Emerging markets (EM) stocks returned 2.8% in October, after shedding 1.9% since their October 14th high, according to Citi’s strategy team. Thing is, this was strong performance, especially considering that it came right after emerging markets surged a remarkable 10.9% in September.
The divergence between emerging markets and developed markets (DM) when it comes to GDP growth (higher vs. lower) and monetary policy (tighter vs. looser) have sent capital pouring into EM. Now the obvious question is whether or not stocks have reached bubble territory.
Not so, says Geoffrey Dennis at Citi, and he has a pretty simple reason — valuations.
Curbing Inflows — Regional currencies rose by just 0.6% in October, according to our FX proxy, down from +3.4% the prior month, as the dollar’s fall slowed and on measures by several EM economies to curb FX appreciation. EM bond prices rose by less in October than previous months (EMBI+ yields fell 16bps to another record low of 5.28%). Flows into EM equity funds eased back by end-month.
Strategy — We maintain our bullish view of emerging market equities for the next 12-15 months; liquidity will likely continue to flow into emerging markets, and our view is that GEMs trading at 11.4x forward earnings and 2.06x P/B are not in bubble territory. We remain Overweight in Asia, Neutral in Latin America, and Underweight in EMEA.
Fair enough, hard to see how 2x price-to-book value is obviously a bubble.
Pre-crisis emerging markets stocks hit nearly 3x price-to-book, and that was before we had the stark GDP growth and monetary policy divergence between EM and DM we now have today.
An 11.4x price-to-earnings doesn’t scream over-valued either, and if ever there were a time for emerging markets to finally re-rate higher relative to developed ones it is now given the long-term stagnant growth outlooks for major developed nations.
(Via Citi, Global Emerging Markets Strategy, Geoffrey Dennis, 1 November 2010)