beyondbrics

With fears of the eurocrisis chilling investors’ veins, it’s easy to forget that emerging market equities are now very cheap by past standards.

That doesn’t necessarily mean that investors are suddenly going to start buying, given everything else that’s going on the financial world. But, once the terrors subside, this could look like a buying opportunity. At least that’s the view of Jonathan Garner, Morgan Stanley’s global emerging markets strategist.

As Garner was speaking to beyondbrics on Thursday, emerging market shares were rising sharply from their lowest levels for two years, with the MSCI EM index up 2.8 per cent on hopes of progress in the eurozone crisis.

Following a 26 per cent decline this year, which has sent EM bulls running for cover, EM equities are now trading on a forward price/earnings multiple of 2012 forecast earnings of just 8.4 times.

Over the past twenty years – all crises included – EM equities have been cheaper than this in only two per cent of the time, says Garner.  The current ratio of price to book value is just 1.45 times: it’s been lower than this in only 10 per cent of the time.

Past performance is no guide to the future, as the disclaimers always say. And Garner accepts that these are challenging times with huge volatility in the markets. He’s not forecasting any gains in EM equities in the current quarter precisely because of the uncertainties surrounding the eurozone crisis.

But by the end of next year, he predicts a gain of nearly 50 per cent in the MSCI EM, after European Union policymakers finally get their act together. If that sounds fanciful, remember that EM equities gained around 114 per cent from October 2008 to October 2009, and a further 20 per cent from October 2009 to October 2010.

Garner argues that while the eurozone crisis is certainly a serious, investors are “discounting something well beyond a shallow recession in Europe” and in fact anticipating a 30 per cent decline in EM companies’ earnings by the end of next year.

Garner says that would be the same drop as occurred in 2008-9. And that’s not likely given that the world economy doesn’t face the same extreme recessionary risks. Morgan Stanley calculates EM company earnings rose 15 per cent in the first half of 2011 and predicts they will increase further – by around 10 per cent – in the 18 months to the end of 2012.

Garner’s optimism contrasts sharply with the gloom coming from UBS, which urged investors to remain cautious about EM.

Admittedly, Nicholas Smithie, UBS’s global EM equity strategist, agreed with Garner in arguing that EM equities were now very under-valued by historic standards and were a buy on a 12- or 18-month view.

But he was far from positive. And his colleague Bhanu Baweja, head of EM fixed income and foreign exchange strategy, was downright bearish: “We are negative on EM FX across the board.”  While Baweja was talking mainly about fixed income, foreign exchange is a significant influence on investment decisions for international equity investors.

But on one point, Garner, Smithie and Baweja all agree – the development of the eurozone crisis over the next three months will be critical to EM equities – and not just to EM equities.

Related reading:
UBS to EM investors: Stay out, beyondbrics
EM equity deals: drying up, beyondbrics