Developed or Emerging Stocks—Who Will Win in 2013?
Developed and emerging market equities were locked in a tight race in 2012, both generating double-digit returns of up to 15 percent, however, this year asset managers expect a clear winner.
While U.S. and European stocks have taken the lead since the start of 2013, emerging market shares will likely outperform this year, according to strategists, citing better economic and earnings growth prospects in the latter.
Since the start of the year, the MSCI Emerging Markets Index has risen 1.4 percent, while the S&P 500 and FTSE EuroFirst Index 300 have gained 3.3 and 2.3 percent, respectively, driven by robust investment inflows.
In the first week of the year, global equity funds saw inflows of $22.2 billion – the highest since 2007 - with $7.4 billion going into emerging market equity funds and $14.8 billion entering developed market equity funds, according to EPFR.
Investor interest for European and U.S. equities picked up in the new year on easing concerns over the euro zone debt crisis and on relief over a last-minute deal to avert the "fiscal cliff" – a series of tax increases and spending cuts that were to kick off on January 1.
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But going forward analysts expect better news out of Asia and are betting on the region for another good year.
"We're positive towards emerging markets – they will be more volatile – but we expect they will do better than developed markets," Andrew Pease, investment strategist at Russell Investments told CNBC on Thursday.
"In emerging markets, there is potential for higher economic and earnings growth – also valuations continue to look attractive," he added. Emerging market economies are expected to grow 5.4 percent this year, compared with 1.7 percent in the United States and -0.2 percent in the euro zone, according to forecasts by HSBC.
While valuations in Asia climbed higher in 2012, they continue to look compelling from a global and historical perspective, analysts told CNBC.
Major emerging markets including China and South Korea are trading at a price-to-earnings ratio of 11, for example, compared with 15.5 for the S&P 500, which is close to pre-financial crisis levels of 16.5, according to Russell Investments.
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Pease, who sees upside of less than 2 percent for U.S. stocks this year said, "The U.S. market is fully valued. Profits as a share of GDP (gross domestic product) are at historically high levels. For bigger gains, the market needs to price a return to pre-crisis growth environment, and this is not likely to happen."
The Return of Risk-On
Geoff Lewis, global market strategist at J.P. Morgan Asset Management, said another factor that will boost emerging market stocks is an increase in risk appetite this year given fewer tail risks concerning the "fiscal cliff" and euro zone debt crisis.
In fact, a survey of fund managers published by Bank of America Merill Lynch this week showed that investor appetite for risk in their portfolios is now at its highest in nine years.
"There's a fair chance that if we get gradual improvement in global economy in 2013 and the euro zone crisis is contained, investors will be more comfortable putting money back into emerging markets. On that basis, they will outperform," he said.
Emerging markets will outpace the single-digit gains expected from global equities this year, said Lewis, adding that the bank has an overweight position on China, Hong Kong and Thailand for 2013.
Europe May Surprise
While Gary Evans, head of global equity strategy at HSBC, agrees emerging markets in Asia will perform well this year, as a result of their relatively attractive valuations, he isn't ruling out an equally solid run in European equities either.
"We're overweight in Asia – China and South Korea look very interesting. China has had a run-up but people haven't fully invested in the improving growth story. And then looking at which countries benefit most from China's growth – Korea stands out in Asia – it's a cheap market currently," he said.
HSBC forecasts global stocks, or the MSCI World Index, will rise 15 percent this year – powered by both Asian emerging markets as well as Europe. The bank, however, is underweight the United States.
"We are overweight Europe. We took the position last October, and it was very much a valuation call." Evans said. He is upbeat on Spain and Netherlands, whose benchmark stock indexes are trading at a price-to-earnings ratio of 10.5 and 14.5, respectively.
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"The last 5 years has been the worst performance for value (stocks) relative to growth (stocks) since the 1930s. Our call is that value will start to outperform, and it has done for the last quarter or so," he said.
Pease and Lewis, however, remain cautious on their outlook for European markets, highlighting that earnings remain a concern given the weak macroeconomic environment.
"The main issues in Europe are a lack of a catalyst to break out of the recessionary cycle. The macro doesn't look like it's conducive for driving corporate performance," Pease said, adding that the stronger euro is a worry for the region's exporters.
Lewis said that while there are some attractive stock picking opportunities in the euro zone markets, it is difficult to make a strong argument to be overweight the region.
"Investors are becoming complacent about the risks in Europe – everyone's assuming that the OMT (Outright Monetary Transactions) has done its job. I think there's quite a lot of optimism built into European scenario," Lewis said, referring to the European Central Bank's bond buying plan announced in September which is aimed at lowering borrowing costs for governments struggling with unsustainable debt levels.
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"The discount you get in Europe markets may be compensating you for the potential risks, so it doesn't make Europe look cheap," he added.