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June 24, 2016 | Global Equity
What Could Help Emerging Markets?

Portfolio Manager

Todd McClone, CFA, partner, is a portfolio manager for William Blair’s emerging markets strategies. Before joining the firm in 2000, he was a senior research analyst specializing in international equity for Strong Capital Management. Previously, he was a corporate finance research analyst with Piper Jaffray, where he worked with the corporate banking financials team on a variety of transactions, including initial public offerings, mergers and acquisitions, and subordinated debt offerings. He also issued fairness opinions and conducted private company valuations. Todd received a B.B.A. and B.A. from the University of Wisconsin–Madison.

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Despite recent signs of improvement, investor sentiment about emerging markets has been fundamentally depressed over the past year. Over the past two years, outflows accelerated to levels witnessed at the depths of the global financial crisis, with a total of $48 billion flowing out of emerging market equities in 2015 versus $53.3 billion in 2008, as the chart below shows.

Driving the asset class’s underperformance are a number of key concerns: disappointing economic growth in emerging market countries, the potential impact of U.S. interest-rate hikes and a stronger U.S. dollar (USD), fears of a hard landing and currency devaluation in China, and the collapse of the commodity complex. I’ve addressed these concerns in previous blog posts, but now I’d like to highlight some factors that in my view could help boost investor sentiment and emerging market performance.

First, valuations are still attractive, especially compared to those of developed markets.

First, valuations are still attractive, especially compared to those of developed markets. In my view, broad macroeconomic fears are priced into emerging market equity valuations as they are trading close or below one standard deviation relative to developed markets on both a price-to-earnings (P/E) and price-to-book (P/B) basis. They are also below levels seen at the depth of the global financial crisis.

Second, with regard to corporate performance, a more significant decline in emerging market earnings revisions relative to those in developed markets has undoubtedly contributed to emerging market underperformance vs. developed markets for some time. However, recent data is showing encouraging improvement as the difference between emerging and developed market earnings revisions is closing.

Additional factors that could support emerging market performance relate to improvements in economic growth and policy communication in China (stabilization of macroeconomic data, further monetary and fiscal stimulus, and improved investor confidence in Chinese policymaking), a benign U.S. Fed tightening cycle coupled with continued weakness in the USD, and a stabilization of commodity prices supported by curtailment of production.

Many of these factors seem to be materializing in the past weeks, bolstering investor sentiment and underpinning the recent rebound in emerging market equities.

 

Portfolio Manager

Todd McClone, CFA, partner, is a portfolio manager for William Blair’s emerging markets strategies. Before joining the firm in 2000, he was a senior research analyst specializing in international equity for Strong Capital Management. Previously, he was a corporate finance research analyst with Piper Jaffray, where he worked with the corporate banking financials team on a variety of transactions, including initial public offerings, mergers and acquisitions, and subordinated debt offerings. He also issued fairness opinions and conducted private company valuations. Todd received a B.B.A. and B.A. from the University of Wisconsin–Madison.

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