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Seize on volatility to buy into emerging markets

Ashmore Group's Jan Dehn says investors are typically rewarded for buying into emerging markets at times of stress.

Seize on volatility to buy into emerging markets

The return of volatility to stock markets caused by an ‘over-reaction’ to mis-priced US equities is an opportunity to buy into emerging markets, says Ashmore Group’s Jan Dehn.

The ‘fear gauge’ that is the S&P 500 VIX volatility index spike by more than 35 points last week from 13 to 50 as higher than expected wage inflation spooked the US stock market.

Dehn, head of research at the fund group, said the reaction to a ‘mere sniff’ of inflation means US and other developed market have not priced in the risks of higher inflation or monetary tightening but emerging market stocks were ‘not similarly mispriced’.

He said the subsequent sell off in emerging markets is ‘of the knee-jerk aversion variety’ and should be used as an opportunity to buy assets which have ‘better valuations’.

‘Since the duration of the sell-off cannot be exactly gauged, we believe that investors should scale the market in a phased manner, starting with a first bullet now,’ he said.

‘Investors should be ready to fire two more bullets if prices fall, say, 10% further.’

Dehn said the case for emerging markets assets wasn't just focused on their positives, but on the 'vulnerabilities in developed markets'.

'These vulnerabilities stem from the fact that valuations have been pushed to such elevated levels after years of quantitative easing (QE) that they now offer very little protection against even small negative surprises,' he said.

'By contrast, emerging markets was the only asset class to cheapen outright during the QE period, which is why emerging markets assets now offer realistic prospects for both capital gain and yield against the improving fundamental and strong technical backdrop.'

Dehn added that buying into emerging markets when volatility spikes had historically rewarded investors. 

'It exploits one of the most irrational investment practices, namely to knee-jerk sell everything in emerging markets in response to risk-off episodes, regardless of their nature or origin.'

Dean Newman, Invesco Perpetual head of emerging market equities, said while the sector may have ‘hit some turbulence’ it was still ‘building on last year’s healthy gains’.

He said optimism in emerging markets, and global markets generally, was being supported by an improving macroeconomic outlook and encouraging corporate earnings.

Newman does not believe a bubble is about to burst in emerging markets due to two reasons. Firstly, is the ‘broad-based acceleration in economic growth’ where inflation is under control and ‘local currencies are in demand versus the US dollar’.

Secondly, there has been a ‘significant improvement’ in corporate earnings following six years of disappointment.

Emerging markets is also an area where valuations have not got ahead of themselves, and are still below historic long-term averages, he argued, claiming there was ‘room to move higher’.

‘Given that developing countries are likely to drive global growth in 2018, we also see significant catch-up room relative to developed market equities,’ he said.

He said during periods of economic expansions ‘investors have shown a greater propensity to pay more for emerging market equities’ and a preference for cyclical stocks over defensives.

‘The cyclicals versus defensives premium has also increased,’ he said. ‘With a strong growth story and earnings outperformance, we expect this gap to narrow, leading to higher valuations in emerging markets. More a case of catch-up than "melt-up".’

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