The general expectation for emerging markets in 2019 is renewed outperformance.
As Goldman Sachs Asset Management notes, 2018 saw a substantial drawdown in emerging market assets, against expectations. Goldman attributes this underperformance to lower-than-expected growth in emerging economies.
Mercer also notes that 2018 was “very challenging” for emerging market economies, as a number of them were hit by currency crises — Turkey, Argentina and, to a more limited extent, Brazil and South Africa. Meanwhile, China has been involved in an escalating trade dispute with the United States.
Morgan Stanley’s economists also explain in their 2019 Global Macro Outlook that rising U.S. rates, a strengthening dollar and lingering trade tensions left emerging markets nearly defenseless in 2018. Even so, most of these countries maintained fiscal discipline, setting them up for solid growth as the headwinds subside, according to Morgan Stanley.
This may be why — despite the negative market sentiment toward emerging markets during 2018 — several industry leaders remain cautiously optimistic about both EM equities and EM debt.
One reason for this optimism is that many emerging market economies are still in the early stages of longer-term expansions.
“We are of the view that, broadly speaking, the emerging world is at the earlier stages of the business cycle, whereas a number of developed economies (particularly the U.S.) are now at the later stages,” Mercer explained.
In addition, emerging market debt and equities both seem attractively valued.
Goldman, in particular, sees attractive return potential for EM assets in 2019, particularly in currencies and equities, which it expects to be unleashed by improving growth.
Based on Goldman’s estimates of fair value, EM currencies are undervalued by 12% and 23%, when aggregated using the MSCI EM and GBI indexes, respectively.
“The magnitude of this undervaluation is similar to what we observed in early 2016 and the early 2000s; both periods were followed by good returns for EM currencies,” Goldman explained.
In addition, EM equities are trading at an “attractive” 25% discount to developed market equities, while also offering potentially higher expected earnings growth, according to Goldman.
In light of the extreme valuation differences between U.S. and emerging-markets equities, Morgan Stanley strategists have issued a double upgrade for emerging markets, moving from underweight to overweight. Their base-case forecast calls for an 8% price return for the MSCI EM index in 2019.
“A slowdown in U.S. growth with EM reaccelerating means EM earnings growth should exceed that of the U.S. in 2019 after lagging in 2018,” according to Morgan Stanley.