Five reasons to be optimistic about emerging markets in 2018

Emerging market equities had a strong 2017. While all eyes were on the UK and US stock markets, which repeatedly posted new highs, the MSCI Emerging Markets index posted gains of more than 25%* – double that of the aforementioned developed markets*.

A supportive macroeconomic environment of global growth, a sustained recovery in global trade, healthy exchange rates and rising commodity prices were significant catalysts for the region, which has lagged in recent years. But can its good fortune continue?

More of the same?

There are a numbers of reasons to be optimistic that emerging markets can continue to do well in 2018. We take a look at five:

1. Strong macroeconomic backdrop

With an improvement in global trade volumes, growth in emerging markets could well continue to gain momentum. According to RWC, real GDP growth is now approaching 4.8% – its strongest level since March 2014 – with Asia, Emerging Europe and Latin America all accelerating. Exports are also growing and are more robust than they have been in some time.

2. Middle class growth gathers pace

More than 525 million people in Asia can already be termed middle class – that’s more than the entire population of the European Union. Over the next two decades the world’s middle classes are expected to grow by another 3 billion people, with the majority coming from emerging markets. From insurance products to better healthcare, from travel to changing food preferences, the investment opportunities this trend provides are enormous.

3. Weaker US dollar

A lot has been done to repair emerging markets balance sheets in recent years, but the recent weakness in the US dollar has still been beneficial to the region. US inflation resulted in the dollar falling by 10.7% last year – its worst year since 2005. If this weakness is sustained, it could also prove a positive for commodities, which will look more attractively priced.

4. Improving company fundamentals

Free cash flow trends are also on a positive trajectory, as companies continue to reduce capital expenditure and debt levels are declining. As companies start to make more money, so the share price climbs higher.

5. Cheaper relative valuations

Emerging market equities did quite badly for a five-year period between 2010 and 2015. While their recent reversal of fortunes has meant that valuations are now back to their long run averages, they are still trading on a 30% discount to their developed market peers, so are looking cheap on a relative basis.

Elite Rated emerging market equity funds

Among our Elite Rated global emerging markets equity funds is Lazard Emerging Markets. The team aims to identify the global brands of tomorrow in developing regions and take a stock selection-based approach to achieve this, as well as using market volatility created by macroeconomic concerns to time trading opportunities.

M&G Global Emerging Markets is another option. The manager looks for two specific types of companies from alternative ends of the return-on-capital spectrum, where the potential for long-term value creation is being mispriced by the market. The first are low-returning businesses that are going through change and the second are companies with high and sustainable levels of returns.

Magna Emerging Markets Dividend is a slightly different option as it offers exposure to emerging market companies that pay higher than average dividends. This results in a slightly lower risk profile than peers and an income stream to boot.

*Source: FE Analytics, total returns in sterling, calendar year 2017. UK and US returns those of the MSCI United Kingdom and MSCI North America