March 21, 2019 / 7:01 AM / a year ago

ANALYSIS-"No-one is breaking out the champagne": EM investors treading carefully

 (Repeats item that ran on Wednesday afternoon)
    * Investors have ploughed $16 bln into EM equity funds in
    * EM earnings growth outpaces developed world
    * Brazil, Russia, India among investors' favourite plays
    * Three straight weeks of outflows from EM 

    By Helen Reid
    LONDON, March 20 (Reuters) - After ploughing billions into
emerging market equities since October, investors have started
to show signs of hesitation, but an uptick in earnings
expectations should reassure those hoping to capitalise on
stronger economic growth in the emerging world.
    Emerging equity funds have suffered outflows over the past
three weeks, according to EPFR data, and investors in a recent
Bank of America Merrill Lynch survey described emerging markets
as the "most crowded trade". 
    Year-to-date net fund flows into emerging markets total
$15.7 billion, against $61.8 billion exiting developed markets,
and global asset allocators have been increasing their exposure,
betting that the worst is over and a declining dollar will help
emerging economies.
    Francois Savary, chief investment officer at wealth manager
Prime Partners, who has an overweight on emerging equities in
his asset allocation, said investors are searching for growth in
a world where it is looking increasingly scarce.
    "It's not only a play on the last phase of the cycle, it is
the fact that we have doubts about the U.S. economy down the
road," added Savary.
    The relative health of emerging companies' earnings compared
to the rest of the world is a central draw. Analysts have
increased their expectations for EM earnings growth this month
while forecasts slide everywhere else. 
    The inclusion of China's domestic A-Shares into MSCI's
emerging markets index has also been a game-changer, making it
far easier for international investors to access Chinese stocks.
    Data from the Institute of International Finance showed that
the lion's share of emerging market equity inflows - $10.6
billion of a total of $13.9 billion in February - piled into
Chinese stocks.
    "The Tencents, Alibabas and Baidus of this world are not
just Chinese growth stories, they're becoming global
international growth stories," said Edmund Shing, head of
equities and derivatives strategy at BNP Paribas in London.
    "From that point of view, people are coming back to that
sector and thinking that’s a better place to be. I would argue
these leading technology companies are more innovative than
their U.S. counterparts," he added.
    But investors are treading with caution, having learnt the
hard way not to be too hopeful after many false dawns.
    "No-one is breaking out the champagne on this. We're just
hoping we get a decent year, and arguing that U.S. valuations
versus EM are quite stretched," said Charles Robertson, global
chief economist at Renaissance Capital. 
    Return on equity across emerging markets has risen to a
five-year high, while valuations, at 11.6 times forward
earnings, are 30 percent cheaper than the S&P 500.
    With the sugar rush of U.S. tax cuts wearing off, U.S.
profit margins look set to wane while EM margins have further to
    Earnings for EM overall are expected to grow 6.8 percent
this year - down from the 12 percent growth expected back in
September, but still set to outpace the United States.
    Thawing China-U.S. trade relations have also helped buoy the
    "Because they're seeing macro getting better, trade getting
better, China doing the right things, as long as they can see
that forward progress they can feel that some level of past
disappointment can be just that - in the past," said Andrew
Jones, emerging markets equity portfolio manager at Pinebridge
Investments in New York.

    The BAML survey could be a bad omen for emerging markets.
Previous "crowded trades" include bitcoin and the FAANGs, which
went on to slide significantly.
    On Tuesday, the latest survey showed short European equities
had succeeded EM, however, comforting investors who say the
asset class hasn't reached the eye-watering valuations
characteristic of such trades.
    "When I meet clients there is certainly a lot of interest,
but have people really started to move? I would say no," said
Robert Horrocks, chief investment officer at Matthews Asia.
    The market is not factoring in the idea there could be a
sustained earnings cycle in Asia, he added, saying Asian
earnings could outgrow Europe by 3 to 5 percentage points.
    Some, like Peter Elam Hakansson, chairman and CIO at East
Capital in Stockholm, are homing in on specific countries where
they see particularly strong earnings growth. 
    "Some of the most interesting developments will be in Brazil
and Russia where you had some very nice earnings growth but the
market is not really appreciating it," said Hakansson.
    Brazil and Russia have delivered the strongest year-on-year
earnings growth of top EM countries, while Taiwan and South
Korea - hit by U.S.-China trade tariffs - have had sharply
negative earnings growth.
    Data from Copley Fund Research shows that emerging market
funds are overweight India and consumer staples stocks, while
the biggest underweights are Taiwan, South Korea, communication
services, and China and Hong Kong.
    Others are seeking contrarian plays in the context of a
U.S.-China trade war potentially nearing its end.
    Al Bryant, EM portfolio manager at River & Mercantile in
Chicago, said he holds some Chinese port operators.
    "Global trade isn't going away," he said. "That's our one
option play, if you will, on a (trade) compromise coming out."
    Bryant is also focusing on small-cap stocks, which have a
better earnings growth outlook while trading at lower valuations
than large-caps.
    "Small-caps are tilted away from state-owned enterprises,
more tilted to privately owned and consumer companies whose
story is a lot more attuned to the consumer demand you're seeing
in EM," Bryant said. 
 (Reporting by Helen Reid, Additional reporting by Karin
Strohecker and Josephine Mason, Editing by Hugh Lawson)
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