Emerging markets step back from abyss as Goldman turns bullish

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(Bloomberg) -- Finally, there may be some relief for emerging-market investors.

Strategists at banks from Goldman Sachs Group Inc. to Bank of America Corp. say that developing-nation assets are bottoming out following three years of losses in currencies and stocks.

It’s not that they are likely to embark on a rally. Rather, that the mood among investors has become so depressed, even a marginal improvement in the economic outlook will be enough to shift sentiment and drive up assets such as the Mexican peso, Russian ruble bonds and Indian stocks, the analysts say.

’‘We are a little bit more optimistic next year,” said Geoffrey Dennis, head of global emerging-market strategy at UBS Securities LLC in Boston, who favors Chinese, Indian and Russian equities. “You get a slightly better earnings story and overall a slight pickup in economic growth in emerging markets next year. This year’s been so dreadful.”

After five years in retreat, developing countries from Mexico and Poland are showing signs of recovery as the U.S. and European economies pick up. While the almost 30 percent decline in emerging-market currencies since 2012 saddled investors with losses, it also helped some nations such as Brazil, Turkey and India to tackle their economic vulnerabilities, narrowing current-account deficits and boosting competitivity.


Cheap Assets


Developing markets look inexpensive by historical standards. The MSCI Emerging Markets Index has declined 30 percent since its 2011 high and now trades at about 12 times estimated earnings, or almost one-third less than the valuation of the Standard & Poor’s 500 Index, the benchmark for U.S. stocks.

On average, emerging-market currencies are 16 percent below their fair values against the dollar as the Brazilian real and the Turkish lira declined to record lows this year, according to Bank of America’s model.

Even though prices will remain volatile as the Federal Reserve prepares to raise interest rates for the first time in almost a decade, Bank of America’s strategists say they are “constructive” on emerging-market currencies in the “medium term.”


Growth Accelerates


They are “highly undervalued” and “exports and direct investment have room to rebound,” analysts led by Alberto Ades in New York wrote in a research note on Nov. 19. They recommend clients buy the Mexican peso and the Polish zloty against the euro and favor local-currency bonds in Hungary and India.

While acknowledging the expansion will remain below the long-term trend, Goldman Sachs forecasts that developing economies will grow 4.9 percent next year, up from an estimated 4.4 percent in 2015, the first acceleration since 2010.

“2016 could be the year emerging-market assets put in a bottom and start to find their feet,” strategists led by London- based Kamakshya Trivedi wrote in a Nov 19 report. “There is the prospect of improved growth and better returns, even if it is not a rerun of the roaring 2000s.”

Goldman Sachs is advising clients to buy the Mexican peso and Russia’s ruble against the South African rand and the Chilean peso as one of the top global trades for 2016. It also forecasts Russia’s domestic bonds will rally as inflation slows.


Default Risks


There’s no shortage of pitfalls to challenge these more sanguine views on emerging markets. Aggressive interest rate increases in the U.S. could make it more difficult for companies in developing countries to pay back their $1.4 trillion of dollar debt.

Barclays Plc estimates the default rate among junk-rated emerging-market companies is set to rise to as high as 7 percent next year, from 3.8 percent in 2015 and a 20-year average of about 4 percent.

In China, the economy is reeling from overproduction and a debt overhang. A record high yuan against its trading partners looks increasingly at odds with a slowing economy, putting pressure on the government to weaken the currency and risking a string of competitive devaluations in the region. The mainland stock crash earlier this year shows policy makers are prone to mistakes as they juggle the conflicting tasks of supporting growth and deepening reforms.

“It is far too early to expect a significant turnaround” in emerging economies, Barclays analysts wrote in a note on Nov. 13.


Country Investing


There will still be pockets of opportunity as growth stabilizes in emerging markets, according to Ruchir Sharma, the head of emerging markets for Morgan Stanley Investment Management, who says the key is differentiation.

“Last decade everything in emerging markets was doing well,” Sharma said. “We had this incredible boom across the market. Now, it’s back to country investing. It’s difficult for emerging markets to boom, but there’s room for some emerging markets to at least be able to start delivering positive return again.”

 

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