ADRIAN CLAYTON: A tidal turn on horizon for emerging markets

But can emerging markets produce elevated profitability again?  Sentiment is overwhelmingly negative against this investment class: news flow is dominated by geopolitical tensions, trade wrestles with the West, and fears of hyper-indebtedness by governments and consumers. None of this can be disputed, yet analysts are upgrading one-, two- and three-year earnings forecasts for emerging markets relative to their larger developed market peers. 

A blunt indicator of valuation is the price-earnings ratio, and while it certainly does not adequately deal with all the nuances on valuation it does tell a story. The MSCI World Index trades at a lofty premium of 26% to the MSCI EM, which is not far off the average premium that has existed since 2011.  The earnings upgrades by emerging market analysts should, given time, be reflected in a lower developed market premium.    

What could upend this thesis? 

Two factors must be closely monitored. The first is an unexpected and severe contraction in global growth. While emerging markets will in time weather this, the immediate outcome will be to postpone their rebound. The second is an escalation in the breadth and depth of the Middle East conflict where it draws in a wider range of countries. Again, this is in our opinion still a relatively low probability outcome and is more likely to lead to a postponement of emerging market gains than negate them altogether.   

As an active manager we believe heightened differentiated stock pricing exists in markets at this stage in the cycle, which lends itself to stock selection. However, emerging markets can be accessed through exchange traded funds, and it is useful to be armed with information on what you would be buying if, say, you bought into an emerging market tracker such as the MSCI EM index. 

This index includes 24 emerging market countries and more than 1,400 stocks. The largest country weights are China (30%), India (16%) and Taiwan (15%). The largest industry groups include financials (22%), information technology (21%) and consumer discretionary (14%). The four most significant stock positions are all technology plays, accounting for 16% of the index.  

For beleaguered investors stuck in emerging market funds your time for reprieve could be drawing near. This includes SA investors; it is true that our market has been a victim of own goals due to our sociopolitical and economic failures, but the JSE has also been shunned through association — with all emerging markets. When this tide turns, it will do so for all small boats. 

• Clayton is chief investment officer at NorthStar.