indexes are unmanaged and one cannot directly invest in them. Past performance is not an indicator or guarantee of future performance.

2. The MSCI Frontier Markets Index captures large- and mid-cap representation across 30 frontier markets countries. Indexes are unmanaged and one cannot directly invest in them. Past performance is not an indicator or guarantee of future performance.

3. Source: MSCI, as of June 30 2017. The P/E ratio for an individual stock compares the stock price to the company’s earnings per share. The P/E ratio for an index is the weighted average of the price/earnings ratios of the stocks in the index. For an individual company, the price-to-book (P/B) ratio is the current share price divided by a company’s book value (or net worth) per share. For an index, the P/B ratio is the weighted average of all the price/book ratios of stocks in the index. Dividend yield is calculated by dividing the annual dividend per share by the current price.

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