The Case for a Stock Rally, Even After Emerging Markets’ Growth Story Buckled

(Bloomberg) -- First, the bad news: corporate earnings across emerging markets aren't as good as analysts hoped.

In four out of every five emerging economies, company finances have fallen short of estimates that were made 12 months ago, according to a study of 25 benchmarks. That's even after analysts cut their forecasts by 6 percent since a peak in April.

Now the good news. Stocks across developing nations aren't as risky as their U.S. counterparts, and they're good value for money. And thanks to a sell-off this year, $11 trillion of equities are about the cheapest since the financial crisis.

Read: Trade-War Detente Gives EM Stocks Their Best Shot at Rebound

It may be hard to convince investors to return to emerging markets based on earnings alone, but the combination of low valuations and reduced volatility could make the asset class too good to pass up in 2019.

Growth is Broken

Profit expectations are unraveling. India, perhaps the biggest emerging-market favorite of global money managers, is missing earnings projections by almost 15 percent. China, the world's second-biggest economy, is trailing by 17 percent. Six other markets including South Korea and Mexico are falling short by more than 20 percent.

There are handful of outperformers, but they're countries where analysts typically give cautious projections, such as Russia and Argentina, because a seemingly endless stream of trouble makes predicting earnings difficult.

Not as Risky

A measure of risk-adjusted return that strips out historical volatility from analysts' target price shows 12 emerging markets are projected to yield returns superior to the U.S. in the next 12 months.

• Dubai emerges as the least risky stock market for the next 12 months. Among the other gauges enjoying the greatest bullishness are Mexico and Nigeria. All the three markets are among the worst performers this year

While emerging-market stock volatility has risen this year, it remains a third of what it was at the end of the financial crisis a decade ago. So any gains next year will come at a lower risk, bolstering the argument of some money managers that emerging markets are maturing.

How Cheap is Cheap?

Among 30 emerging markets, 16 trade at a standard deviation above the 10-year mean. In other words, companies are earning more profit for each dollar of their share price. Returns from Argentina are almost three standard deviations above normal, the best value-for-money across the emerging world.

• The best picks for value traders are in Latin America, eastern Europe and China's neighborhood
• Other Asian and Middle Eastern markets trade close to their historical returns and are considered expensive

The MSCI Emerging Markets Index capped the best November since 2009 and rose toward the best two-day gain in a month.

To contact the reporter on this story: Srinivasan Sivabalan in London at ssivabalan@bloomberg.net

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Alex Nicholson

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