Emerging market assets, particularly bonds but also equities, are staging a comeback as investors gradually return to risky assets.
A survey of investor sentiment carried out by Societe Generale in February among 41 hedge funds and 41 real money investors such as pension funds, showed the bullish bias towards emerging markets strengthening for the near term.
On a two-week horizon, 74.4% of investors said they were bullish on emerging markets, with only 17.1% saying they were bearish and 8.5% neutral.
“This month’s (bullish) reading has basically recovered to levels only tracked by our survey back in November 2012, on the heels of the QE3 announcement,” Benoit Anne, head of emerging markets at Societe Generale, said referring to the Federal Reserves’ third asset-purchasing programme since the financial crisis of 2007-2008.
The short-term bearish sentiment on emerging markets is at its lowest in a year.
Over a three-month horizon investors are also bullish, but sentiment has eroded slightly compared with January, with 54.9% saying they were bullish regarding emerging market assets in February from 62.2% in the previous month. The population of bears increased to 34.1% from 25.6%.
In terms of asset classes that investors favour in emerging markets, hard currency debt came on top, followed by local currency debt and equities. Emerging market currencies remained the most disliked asset class.
Emerging market equities might be picking up speed going forward. Their valuations are much better than those of developed market equities, as Capital Economics chief markets economist John Higgins pointed out in recent research.
The price/12-month forward earnings ratio of the MSCI Emerging Markets Index is below that of the MSCI World Index of developed market stocks by around five points, while returns from emerging market equities have lagged behind their developed market counterparts over the past month, when they eked out a 2% gain.
Price/12-month forward earnings ratios in emerging markets are above their five-year averages with the exception of emerging Europe, partly reflecting the low valuation of Russian equities – so this seems to be the region that would post the most significant gains.
However, not all markets in emerging Europe are good value. The Czech Republic – which is used by many investors as a proxy for Germany due to its strong trade ties — appears to be one of the most overvalued stock markets compared with its five-year average. Its price/12-month earnings ratio is 15, 36% higher than its five-year average.
In emerging Europe, Turkish stocks look attractively priced, at just 9.2 times 12-month forward earnings and 1.5% above their five-year average.
Despite a difficult political situation, Turkey has benefited from the fall in oil prices which has helped it cut the current account deficit and avert a potential devaluation of its currency.