Emerging Market Shares Gain Ground on Economic Firming and an Improved Earnings Environment

Emerging markets delivered strong performance in the second quarter, driven by improved economic conditions and stabilized corporate earnings.1 The macro-level strengthening included lower inflation, stable commodity prices, improved current account balances and a reversal in currency depreciation. Assuming an accommodative monetary backdrop, emerging market gross domestic product (GDP) is expected to grow by roughly 4% this year and to accelerate in 2017 — the first acceleration in four years.2

Brexit fallout in emerging markets minimal

The impact of Britain’s exit from the European Union (Brexit) has been moderate, given that emerging markets have limited trade exposure to the UK and emerging market exports to the European Union account for only 4% of emerging market GDP.3 Although global GDP has fallen post-Brexit, we see only minor changes to emerging market GDP. Additionally, the developed world is likely to see continued low interest rates. Low rates, coupled with slower growth in the developed world, have translated into emerging market currency strength. We believe this could be a catalyst for emerging market equities and allow for a benign monetary environment.

Brazil’s markets on the mend

Despite Brazil’s long, deep economic contraction, the Brazilian market performed strongly in the second quarter and has done well year-to-date.1 In fact, economic data suggest the recession may now be close to bottoming out. Brazil is also seeing renewed optimism on the strength of a recent change in government, a new economic team and signs of a shift in economic policy. Interim president Michel Temer’s government has announced a budget cap for 2017, with more measures to restore fiscal stability on the way. Despite the political situation in Brazil, our strategy, as always, is to focus on company fundamentals — particularly Earnings, Quality and Valuation (EQV).

Over the long term, lower wage rates, a weak currency and fiscal consolidation should help correct imbalances in the Brazilian economy. We are already seeing the process work, reflected in an improved current account and reduced inflation. If these trends continue, we should see normalization of interest rates and, more importantly, lower long-term borrowing costs. Brazil has some of the highest interest rates in the world, and rate normalization is critically important to economic recovery.

Emerging market corporate earnings stabilizing

While downward-trending earnings have weighed on emerging market shares over the last few years, earnings have stabilized of late. During the past few months, earnings revisions have turned positive in Brazil and Russia in local currency terms. The consensus earnings forecast for emerging markets in 2016 includes 7% growth — a sharp reversal from the double-digit declines of 2015. The forecast for 2017 is even higher, with 13% earnings growth projected in emerging markets.2 We may yet see downside earnings revisions. However, with profit margins likely at a nadir and currency levels stabilizing, the worst seems behind us.

Emerging market valuations remain compelling

Despite the improved performance of emerging market equities, valuations remain compelling. On a price-to-book basis, emerging market equities are trading at 1.4 times earnings, which represents a 32% discount to developed world equities versus an average discount of 10%.1 This discount is especially notable given the fact that emerging market issuers are generating return on equity comparable to firms in the developed world.

1 Source: MSCI Emerging Markets Index, as of June 30, 2016

2 Source: Morgan Stanley, as of June 30, 2016

3 Source: JPMorgan Chase, as of June 26, 2016

Important information

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

Price-to-book (P/B) ratio is the market price of a stock divided by the book value per share.

Earnings refers to the amount of profit a company produces during a specific period, typically a calendar quarter or year.

A discount measures how much less one stock (or index) is trading compared with another stock (or index).

The MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers, including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd.

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