1) Outside of Europe and Hong Kong, global equity markets are near all-time or 52-week highs. What is your view on emerging market (EM) equity valuations? Can EM equities continue the strong performance seen in the second half of 2020?
We see several factors that should contribute to strong EM equity markets in 2021:
- Stronger consumer and business confidence due to the COVID-19 vaccine rollout
- Manufacturing sector recovery from a low base
- A rise in global travel and tourism
- A US administration with a less hawkish attitude toward globalization
- Continued strong V-shaped recovery in China
- Accommodative monetary policy from the US Federal Reserve and the European Central Bank (ECB)
If growth in EM economies rebounds as we anticipate, inflation could play the spoilsport. However, we believe economic recovery could help supply chains normalize and aggressive developed market monetary expansion could help EM currencies appreciate, which should contain inflation pressure. Several of these emerging economies also have high real interest rates that should afford their central banks room to maneuver. EM economies have benefited tremendously from the surge in global liquidity unleashed by the Fed and ECB. This increased liquidity was one of the key factors supporting a significant increase in EM hard-currency sovereign debt issuance during 2020. Conversely, declining liquidity and/or a steepening of the US yield curve could certainly pressure the debt dynamics of some EM countries, which could hurt their equity markets.
EM equities currently look expensive on a price-to-earnings basis, trading at almost 15x compared to the 20-year mean of almost 11x.i However, when taking into account the prevailing low interest rates, we believe EM valuations look attractive on a forward-earnings-yield-ratioii basis, which is currently at around 8.0, two standard deviations cheaper than its long-term average of 5.0.iii