by Investors in emerging markets have underperformed their developed world peers for the past three years. After a particularly difficult year in 2015, due to the sharp depreciation many currencies experienced against the U.S. dollar, investors will need to be discerning in 2016, but Credit Suisse’s Investment Solutions & Products (IS&P) team expects economic growth to stabilize, opening opportunities to invest in select emerging market assets at attractive prices. What follows is Credit Suisse’s guide to what it believes are the best developing world opportunities for investors in both foreign equities and fixed income. Equities Credit Suisse’s top emerging stock markets are in Asian countries where inflation is low, currencies are stable, and countries import more commodities than they export – specifically China’s H-share market, India, South Korea, and Taiwan. IS&P analysts expect China’s ongoing fiscal and monetary stimulus to help GDP growth reach the government’s target of 7 percent. Additional monetary stimulus would also be supportive for H-shares, which trade in Hong Kong and appear attractively valued following a 37 percent selloff since May. In early December, stocks were trading at a 12-month forward price-to-earnings ratio of 9.8x, a 12 percent discount to other emerging markets, according to Credit Suisse’s Global Markets division.
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Investors in emerging markets have underperformed their developed world peers for the past three years. After a particularly difficult year in 2015, due to the sharp depreciation many currencies experienced against the U.S. dollar, investors will need to be discerning in 2016, but Credit Suisse’s Investment Solutions & Products (IS&P) team expects economic growth to stabilize, opening opportunities to invest in select emerging market assets at attractive prices. What follows is Credit Suisse’s guide to what it believes are the best developing world opportunities for investors in both foreign equities and fixed income.
Equities
Credit Suisse’s top emerging stock markets are in Asian countries where inflation is low, currencies are stable, and countries import more commodities than they export – specifically China’s H-share market, India, South Korea, and Taiwan.
IS&P analysts expect China’s ongoing fiscal and monetary stimulus to help GDP growth reach the government’s target of 7 percent. Additional monetary stimulus would also be supportive for H-shares, which trade in Hong Kong and appear attractively valued following a 37 percent selloff since May. In early December, stocks were trading at a 12-month forward price-to-earnings ratio of 9.8x, a 12 percent discount to other emerging markets, according to Credit Suisse’s Global Markets division.
India’s economy is large and domestically oriented, offering a buffer in the event of a further slowdown in China or weaker-than-expected growth in the developed world. Credit Suisse’s IS&P team expects GDP to expand by 7.3 percent in 2016, up from 6.9 percent in 2015. Low commodity prices have helped reduce inflation, giving the Reserve Bank of India room to cut rates in 2016, which would provide further fuel for both economic growth and corporate earnings. Consensus forecasts estimate a 17 percent increase in earnings for Indian firms in the fiscal year that begins in April 2016, Credit Suisse’s Global Markets division says.
South Korea and Taiwan should be relatively immune to the deleterious effects of any further U.S. dollar appreciation in 2016. South Korea is the emerging world’s largest net commodity importer, followed by Taiwan, while Taiwan has the largest current account surplus in the emerging world, followed by South Korea, according to Global Markets analysts. Both countries have low levels of debt. A positive for Korean equities investors: the Samsung conglomerate has announced a very large share buyback program, and Credit Suisse’s Global Markets division believes other Korean firms could follow. For its part, Taiwan’s trailing 12-month dividend yield of 4.2 percent is also the highest in emerging Asia and 47 percent higher than emerging markets as a whole, the Global Markets analysts say.
All that said, emerging market equities have historically underperformed global equities by 4 percent in the two months after a U.S. rate hike. Stocks in Latin America and South Africa appear the most vulnerable to rising U.S. rates.
Fixed Income
Local currency bond investors will be keeping a close eye on the U.S. dollar, which Credit Suisse expects to appreciate further against emerging market currencies in the first half of 2016. As for dollar-denominated debt, the bank’s analysts expect returns to stabilize at low levels. Overall, Credit Suisse’s IS&P team expects emerging market debt to produce returns between 3 and 5 percent in 2016 – not exactly impressive for relatively risky assets. Still, it believes pockets of value have opened up in Russian, Mexican, and Peruvian bonds that make them worth a look.
IS&P analysts expect Russian bonds to achieve higher returns than any other emerging market country at 18.1 percent, thanks to improving growth (0.5 percent compared to a 3.5 percent contraction in 2015) and lower inflation (7.5 percent compared to 15.4 percent in 2015). A calmer price environment should make it easier for the Central Bank of Russia to cut interest rates to stimulate growth, which should support the bond market.
Slumping commodity exports and large current account deficits make Latin American countries such as Brazil and Colombia vulnerable to capital outflows when and if rates rise in the United States. Elsewhere in the region, however, there are bright spots, including both Mexico and Peru. Mexican and Peruvian bonds are trading at attractive valuations, according to the IS&P analysts, and both economies are on a relatively solid footing.
Credit Suisse’s IS&P team believes Mexico’s GDP will grow 3 percent in 2016, up from 2.6 percent in 2015. The Banco de Mexico will likely mirror any rate increases from the Federal Reserve to prevent the peso from depreciating, which would reduce currency risks for peso-denominated debt. Finally, government budget cuts and a commitment to shrinking the deficit should help hard-currency bonds outperform.
Meanwhile, IS&P analysts expects Peru’s fixed-income assets to earn the second-highest returns of any emerging market debt in the coming year – 13.3 percent in dollar terms. The Peruvian central bank is also likely to raise interest rates, but the IS&P team notes that local-currency bonds are paying high enough interest rates to offset any tightening-related decreases in value.
Photo of downtown Seoul from Bongeunsa Temple courtesy of Pairat Pinijkul / Shutterstock.com