Emerging-market stocks are trading at the steepest discount to US equities since the Covid-19 panic in March 2020 as skittish investors look elsewhere for growth opportunities.
For each dollar of future profits, investors are now paying 45% less to own EM rather than US stocks. Before Covid, the stocks index hadn’t seen this wide a discount in records going back to 2006.
The broad gap today is due primarily to two things: analysts have raised the average earnings estimate for the MSCI Emerging Markets Index by 5.2% in the past two months, faster than a 1.9% increase for the S&P 500 Index; while at the same time, price performance for EM shares has trailed the US as investor sentiment remains cautious.
“The current low valuations of EM compared to the S&P 500, despite improving earnings estimates, reflect investor hesitance,” said Nenad Dinic, an equity strategist at Bank Julius Baer in Zurich. “This caution is linked to ongoing debates about US economic growth and the potential impact of a Republican victory in the upcoming elections, which could introduce strong tariffs and weigh heavily on EM sentiment.”
The EM stocks index trades at a price-to-earnings ratio of 11.9 times, based on 12-month blended estimates compiled by Bloomberg. In contrast, the S&P 500 trades at 21.5 times.
Just over three years ago, investors accepted only a 28% discount in the price-to-earnings ratio for EM stocks. That gap has widened to 45% as the impact of a stronger dollar, stubborn inflation and elevated interest rates takes a toll on emerging-market growth and corporate performance.
“Emerging markets are very cheap, underloved and underowned,” said Ygal Sebban, investment director at GAM UK Ltd. “The US takes it all still.”
The MSCI EM gauge is on track to underperform the US index for a seventh successive year — even though it has advanced almost 8% since Jan. 1 on a standalone basis.
Global growth will be key for emerging markets to start outperforming, Sebban said.
“We need a soft landing in the US enough to lead to the Fed cutting rates that will be helpful for EM rates and EMFX, some clarity about US tariff, no drama on the Chinese growth front,” he said.
Money managers also point to the need for a sustainably weaker dollar and more EM companies comparable to the US’s so-called Magnificent Seven that can excite investors.
“Longer term, the core problem of emerging markets is that they have very few innovative companies,” said Mark Matthews, head of Asia research at Bank Julius Baer in Singapore. “Since around 2010, investors have focused on innovation and so emerging markets in aggregate have been left behind.”
Analysts, for their part, are stepping up their forecasts for EM profits amid rising expectations for Federal Reserve easing that will support interest-rate cuts within developing nations. Technology companies are at the forefront of this increase, with the consensus profit estimate for the group nearing a record high.
Similar to the US, excitement over artificial intelligence has underpinned the EM stocks rally this year, but there are also concerns that the expected financial performance from the sector may not materialize quickly. Investors are waiting for results at the end of August from the most-watched AI stock, Nvidia Corp., to gauge whether the sector’s gains can be sustained.
Another portion of the increase in EM earnings estimates has been driven by a weakening greenback, which boosts local-currency estimates when converted into US dollars. The MSCI EM Currency Index is on track for a second month of gains after setting a record high on Tuesday.
“The recent improvements in EM earnings estimates can be attributed mainly to stronger EM currencies and a weaker US dollar amid expectations of gradual interest rate cuts by the Fed,” Dinic said.
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