Global emerging markets: Are investors missing out on a rare entry point?

Emerging market equities have underperformed developed markets over the last decade. Some investors seem to have given up on the asset class as a result. But are they missing out on a rare entry point?

What is putting investors off emerging markets?

• ‘Emerging market equities are cheaply valued and likely to remain so’ – but company fundamentals are strengthening.
• ‘Emerging markets have underperformed for the last decade’ – we see catalysts that could change this.
• ‘There is too much political risk’ – political risk can be managed through portfolio positioning and does not affect company fundamentals.
• ‘What about China?’ – with China’s reopening post Covid, news flow has turned positive.

Attractive valuations

Emerging market stocks are trading on multi-decade valuation lows against developed markets across a range of metrics. They remain out of favour and extremely cheap relative to US stocks.

Emerging markets are cheaply valued, but not deservedly so

Shiller P/E by region

Shiller P/E – emerging markets versus S&P 500

We have been using our quantitative process, SmartGARP, for nearly 30 years to run a range of funds focused on different regions. SmartGARP aims to identify companies with superior fundamental growth. It uses Value-per-share (VPS) – capturing trends in earnings, cash flows, dividends, operating profits and assets – as a starting point for evaluating companies. It looks at 6000 companies worldwide.

As you can see from the chart below, SmartGARP is currently finding its best opportunities in emerging markets.

Emerging markets fundamentals compared to other regions: the SmartGARP perspective

Political risk can be managed

When looking at emerging markets, investors tend to focus on political risk, but we believe country risk exposure can be managed. It tends to hit headlines but does not necessarily affect corporate fundamentals.

For example, in 2022, the Turkish economy was battling against inflation near 80% and persisting in unconventional monetary policies. Despite this, its stock market was the best performer in emerging markets over the year, rising over 84% in US dollar terms. For our Turkish holdings, profit growth remained strong against the backdrop of economic headwinds. Glass producer Sisecam, bottler Coca Cola, Icecek and telecom operator Turkcell were good examples.

What about China?

Towards the end of 2022, there was a great deal of optimism about China’s reopening after the stringent Covid controls and its potential to release suppressed demand in all areas. Indeed, Q1 GDP figures showed a strong recovery in exports and retail sales. Since then, the news has been more disappointing, with Q2 GDP showing slower growth and other economic data weakening. Investors’ attention has now shifted towards the potential for government stimulus and monetary easing.

A sustained recovery is likely to be the key determinant in changing sentiment towards emerging markets. This should lead to a better outlook for Chinese stocks, particularly given their depressed valuations versus history.

It's also worth noting that investors tend to focus on headline figures such as GDP or manufacturing output, which have the potential to disappoint. Meanwhile, news reported by companies has been positive.

Looking beyond China…

Meanwhile, the emerging market story is not confined to one country. While the headlines are still dominated by China, positive trends are evident in areas outside of the world’s second-largest economy. Brazil is one such area. As an agricultural heavyweight, supplying soya beans, beef, coffee and sugar (among others) to many parts of the world, its economy is thriving. Brazil is at the end of its monetary tightening cycle. Its inflation is lower than in many parts of Europe and the country has an abundance of energy and commodities. For shareholders, substantial dividends are on offer, with good growth and attractive valuations. Banco do Brasil and Petrobras are examples of stocks we hold to access this.

How is the Artemis SmartGARP Global Emerging Markets Equity Fund positioned to benefit from market conditions and manage the risks?

For a number of years, we have seen speculation following surging share prices, which has reduced the focus on fundamentals. This has created excessively high valuations in some parts of the market that have now started to unwind.

We think this unwind has further to run and are therefore cautious on expensive companies that show signs of investor exuberance. We see less risk in companies that have been overlooked and trade on low valuations, but where there are signs of improving fundamentals.

This leads us to be overweight China, Brazil and Turkey at the country level and underweight India, Taiwan and Saudi Arabia. At the sector level, insurance, banks and energy feature as the largest overweights with materials and semiconductors the largest underweights.

Our value bias remains substantial, with the fund trading on a p/e of 6.4, compared to the benchmark index at 11.9 (a 46% discount). The fund remains well diversified, with high active share and contrarian positioning.