As global recession fears flared this summer, investors tore out of emerging-market stocks. The MSCI Emerging Markets Index fell almost as much as the MSCI Europe Index in the third quarter—although Europe was at the center of market concerns. And within emerging markets, as elsewhere, cyclically sensitive sectors did worse.
No doubt, many investors were recalling 2008, when credit crises and recessions in the developed world briefly slammed the brakes on emerging economies. And, no doubt, the flight from emerging markets was in large part a flight from risk. But fundamentals and valuation got trampled in the rush to the exits. To us, this sell-off was excessive, and created rich opportunities to exploit.
The emerging nations are not immune to global economic slowdowns. Many are already feeling the pinch of weakening export demand. But our research indicates that, in aggregate, emerging markets are far less vulnerable than they used to be—and than investors seem to fear. Their populations are richer, their companies are more productive, and domestic consumption drives more of their growth than in the past. Governments in many emerging markets also enjoy greater fiscal and monetary flexibility to stimulate growth than their debt-constrained counterparts in the developed world.
Consensus earnings forecasts have come down for developing and developed markets to a similar degree, but the consensus still expects earnings growth for emerging-market companies in aggregate to outpace earnings growth in developed markets. Nonetheless, emerging-market stocks are trading at comparable or lower valuations than developed-market stocks.
The mad dash for safety has also created large price distortions—and ripe conditions for stock-picking—within the asset class. Valuations among downtrodden cyclical stocks have collapsed—in our view, far more sharply than their lowered earnings outlooks explain. For example, price-to-earnings multiples for energy stocks fell by more than 25% on average in the third quarter, while forecasts for the sector’s earnings growth through 2012 were shaved by 15% (Display). Financials suffered similar multiple compression, although growth estimates were trimmed by only 5%.
By contrast, consumer staples’ P/Es contracted only 7%, despite a 9% drop in consensus earnings growth expectations. The sector finished the third quarter trading at three times book value—twice the level for all other emerging-market sectors and the MSCI World Index as a whole. It is priced at similar premiums based on one-year forward earnings estimates.
The “safety premium” is even more pronounced for the largest-cap staples company—Brazilian brewing company AmBev. It was trading at seven times book value and 19 times forward earnings on September 30. Yet our analysts expect its earning growth to slow as its shares of various markets plateau and rising costs constrain its margins.
In our view, these safety-trade disconnects create compelling opportunities within the financial, industrial commodities and energy sectors. We are confident that these valuation disparities will correct once markets become less focused on the macroeconomic outlook and begin to pay more attention to company-specific fundamentals.
The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AllianceBernstein portfolio management teams.
MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices, any securities or financial products. This report is not approved, reviewed or produced by MSCI.
Kevin Simms is Global Director of Value Research at AllianceBernstein.
