Scope for investment: Emerging markets could spring right back to global favour

livemint.com:

For many years now, emerging-market (EM) assets as a class have got little attention, globally. Data from JPMorgan suggests that over the past year, foreign investors have pulled out over $36 billion from this asset class. No discussion about EMs is complete without someone pointing out their insipid returns over the past decade—a paltry 3% annualized in US dollars (including dividends).

While the composition and computation of the MSCI EM index depress its headline returns somewhat, the broad assertion that EM returns have been forgettable is true. They pale even more in comparison with the S&P500’s nearly-13% dollar return over the same period. Global asset allocators have been feeling vindicated in opting for US markets over EMs.

People tend to judge a movie by the size of crowds that come to watch it. By that yardstick, the EM movie seems like a flop, but regular moviegoers will notice that the show has gotten better and promises to improve further. To begin with, the tickets are cheap.

The 12-month forward price-earnings (PE) ratio for EMs is barely 12 times. This is not only cheap versus its own history, it reflects a discount of over 40% to US markets, the widest gap in a decade. Sizeable EMs like Brazil, Korea, Poland and South Africa are trading at single-digit PE multiples.

Add to this a 3% dividend yield that the EM index offers, and the valuation case becomes more compelling. Consensus forward return-on-equity of nearly 13% and earnings growth in excess of 20% should allay fears that EMs are a value trap. In most EMs, private-sector balance sheets are in a better shape than they were five years ago.