Emerging market stocks drop to record discount to US

Stocks across emerging markets have dropped to a record valuation discount to US equities, according to the Institute of International Finance (IIF), as investors ditch assets deemed risky due to the coronavirus crisis.

Stocks across the developing world now trade at an average 7.8 times profits, on a cyclically adjusted price-to-earnings basis — a 65 per cent discount to the CAPE ratio of 22.6 for the US stock market.

The 23 per cent slide in the MSCI Emerging Markets index this year has taken its CAPE ratio below the levels witnessed during the global financial crisis. In contrast, US equities, as measured by the S&P 500 index, are still comfortably above their 2009 low of 13.7 times.

The CAPE measure, which is based on inflation-adjusted average earnings over the previous 10 years, is seen by some analysts as the best single measure of valuations as it smooths out booms and busts by looking across the economic cycle. In doing so, it avoids the standard problem of shares looking expensive when profits collapse in a recession, and cheap when profits are at their peak.

Sonja Gibbs, managing director for global initiatives at the IIF, said the resilience of the US market reflected an expected boost from fiscal and monetary stimulus, while emerging market equities were being hurt by their exposure to the commodity and tourism sectors.

She added that investors were also spooked by “tangible [foreign exchange] liquidity risks” for heavily leveraged companies in emerging markets, as debt burdens became harder to service when currencies dropped against the dollar.

“With both retail and institutional investors hoarding cash at an exceptional pace, lack of visibility on corporate earnings and anticipated job losses is undermining investor appetite for risk assets,” said Ms Gibbs.

Richard Titherington, chief investment officer for emerging market equities at JPMorgan Asset Management in London, argued that the widening valuation gulf was a sign of US stocks being overvalued, despite a 17.5 per cent slide this year, rather than emerging market stocks being cheap.

He said that on his preferred measure, price-to-book value, EM stocks were now trading at 1.38 times, still comfortably above the lows of 1.17 times in the global financial crisis and 0.9 times in 1998, amid the Asian financial crisis.

“I don’t think 1.38 is particularly attractive,” he said Mr Titherington. “Anywhere around about 1.2 is a reasonable place to be buying.”

However, Justin Leverenz, chief investment officer of developing market equities at Invesco, said he had “not been this excited for more than a decade” about emerging market stocks.

“One has to be quite selective, but prices are really spectacular now in a handful of places,” he said, citing Russia, India and Brazil.

Mr Leverenz said he had been “aggressively” buying stocks in Brazil, which he said had the added appeal of a cheap currency. About $1bn of purchases within the past month included stakes in PagSeguro, a digital payments company, brewer Ambev and Itaú Unibanco.

The US Federal Reserve has attempted to stabilise struggling emerging economies, with a $60bn repurchase agreement signed on Tuesday with Indonesia, building on the dollar swap lines it had already set up with many developed and emerging countries.

Ms Gibbs agreed that valuations of emerging market stocks looked “compelling”. But she added that concerns over growth and commodity prices, coupled with the effects of the virus on “under-developed” healthcare systems, “will weigh on risk appetite”.

She noted that the positive correlation between emerging market stocks and commodity prices was close to all-time highs. 

The IIF is a global association of financial institutions that was created 37 years ago by dozens of banks in developed markets in the wake of the international debt crisis of the early 1980s.