The underperformance of EM equities has lasted for six years and is likely to persist for a while longer.
The previous cycle of EM underperformance suggests we could have a drawn-out bottoming process rather than a quick rebound. Emerging equities look like decent value on the simple basis of relative price-earnings ratios (PER), but the comparison continues to be flattered by the valuations of just two sectors – materials and financials. Valuations are less compelling if you look at relative PERs on the basis of equally-weighted sectors.
More importantly, the cyclical and structural issues undermining EM equities have yet to be resolved. The deleveraging cycle is still at an early stage, the return on equity remains extremely low, and earnings revisions are still negative. The failure of the past year’s rebound in non-oil commodity prices to be matched by strong gains in EM equities highlights the drag from more fundamental forces.
Bottom Line: We expect EM equities to underperform developed markets.