Positive sentiment on emerging markets seen

The coming year is fraught with volatility and risks, but sentiment on emerging market equities could turn more positive in 2017 as investors search for higher yields and improve their risk perception, said the chief investment officer at Templeton Emerging Markets group.

In a yearend research note dated Dec. 20, Stephen Dover, who is also the managing director of Templeton, said improving risk perception toward emerging markets would be aided by robust economic tailwinds. This, he said, could provide a basis for further strength in emerging-market equities.

The Templeton research noted that in 2016, emerging markets had started on a weak note as equities were buffeted by concerns surrounding China’s economy and falling oil prices. But as the year progressed, positive factors took hold of investor sentiment.

Templeton believes in a “robust” foundation for emerging market equities this year.

Overall, the investment firm expects to see gross domestic product growth for emerging markets in 2017 at a “solid and accelerating level, markedly above the rate expected from developed markets.”

“Emerging-market countries are still far behind their developed-market counterparts when it comes to overall GDP-per-capita, and so we continue to expect strong growth prospects over the long term,” Dover said.

Dover also noted that manufacturing economies were generally back into a position of current account surplus, while citing headway in bringing down the deficits of commodity-exporting countries.

Dover also noted that the debt-to-GDP ratios of emerging-market countries were generally below those of developed markets, providing a more stable and sustainable economic foundation.

He noted that interest-rate differentials between the two groups were wide, giving emerging-market central banks greater flexibility to maneuver, if required, in the future.

“The ‘hunt for yield’ has been a frequently used term in recent years, yet the issue still remains front and center for many market participants. With low and negative yields on many government bonds globally, we continue to expect investors to look toward emerging-market equities, given the income prospects available,” he said.

In terms of valuations, Dover said the MSCI Emerging Markets Index had traded at a significant discount to the MSCI World Index, for example, on a price-to-earnings-multiple basis.

“Earnings growth trends have improved markedly during 2016, and we expect this turnaround to continue, with economies and corporate fundamentals across the asset class stabilizing,” he said.

Dover said companies in the consumer-related and information technology (IT) sectors are particularly attractive in the current environment.

“Select stocks in the consumer sectors can provide an effective means to gain exposure to emerging-market economic expansion and, in particular, access to growth in spending as rising regional wealth fuels a burgeoning consumer class,” he said.

“IT, in particular, is becoming increasingly integral and competitive in emerging markets, and, although we are cautious of the recent rapid share-price advances in many of the China-based Internet stocks, we see value in the sector across emerging markets as a whole. Elsewhere, select commodity shares remain attractively valued, in our view, even though oil prices, for example, are currently significantly above their 2016 lows,” he said.

In the meantime, Dover remains cautious of China’s banks, noting that non-performing loan recognition dampened outlook for the country’s financial firms. He also cited risks of over leveraging and regulation on China’s real estate sector.

“We continue to like Asian small-capitalization stocks as they are particularly exposed to the solid growth potential we expect from this region over the long term. This is helped by small-cap companies’ generally greater domestic focus than their larger peers, binding them less to challenging macroeconomic factors at a global level,” he said.

Meanwhile, Dover noted that the US Federal Reserve monetary policy was still a source of apprehension for many participants in emerging markets.