Something strange is happening. As a child of the bear market, I have been used to changing trends, but the stark underperformance of emerging market equities versus developed world equities is not something we have become used to in rising markets.
Indeed, after recent falls in emerging market equities the valuation and dividend yield gap between emerging and developed world equities has risen to levels that have historically led to decent outperformance from emerging equities.
Importantly emerging equity sentiment has become weak, in stark contrast to strong sentiment towards the US, fewer worries over Europe and even a warmer feeling towards Japan. We would suggest that it is time to start increasing allocations to emerging equities, particularly unloved markets such as China.
Valuations in China have fallen sufficiently to at least partially compensate for the risks that exist in the Middle Kingdom. We added the Allianz China fund to our portfolios as it could be a strong ‘value performer’.
Value is the place to be in emerging markets, following the unsustainable outperformance of ‘quality growth’ in the past few years. This is ‘trend bias’ that will be shared with developed markets, but the juxtaposition between expensive defensives and cyclical recovery in emerging market equities is extraordinary and could be rewarding for patient investors.
Tom Becket is chief investment officer at Psigma Investment Management
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