Outperformance of EM equities set to continue

There was a mixed performance for EM equity markets on Monday, but the bigger picture is that the MSCI Emerging Markets Index has rallied 12% in dollar-terms since late August. As a result, EM stocks have outperformed the 7% increase in the MSCI World Index of developed market equities.

Looking ahead, more support for riskier assets appears to be on the way. For a start, it seems likely that Fed rate hikes will be pushed back into next year, while central banks of the euro-zone and Japan look set to announce more stimulus in the near future. Indeed, economists would not be surprised to see the Bank of Japan announce more QE as soon as Friday. All of this suggests that global monetary conditions will remain looser for longer.

"In addition, we expect better news from China. The authorities will discuss their Five Year Plan for the economy at this week's fifth plenum. Full details are unlikely to be revealed until March. But any snippets that reaffirm the government's commitment to structural reform and a rebalancing of the economy onto a more sustainable path are likely to be greeted positively by investors - not least because concerns about the outlook for China's economy were the trigger for the summer sell-off. More generally, while GDP growth is almost certainly weaker than the official data suggest, we expect a rebound next year", says Capital Economics in a research note.

Attractive valuations mean that EM stocks stand to benefit. Despite the recent strong showing of EM equities, the gap between the price/12month forward earnings ratios of emerging and developed market stocks is the widest it has been in recent memory. Moreover, the price/12month forward earnings ratios of most markets are now either in line with, or often below, their five-year averages.

"The upshot is that, while equities will remain vulnerable to periodic sell-offs, we forecast the MSCI Emerging Markets Index will rise by at least 15% in 2016-17. With stocks in the developed world set to only grind higher, our forecasts suggest that the recent outperformance of EM equities will continue", added Capital Economics.