The outlook for emerging markets equities looks promising —at least from a valuation standpoint.
The cyclically adjusted price-to-earnings ratio for emerging market equities is 15x, compared to 27x for those in developed markets and 34x for those in the U.S., according to a recent report by Phillip Wool, global head of research at Rayliant Global Advisors. China is trading at a significant discount of a little above 10x, the lowest across all emerging economies. In May, Rayliant received a non-controlling equity investment from East West Bancorp, which it will use to expand its research capabilities using artificial intelligence tools, among other things.
“While tightening across developed economies continues in a battle against persistently rising prices, threatening a significant downturn in Western economies, policymakers in emerging markets were generally ahead of the curve in fighting inflation, sooner to raise rates and now in a position to pivot earlier to easing,” Wool wrote in the report. “Amidst a risk-on frenzy in developed market stocks, particularly the U.S., we think there’s a strong case to be made that EM equities have lagged behind in pricing a comparatively favorable macro picture.”
Even for investors who want to steer clear of China due to rising geopolitical tensions between China and the West, there are still many EM opportunities worth considering, according to Rayliant. In countries such as Korea, Brazil, Malaysia, and Hungary, stocks are trading at a cyclically adjusted P/E ratio of 10x to 15x. Equity markets in Thailand, Mexico, and throughout Latin America are trading between 15x to 25x, according to the report.
“China tends to suck the air out of the room in most conversations about emerging markets — it does represent up to one-third of broad EM indices — but there’s much more to EM that merits investors’ attention,” according to Wool. “For one thing, China isn’t the only apparent bargain among emerging economies on valuation…From another angle, the very challenges plaguing China present big opportunities for investors in the EM ex-China basket.”
Wool cited Mexico as an example. Since China joined the World Trade Organization in 2001, American companies have rushed to take advantage of cheap Chinese exports, leading to declining trade volume between the U.S. and Mexico. But in recent years, trading volume between the U.S. and China has reduced drastically due to the trade war and supply chain disruptions caused by the pandemic. In the first four months of 2023, Mexico became the largest trade partner of the U.S. for the first time in two decades.
But not all EM markets are bargains. Indian equities, for example, are now trading at a cyclically adjusted 10-year P/E ratio of about 37x, which is higher than that of the United States. “That makes good deals a little harder to come by these days and creates a bit less margin for error,” Wool wrote. He added that Taiwan’s Foxconn pulled out of a $19 billion chipmaking project from India last week due to fears of policy instability. Instances like this suggest that investors should adopt an active investment strategy in the country, he concluded.
