The investor who called emerging markets the “trade of a decade” before their rally last year sees further gains to come from developing-nation assets.
Christopher Brightman, the chief investment officer at Research Affiliates, says that while emerging equities cost more now than when he first made the call in February 2016, they remain "an enormous bargain." He cited their valuations relative to U.S. stocks, which by his preferred measure are the most expensive since the dot-com bubble of the late 1990s.
The fund manager says emerging-market shares and bonds have been unfairly beaten down by concern over the outlook for higher global rates and a slump in commodities. While they have gone through busts and booms over the past few decades, investors are being compensated for the risk and have the opportunity to get in early on what should be a multi-year bull market, according to Research Affiliates, a sub-adviser to money managers including Pacific Investment Management Co., Invesco Ltd. and Charles Schwab Corp.
"One has to go back and ask how did it ever get so cheap?" Brightman said from Newport Beach, California. "People finally realized that the world economy is not coming to an end, and that’s what made a bottom for emerging markets."
The MSCI Emerging-Markets Stock Index has surged 31 percent since Brightman made his call last year, while Bloomberg’s index of dollar-denominated debt from developing nations has returned 9.7 percent.
A look at the Shiller P/E Ratio, a measure of valuation based on cyclically adjusted price-to-earnings ratio, shows equity investors paying a high premium for U.S. stocks versus emerging markets and developed nations in Europe, Brightman says.
"You’re paying twice as much for a U.S. earning stream than for the U.K., Germany and Japan," he said. "We’re not even talking about scary countries like Turkey, Russia and Brazil."
Brightman also sees gains outside the U.S. propelled by a coming drop in the dollar. He says he’s been amazed on trips to Canada, the European Union and the U.K. at how cheap everything seems in dollar terms. Compared to its historical average, the dollar is expensive, typically a harbinger for depreciation in coming years, he says.
Emerging-market assets account for 35 percent of the $40 billion in assets that Research Affiliates manages for Pimco, according to Brightman, who oversaw the endowment at the University of Virginia before joining the firm co-founded by Rob Arnott in 2002.
Last year, their Pimco RAE Fundamental Emerging Markets Fund surged 33 percent to outperform the benchmark index by more than 20 percentage points, boosted by overweight positions on Brazilian and Russian energy firms and South African gold miners. The fund lost 23 percent in 2015, much worse than the 17 percent drop in the benchmark.
For developing equities, bargains can still be found in the energy and resource space, while well-known consumer product brands that are traditionally viewed as safer plays are overvalued, Brightman said.
He also sees local-currency bonds in developing nations trading at a discount, especially those in Turkey, Malaysia, Indonesia and Mexico.
Emerging markets offer an average yield of 2 percent after accounting for inflation and offer an additional 2 percent in pickup from currency appreciation -- attractive numbers compared with next-to-zero yield and an expensive currency in the U.S., according to Brightman.
"If you don’t hold a substantial allocation to EM local-currency debt, now is a great opportunity," he said.
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