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Emerging markets cheap or a value trap

In the recent BofA Merrill Lynch Fund Manager survey, a net 36% of the respondents said that global emerging markets are the most undervalued of all markets, the strongest reading since 2004.

A number of commentators have been suggesting that low valuations in emerging markets make them the contrarian opportunity of all-time.

To buy or not to buy..?

Stuart Rhodes, manager of the M&G Global Dividend fund, says he is finally seeing value in the asset class after a long period of relative underperformance. Increasingly it is clear that emerging markets are cheap, but does that make them worth buying?

Rhodes, selectively, thinks they are. He has taken exposure to Standard Chartered, Aberdeen Asset Management and Jardine Matheson, as recent share price weakness has allowed him an entry point. He says that historically he has struggled to find companies in emerging markets that fit his investment criteria, but he is beginning to find more opportunities as prices have moved lower.

Multi-managers such as Tom Becket, chief investor officer at Psigma Investment Management, have been tentatively returning to the asset class believing that the long-term opportunity remains intact.

There appears to have been a marginal, blink-and-you-miss-it change in sentiment towards the asset class over the summer. For example, the global emerging markets sector is the top-performing sector over one month, with Asia Pacific ex Japan and China/Greater China hot on its heels. The turning point appeared to be Chinese economic data, which had consistently missed forecasts, but then started to improve in July and August. The most recent GDP reading was ahead of consensus estimates.

Sentiment is less bad

In the BofA Merrill Lynch survey, emerging markets remained unpopular, but sentiment had stopped getting worse. It seems as soon as data stopped deteriorating, the contrarians moved in.

There is also an argument that stronger emerging markets are benefiting from the rising tide of risk appetite among investors. Investors have shown themselves more inclined to take cyclical exposure, but have so far confined this to developed markets.

The growth story for emerging markets remains largely intact, even if asset allocators are not as convinced of its strength and it would be a natural place for those wishing to bet on a global economic recovery. Decoupling works in both directions and a stronger US should create strength in emerging markets as well.

That said, Gavin Haynes, investment director at Whitechurch Securities, believes that investors should not lump all emerging markets together: “Each market has different dynamics and it is difficult to say, generally, whether there are opportunities or not.”

QE tapering over cracks

India, he points out, remains an investment disaster zone, with a weakening economy and sliding currency. Brazil is doing little better. He is taking specific exposure to China through the GAM Star China fund, saying that the headwinds for the economy are starting to unwind and the market has been widely unloved, leaving valuations attractive.

Also there is the QE problem. Fed chairman Ben Bernanke may have temporarily called off any tapering of QE, but everyone knows it is still coming. Much of the liquidity that has been created by monetary stimulus has headed for emerging markets, and its withdrawal will put pressure on emerging market currencies.

The withdrawal is likely to affect emerging market bonds more than emerging market equities – this has certainly been the situation to date – but it still has the potential to hit emerging market equity investors. Again, it suggests selectivity is needed. Countries such as India are likely to be far harder hit than more robust emerging markets.

Emerging markets are cheap and may be at an inflection point. However, some emerging markets are cheap for a reason and are unlikely to participate in any shift in sentiment. Allocations need to be made with considerable discernment.

Part of the Mark Allen Group.