Goldman Sachs: Emerging market selldown is overdone

World currencies

The drop in emerging market equities amid the global market selldown is overdone, with firmer valuations warranted by stable earnings and economic growth, Goldman Sachs said in a note this week.

Rising interest rates in the U.S. as well as slowing global economic growth have weighed emerging market assets, Goldman said. But it added that it expected emerging markets ex-China to see a pickup in economic growth in 2019.

“EM equities have de-rated alongside global equities with current price-to-earnings ratio now at their lowest levels since 2014, before the latest EM bull market began in early 2016,” Goldman Sachs said. “The valuation picture vs the U.S. looks even more stretched, with relative P/Es vs the S&P 500 at the lowest level since the 2008 trough of the Global Financial Crisis.”

It described emerging market assets as modestly inexpensive, based on historical levels, with earnings steady in local-currency terms, even if they’ve fallen in U.S. dollar terms.

While it didn’t see valuation as a catalyst for emerging market assets, it does view the low valuations as important for measuring risk-reward, the note said.

“They should provide greater upside if EM growth does indeed stabilize as we suspect and perhaps provide more of a cushion to the downside if fundamentals continue to deteriorate (in particular they may cushion against other regions where growth has been softening, such as Europe),” Goldman said.

The investment bank said that for much of 2018, it preferred Latin America to Asia within emerging market assets, due to a bullish outlook for commodities, cheaper valuations and expectations the U.S.-China trade war would drag on.

But it added that now it expected that story has played out.

“Market pricing is significantly more negative in Asian markets than what the growth data merit. We are also optimistic that the Chinese government is willing and able to significantly ease policy to prevent a significant slowdown in growth,” Goldman said.

It tipped its favored way to play the theme as long Taiwanese vs short Brazilian equities.

It noted Brazil is more heavily owned by equity investors amid election-related speculative flows, while it has “significant vulnerabilities” and the entry point doesn’t appear attractive.

At the same time, Taiwan has underperformed emerging markets since September amid China trade tensions and concerns over a potential U.S. economic slowdown, Goldman said.

“We believe the relative performance of Taiwan vs. Brazil is ‘undershooting’ the growth differential between the two EMs and see tactical upside in Taiwan over Brazil,” Goldman said.

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