EMs on a 'whopping' 30% discount
Emerging market equities and bonds will outperform US assets over
the next seven years, according to forecasts from GMO, which believes
the current sell-off in developing country stocks on fears over the
potential impact of Donald Trump's presidency are unjustified in the
long term.
According to the investment firm's Seven-year asset class real return forecasts, emerging market stocks will generate an annual return over seven years of 4.4%, far outperforming a projected 3.1% annual loss across the same period for US large caps, and a 2.1% loss for US small caps.
Likewise, US high quality stocks are expected to generate a meagre annual return of 0.6%, while international large caps look set to generate just 0.1% per annum and international small caps are forecast to remain flat.
The poor expected returns across US stocks compare to a long-term historical US equity return of 6.5% per annum.
Emerging markets are also expected to outperform the US in
GMO's fixed income forecasts, with emerging market debt set to generate
an annual return of 1.5% over seven years, versus a loss of 0.6% for US
bonds, a return of 0.1% for US inflation-linked bonds, and a flat
performance for US cash.
Meanwhile, GMO expects hedged international bonds to fall 3% per annum over the next seven years.
Binu George, portfolio strategist for GMO's emerging markets
equity team, said: "The rise of the middle class in emerging markets
and its associated consumption wave will drive domestic demand in
emerging markets.
"Investors have much to gain if they look through the noise
of short-term volatility in emerging markets to focus on the secular
forces behind domestic demand."
Rick Friedman, a member of GMO's asset allocation team, said: "While
falling relative return on equity may lead some investors to sell
emerging market equities, we believe they should trade at a discount to
their developed brethren because of their higher levels of fundamental
risk.
"Developed countries separate themselves from emerging
countries based on the durability of their institutions. Strong, weak,
dynamic, or dull leaders come and go, but the countries' key
institutions live on.
"Emerging countries do not offer such consistency and are
prone to chaotic and highly dilutive events. As such, a discount of
about 10% seems appropriate to us, but today that discount has swelled
to a whopping 30%.
"Recently, investors have rightly been concerned about a
variety of issues in the emerging markets, most significantly the
radiating effects from slower than expected growth in China; the
election of Donald Trump has further intensified these anxieties.
"Importantly, it is unlikely any one administration in the
US can dramatically alter the long-term earnings power for emerging
companies. Yes, the short-term earnings of some countries/companies may
be impaired, but as equity owners our horizon extends out for decades,
not the length of any single administration.
"The question all investors should be asking is not, ‘Is it
risky?' but rather, ‘How is that risk being priced?' While the absolute
valuations of emerging equities are nothing to get too excited about, we
believe the relative valuations are most definitely attractive."
Daniel Flynn is a senior reporter at Investment Week. He joined the publication in September 2015.
After graduating from Southampton University, Daniel began his journalism career in February 2014 as a reporter at International Adviser covering cross-border investment products.
After graduating from Southampton University, Daniel began his journalism career in February 2014 as a reporter at International Adviser covering cross-border investment products.
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