2019 Outlook: Emerging Markets equities

Emerging markets should be able to withstand a challenging environment in 2019

Dec 27, 2018 | Ian Hargreaves and William Lam

Key takeaways

  • Headlines have dominated negative sentiment – it is important to take a more fundamental long-term approach to European equities.
  • Domestic demand continues to drive the European economy.
  • Valuations are attractive in many sectors.

2018 has been a challenging year for both Asian and global emerging equity markets. The year began with upbeat earnings expectations and valuations above long-term historical averages. However, since the start of the year, valuations have contracted due to a number of factors. Firstly, we have seen a marked increase in the risk premium for emerging markets given increased uncertainty surrounding trade tensions and geopolitics. Secondly, this has led to greater concern about China where growth has already been slowing due to the government’s deleveraging campaign. Lastly, the tightening of US monetary policy has led to a deteriorating US dollar liquidity environment with negative implications for emerging market equities and currencies.

This backdrop is likely to continue into 2019, but emerging economies are better placed to withstand these pressures than before, in our view. Valuations are also beginning to reflect the risks being faced, and are currently nearer the bottom end of their historical range.

 

Trade
Escalating trade tensions between the US and its major trading partners have dominated the headlines in recent months and have accelerated the broader market’s derating. Negotiations between the US and China have not yet yielded any results, with President Donald Trump happy to ratchet up the pressure by announcing further rounds of potential tariffs. The outcome is unpredictable, and there is a danger that tensions may escalate further. However, as the negative implications of tariff increases for the US economy become clearer, there is also a possibility that striking a deal becomes expedient. In the near term, we expect not only a direct impact on trade activity, but also an impact on corporate and consumer behaviour, with implications for investment and consumption. This would impact companies in different ways, and we are seeing more opportunities for investment where the market’s reaction has been indiscriminate.

 

US monetary policy tightening
Although policy normalisation in the US has been well telegraphed, investors have been concerned about a potentially faster-than-anticipated rise in interest rates. As the risk free rate rises, so does the cost of capital, leading in theory to a valuation de-rating of long duration assets such as stocks. Also, a stronger US dollar has led to tighter global liquidity conditions and greater headwinds to global demand growth, which could impact emerging market earnings.

 

Click Download PDF to read the full outlook