Over the past eight months, the conversation surrounding emerging markets has progressed from debates about their validity as an asset class to the factors driving their outperformance and the sustainability of this rally.
When we last highlighted our favorite plays in Asia’s emerging markets, many analysts took a neutral to bearish stance on the region and its equities. (See Asia: As Bad as it Gets?)
Asian emerging markets still offer value—especially relative to the US and other developed markets—and corporate earnings continue to improve. We expect the MSCI Asia Ex Japan Index to finish the year on a strong note, especially if the global economy doesn’t experience any unexpected challenges.
The stabilization of the US dollar relative to currencies in Asia’s emerging markets should continue to benefit regional equities in this region. This tailwind, which we highlighted back in mid-March, has contributed to the MSCI Asia Ex Japan’s strong performance.
Real interest rates in China and other emerging markets in the Asia-Pacific region remain above long-term averages, giving central banks the capacity to pursue accommodative monetary policies.
This confluence of factors has helped to improve investor sentiment toward emerging markets while reducing risk aversion.
Nevertheless, investors continue to favor defensive stocks in Asia’s emerging markets, bidding these lower-risk names up to expensive multiples relative to their counterparts in cyclical industries. This valuation gap has narrowed somewhat, but remains intact.