Valuations of stocks don’t matter much in emerging markets

Like the Nasdaq, emerging markets are no strangers to booms and busts. Unlike the US market, valuations no longer matter much outside the developed world.
That’s because sell-side analysts’ earnings estimates are unreliable. The 10% correction in the Nasdaq 100 Index shouldn’t have surprised US analysts — they’ve been revising down earnings estimates since April, when trade tensions started to brew.
Aggregating estimates for all companies in the Nasdaq, the implied Ebitda growth rate for the next three fiscal years tumbled from a high of 24.3% in February to 12.9% recently. So the sell-off is a catch-up with analysts’ wisdom.
The same can’t be said of emerging markets. Using that approach, implied future earnings growth for companies in the MSCI Emerging Markets Index has been eerily stable this year, even though the benchmark has lost one-third of its value from a January high.
The picture looks even stranger for the MSCI Asia ex-Japan. Sell-side analysts have actually revised expectations up — as if companies from China to South Korea won’t be touched by the trade war.
One obvious explanation is that developing-nation analysts need to hone their analytical skills. Perhaps out of laziness, or fear of losing access to companies, they’re
reluctant to be bearish.
Emerging markets are vulnerable to so many known unknowns — from the Federal Reserve’s rate hikes to oil shocks — that forecasting earnings growth may be too challenging.
Regardless, unreliable bottom-up earnings estimates make life difficult for investors and strategists. The MSCI EM index is now trading at 10.6 times forward earnings — one standard deviation away from its 10-year average. Does this mean it’s time to buy into dips?
Goldman Sachs Group Inc., for one, isn’t going along with earnings estimates. In its 2019 outlook, the bank reckons Asian equities will have a challenging year and sees EPS growth slowing to 5 percent, about half the consensus forecast.
Morgan Stanley, on the other hand, went bullish in its 2019 global outlook, double-upgrading emerging markets from underweight to overweight. The firm cites mean reversion: What goes down must come up.
There’s a lesson from the 2008 global financial crisis. The MSCI Emerging Markets and MSCI China indexes were among the world’s worst performers, only to come out on top in 2009.
This year is shaping up to be a “rolling bear market” like that of 2008, Morgan Stanley says, noting that global investors now have nowhere to hide: From the S&P 500 to US high-yield corporate debt, none of the major asset classes is returning more than the rate of inflation. But for next year, “the lower an asset is on the 2018 rankings, the better we feel about its prospects for 2019.”

Bonus season is almost upon us, and equity analysts surely are jostling for more pay. With their estimates diverging so sharply with the market, your guess on emerging markets might be better than theirs.

—Bloomberg

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron’s, following a career as an investment banker, and is a CFA charterholder.