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A combination of poor investor sentiment and expectations of continued economic stimulus suggests that battered emerging-market equities could soon see a turnaround.

Continuing US-China trade tensions and a slowing Chinese economy have dented investor sentiment in the past few months. The MSCI Emerging Markets Index is still down about 8percent from this year’s high in mid-April. However, investors are saying that a potential bottoming out of risk-off sentiment and accommodative monetary and fiscal policies mean that flows could start coming back to developing countries.

An indicator of investor sentiment toward emerging market and Asia ex-Japan stocks compiled by Bank of America Merrill Lynch remains in the “panic” zone. But that is good news if history is any guide. Barring two instances, whenever the indicator has been at such low levels, the MSCI Asia ex-Japan Index has delivered positive returns over the next 12 months, analysts led by Ritesh Samadhiya wrote in a note last week. The gauge is nearly 10percent below its April high.

“The indicator has been pretty accurate in recent years,” said Nick Payne, the head of global emerging markets at Merian Global Investors (UK). “Emerging markets don’t seem to be popular with people and historically when it is out of favour, it has been a good time for investors to look at the markets.”

Barings’ Christopher Smart agrees with Payne, stating that a recent leg-up in the yields of 10-year US Treasuries, seen as a safe haven, indicate low probability of a sharp recession in the US. That, alongside strong US consumption, is a bullish sign for emerging stocks, the asset manager’s Boston-based chief global strategist said during a visit to Singapore.

Meanwhile, emerging market central banks and governments continue efforts to prop up their economies. Indonesia, the Philippines and Thailand have all cut interest rates in the past two months. India’s $20 billion (R303bn) corporate tax cut last week is another reason to be positive on emerging market equities, and Chinese stimulus will likely be increased by the end of the year, added London-based Payne, who oversees $250m of assets for Merian Global.

United Overseas Bank upgraded emerging market equities to overweight last week, betting on Chinese interest-rate reforms. However, China’s central bank governor Yi Gang said the central bank is in no rush to add monetary stimulus to the world’s biggest emerging market as overall financial risks appear to be contained.

JPMorgan Asset Management said it sees some opportunities in emerging markets, as earnings estimates are “sufficiently bearish” and price-to-book valuations are lower than average. “Historically at these valuation levels, investors have been rewarded over the long term,” said Richard Titherington, chief investment officer for emerging market and Asia-Pacific equities at the money manager.

All eyes are now on the next round of US-China talks slated for October, with some observers believing that emerging market equities need only one new positive catalyst to get going. “They generally have some room to run because the pessimism in the market has been so strong lately,” said Smart. 

 Bloomberg