Henry D’Auria (pictured) and Morgan Harting
Years of playing defense have left many emerging-market (EM) equity portfolios laden with pricey safe-haven stocks. We think they risk missing the big opportunity that’s brewing in value stocks, especially as EM economies begin to stabilize.
The risk rally that has thundered across the developed markets (DM) over the past 18 months has largely bypassed the emerging world. Emerging economies have responded more slowly than usual to improving DM activity, while uncertainties about rich-world monetary policies loom. Nervous EM investors have been slow to abandon the relative safety of predictable, fundamentally stable stocks, while shunning riskier stocks—regardless of valuation.
We think it’s time for a rethink. Nearly two-thirds of actively managed EM equity assets are in stocks trading at premiums to the market of 10% or higher, with the largest portion skewed to those with premiums above 20% (Display 1). This is a big change from the past. As recently as 2006, allocations had been more evenly dispersed between expensive and cheap stocks, following a lengthy stretch of value outperformance in the wake of the bursting of the tech bubble.
This indifference to value seems pretty risky to us, and carries considerable opportunity costs, especially if developing economies gain a firmer footing next year as we expect. Why? Because, after prolonged underperformance, long-neglected high-beta, cyclically sensitive stocks now dominate the value realm, making it far more sensitive than usual to broad EM economic trends, which themselves are more sensitive to broad global economic developments.
Despite recent rebounds, these high-beta stocks continue to sell at some of the deepest discounts versus the overall EM market in more than 15 years—and are extraordinarily cheap versus low-beta, defensive stocks, which trade near record premiums. Relative returns of deep-value stocks have become abnormally correlated with EM market movements since the crisis (Display 2). What’s good for EM should be even better for EM value.
Value stocks typically lead market recoveries as the anxieties that made them cheap in the first place begin to subside and investors start focusing again on long-term fundamental prospects—not near-term controversies—to define companies’ true worth. Though they haven’t worked lately, value strategies have been highly successful in developing markets historically: the cheapest price/book quintile of EM stocks has outperformed the most expensive quintile by an annualized 7.5 percentage points since 1992.
Of course, much will depend on EM economic progress next year. Though the normally powerful symbiotic relationship between EM and DM economies is facing new strains, it is far from broken, as we wrote in a recent post. Forward-looking indicators suggest that EM activity is finally getting the boost from the DM recovery. Collective EM GDP growth is still outpacing that of the rich-world economies, and profit margins are higher. EM balance-sheet leverage has steadily improved since the Asian currency crisis of the late 1990s and is now significantly lower than at other periods of low EM stock valuations. In our view, even small improvements could drive outsized performance for EM stocks in general and value stocks in particular.
EM investors need to consider the risks of overplaying the safety card. We think a rebalance to value is in order.
This blog was originally published on InstitutionalInvestor.com
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Henry D’Auria is Chief Investment Officer of the Emerging Markets Value portfolio at AllianceBernstein. Morgan Harting co-heads the Emerging Markets Multi-Asset portfolio team at AllianceBernstein.