In the past few years, investors have been fleeing from emerging market stocks as concerns over growth and stability have increased.
Stocks in these countries, however, appear primed for a huge comeback according to Christopher Brightman chief investment officer of Research Affiliates, a subadvisor to PIMCO.
“From the rear-view mirror, the bear market in emerging markets has been painful,” he said in a post on PIMCO’s blog.
“When we look out of the windshield, however, these very asset classes offer the highest potential returns available to today’s opportunistic investor. So, the exodus from emerging markets is a wonderful opportunity — and quite possibly the trade of a decade — for the long-term investor.“
Brightman said that there have been a number of reasons for investors to worry about emerging market economies — the Chinese economic slowdown, tumbling commodity prices, geopolitical concerns — but those concerns are mostly priced in at this point.
“We are sympathetic to those alarmed by these events and recognise that this understandable fear creates today’s bargain prices,” said Brightman. “While markets are not efficient, neither are they irrational.”
Brightman highlighted the current Shiller price-to-earnings ratio for these emerging markets, which adjust from inflation.
Brightman again (emphasis added):
As of January 31, 2016, emerging market equities are priced at a Shiller P/E multiple of 10x, ranked in the lowest 4th percentile since 1990. We find six times in the last 25 years when the emerging markets’ Shiller P/E multiple dipped below 10x. How did these stocks perform after reaching these bargain-basement multiples? Five years later, emerging market equities delivered an impressive average cumulative return of 188%!
As we previously noted, UBS said that betting on the US and against emerging markets has become such a popular trade that it is close to “bubble territory.” UBS also noted that the US Federal Reserve’s rate hike and the dollar’s weakening recently has “provided the catalyst for DM equities to underperform their EM peers.”
And this is exactly what gives Brightman the entry into arguing for a bet on emerging markets.
As Brightman’s colleague Robert Arnott noted in the same post, the asset classes that look their worst are the most likely to outperform going forward.
“When fear and pessimism are endemic, investors feel pain from even modest losses; the natural reaction is to exit whatever is causing pain,” Arnott said.
“And yet, fear and pessimism create bargains. Bargains cannot exist in the absence of fear!”