By Scott Berg
Equity investors have enjoyed a remarkable period since the global financial crisis, seeing both volatility and opportunity on an unprecedented scale. While the magnitude of equity returns delivered over the past five years needs to be separated from today’s outlook, given prevailing valuations, we believe equities can deliver solid returns to investors over the next two to three years.
Global equity valuations have moved far from the distressed levels seen at the beginning of 2012, but remain reasonable in aggregate. Having seen multiple expansion drive a large amount of equity returns over the past year in particular, it is important to recognise the future drivers of equity markets are now likely to evolve. A more even balance of returns spread over earnings growth, cash return from balance sheets, and more stock-specific multiple expansion may make for a more complex outlook – but one that will favour profits delivery as we move into the next phase of global growth.
EM sell-off seems excessive
For those willing to look through near-term volatility and the slowdown in growth, as stability-enhancing policy efforts are prioritised, valuations and elevated correlations suggest an opportunity within the emerging world. While selectivity is required, given the end of the commodity super cycle and the evolution taking place within many EM economies, the price-to-book de-rating for the MSCI Emerging Market Index since 2007 appears extreme. Relative to other equity regions, the MSCI EM Index is trading close to Japan and Europe on a P/B basis. This is unusual considering our view of the long-term growth prospects for the region.
On a regional basis, we continue to maintain a significant overweight position in EMs, especially via non-BRIC countries. While this has generally been a challenging period for bottom-up stock pickers in the emerging world, our conviction regarding the long-term potential of many consumption-led EM economies remains high. While the emerging world has been spoken of as a single equity class, we would emphasise more than ever the importance of selectivity at country, industry, and company level. While correlations are temporarily elevated, the fundamentals of the emerging world are dispersing both near and long term.
Opportunities in financials
Areas within EMs where we remain most confident include ASEAN nations, high-quality banks operating in secularly advantaged economies, and staples/retailers. On a broader basis, we have also viewed the sell-off within EMs as an opportunity to improve the quality and shareholder friendliness of our holdings. Although experience tells us that EM stocks can always fall further than anticipated, we believe all but the most extreme scenarios are now largely priced into valuations.
We see EM financials as the most attractive way to benefit from superior economic growth rates and low-penetration levels in emerging markets relative to developed markets. Additionally, valuations have become widely attractive in the wake of concerns regarding the effect of rising US interest rates. We have also added to our positions in the technology sector – in order to benefit from the ongoing transition toward greater user mobility, increasing internet engagement, and growing technology consumption in EMs. These are all powerful long-term growth drivers.
Look to exploit volatility
While we maintain an optimistic medium- to long-term outlook, we are concerned near-term uniform bullishness in the developed world is likely to contrast with the reality of the next stage of the cycle, especially as fundamentals remain highly dispersed. This will inevitably lead to increased volatility but, importantly, opportunities to refresh stock positions as expectations adjust.
Overall, corporate fundamentals are in good shape. With many opportunities remaining at the stock level and with equity valuations still reasonable, we believe with a focus on fundamentals there remain many opportunities for global equity investors.
Scott Berg is manager of the T. Rowe Price Global Growth Equity fund
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