- Emerging Market growth has rebounded since commodity prices bottomed in the first quarter (Q1) of last year. World trade growth and rising domestic demand have allowed EMs to outperform the US during its recent soft patch.
- Improved sovereign balance sheets and stabilising inflation rates mean little upside for interest rates in the near term – even with US rates set to rise again. EM FX appears protected by positive real interest rates.
- In Fixed Income, the chase for yield and stable carry continues. We prefer High Yield (HY) vs Investment Grade (IG) and 3-5 year corporate bonds. Credit differentiation will be key in H2 2017. In China, State Owned Enterprise (SOE) related corporates rated BB stand out, especially those with stable credit matrixes and low leverage. They have better yield pickup vs IG and will be less volatile than single B credits if growth deteriorates.
- Local currency bonds offer attractive yields, but mostly in unhedged terms. Expected stability for EM FX adds to selective appeal.
- In equities, as long as the earnings picture remains supportive, we expect that EM will continue to perform. EM trades on a price to earnings (PE) multiple of 13 times (x) vs DM’s 17x, but with similar earnings growth expectations of 10-11% per annum. On a price-to-book basis (PB), EM at 1.5x vs 10% Return on Equity (ROE) is attractive compared to DM’s 2.2x vs 11% ROE.
- Leaders in this earnings recovery are Korea, Taiwan, Thailand and India. China is the most significant earnings recovery laggard, but the index is the second best performer behind Korea. By sector, leaders are Energy, cyclicals and Technology. Financials and defensives are not yet contributing to the earnings recovery.
- Asia’s outlook is superior. We prefer cyclicals, and large regional Financials/Technology stocks in China, Korea and India.