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Consider emerging markets with a long-term horizon in mind

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The times, they are a-changing

Emerging markets underperform since 2011. This reflects most of all the growth slowdown in China – which went from 10% to 6% - declining commodity prices, both base metals and oil, and a moderate ascent in the US dollar.

Short-term, the outlook remains unimpressive, despite the improvement in a) China’s Caixin manufacturing PMI index and its new orders component, b) the credit impulse and c) new loans.

 

A bouquet of catalysts, not single drivers

There is no single factor likely to be strong enough to lead to this shift in relative performance. It is more the combination of several drivers that creates a force powerful enough to deliver this outcome. We see essentially five catalysts for these markets to start outperforming.

First, the US and China have incentives to stop escalating tensions. In the case of the US, it is the nearing of the next presidential election. For China, the incentive relates to the current weakening of economic activity.

Second, an impressive number of central banks are looking to cut rates, as inflation is not an issue, to help improve the economic outlook.

Third, the growth differential between emerging and mature economies slowly turns to the advantage of the former, with positive implications on the earnings growth differential. Several secular trends favour that view, such as the development of the middle class, infrastructure spending or technology spending.

Fourth, risk appetite should increase on confirmation that recession fears remain clearly premature, which should lead to a weaker dollar and rising bond yields.

Finally, the technical picture is improving. Positive divergences can be observed (RSI, MACD…) or the break of resistance lines on charts.

 

Valuations are not an issue, to the contrary

However we look at valuations, they are mostly around their long-term averages. This is not a handicap given the change in composition of indices towards more added-value sectors, to the contrary. It means that investors have still to recognise this structural trend.

 

To summarise, investing in emerging stock markets should not only be done because of their importance in global indices but increasingly because favourable winds are starting to blow