Most emerging markets (EM) have outperformed global equities this year so far. In dollar terms, while MSCI EM is down 4.7%, MSCI Europe is down more than 13% and MSCI USA is down 4%. But interestingly, there are a lot of brokerages betting on the developed markets to outperform the emerging markets and are advising their clients to have exposures to equities in Europe and the US.
The prime reason analysts are favouring the developed markets in Europe, despite their worsening fiscal situation and poor economic growth, is their compelling valuations. Long-term dividend yields and price-to-earning ratios are at multi-decade lows.
European market valuation in terms of price-to-earnings ratio is 40% below its long-term average, mentions a Barclays report. Today, the premium on UK dividend yield over that of its gilt is at a 50-year high. The US?s S&P 500 index is currently trading at about 12.5 times its estimated 2010 earnings, far lesser than the PE multiples across the globe. If it is not cheap, it isn?t costly either.
Another factor in favour of the developed world is a relatively favourable policy environment. Analysts expect a relatively favourable policy environment throughout 2011 for the developed economies, which is likely to result in strong equity performance. In contrast, most Asian economies?saddled with inflation and worries of overheating?are looking at hiking interest rates and following other monetary tightening policies. The possibility of a double-dip, while a worry, is only expected under extreme circumstances. According to Barclays, the developed economies are in the early stage of their expansion cycle, giving plenty of scope for sustained above-trend growth. It is overweighting US and European equities, more the latter.
Barclays has a year-end target of 3,100 for EuroSTOXX 50 index?a 17% upside from current levels. The target is based on modest rerating combined with high single-digit 2011 EPS growth. Brokerages are favouring US equities despite a slow-paced economic recovery and challenges of European fiscal tightening slowing down the world economy.
While most investors are hoping that if Europe comes out of recession, risk appetite will increase, which will result in more money coming into emerging markets, the flip side will be that lower valuations there could also spur a shift of money back into some European markets where the risk-reward ratio looks favourable.