Risk assets such as emerging market equities have been thrown under the bus in the recent months on concerns about the Federal Reserve scaling back its monetary stimulus, but with investors coming to terms with tapering, are the worst days over for the battered asset class?
The MSCI emerging markets index has plunged 8.2 percent over the past three months, a stark contrast to the S&P 500 and FTSEurofirst 300 gains of 7.9 and 1.6 percent, respectively, over the same period. This is among the worst-ever periods of performance for emerging market equities relative to their developed market counterparts, according to Morgan Stanley.
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But the storm has likely passed, says research firm Capital Economics, which argues that impact of tapering and worries over a growth slowdown in the developing economies, have now been factored into equity prices.
"A tapering of the Fed's asset purchases is surely now discounted. The central bank should continue to tread extremely carefully, with rates probably remaining near-zero until early 2015," Capital Economics, wrote in a new report.
"Second, although the prospects for growth in emerging economies may have diminished we do not think this will have much additional negative impact on the prices of emerging market equities," the firm said, adding that some countries, such as Mexico, should actually benefit from a revival in the U.S. economy.
In addition, valuations do not appear to be stretched anymore, the firm said, noting that the price to earnings ratio of the MSCI Emerging Markets Index at around 12 remains comfortably below its ten-year average of 15.
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Given the decline in valuations, the firm expects emerging Europe and parts of Southeast Asia to attract investor interest. It forecasts the MSCI Emerging Markets index, which currently stands at 956 to end the year at 940, before climbing to 975 in 2014, and to 1,025 in 2015.
"Another reason why we are relatively sanguine about the outlook for emerging market equities is that persistent underperformance vis-à-vis developed market equities has typically only occurred when there has been a major global economic or financial crisis. We do not assume there will be another such crisis in the next few years," it added.
While Capital Economics believes the medium to longer-term outlook may be more encouraging for the asset class, Morgan Stanley is not as convinced. The bank, which rates emerging market equities as the "least preferred" within its global equities coverage, said a host of factors need to be watched to determine the outcome for the asset class.
(Read more: Citi sees big turnaround for emerging market stocks)
Some of these include the funding environment for emerging markets as U.S. monetary policy tightens, the impact of Japan's resurgence on other export-driven economies, and China's slowdown. The dependence of emerging markets on China, particularly those in Asia, has increased sharply in the recent years as the country has emerged as a key source of end demand for exports.
—By CNBC's Ansuya Harjani; Follow her on Twitter: