Market Insider

Invest in emerging markets: Barclays

Nygren: Large opportunity in Europe
Nygren: Large opportunity in Europe

Foreign stocks should do better than U.S. equities in the second half, as emerging markets economies improve, according to Barclays.

"More competitive currencies, lower energy costs and aggressive monetary policy easing are combining to provide a solid underpinning for growth," Barclays said in its June 2015 outlook.

With that fundamental backdrop, the firm added emerging markets to its overweight holdings, while keeping Europe (ex-UK) and Japan on the list. The firm maintains a "neutral" stance on the United States with a target of 2,100 on the S&P 500.

"Emerging Market equities have underperformed global equities since 2010 and during the first half of 2015. Valuations are attractive relative to developed market equities, while acceleration in global economic growth should improve the outlook for their earnings. Sentiment is negative," the note said.

The iShares MSCI Emerging Markets ETF (EEM) is up 2.8 percent for the year, with three countries in correction territory: Brazil (which Barclays expects to bottom soon), Greece and Russia. On the other hand, the STOXX Europe 600 is up 15.7 percent and the Nikkei is up 19 percent. The S&P 500 is up about 2.6 percent year-to-date.

To be sure, not all emerging market countries should be treated equally, as growth prospects vary, the report noted. For example, Barclays forecasts a deeper recession in Russia in 2016 while India and Indonesia should see "robust growth."

Overall, the developing China story should support the case for emerging markets. As the second-largest economy in the world, China "has greater potential for significant and sustained effects on global markets," both positive and negative, the report said.

While exponential gains in mainland Chinese stocks is "worrying us," Barclays Head of Research Larry Kantor said in a panel presentation Thursday, "We don't think it's something that will topple global equities and markets in the next six months or so."

Key for investors focused on the upcoming earnings season, the firm expects earnings growth of 12 percent or more in Europe, Japan and Emerging Markets, while the forecast for the United States is 7 percent.

The benefits from earnings growth are most pronounced in the underperforming emerging market stocks or the German DAX, which was in correction territory last week and remains more than 7 percent off its recent intraday high.

More opportunities to buy European stocks could come soon with short-term fallout over a Greece default or exit from the euro zone, Kantor said.

"We think there will be enough to keep this contained," he said, citing the ability of the European Central Bank to maintain control.

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Easy monetary policies by the ECB and Bank of Japan, the weaker euro and yen, and signs of economic improvement in both regions supports the local markets, Barclays analysts said.

An added bonus for Japanese stocks is the imminent approval of the Trans-Pacific Partnership (TPP), which Charles Schwab's Jeffrey Kleintop says will benefit Japan the most as the elimination of tariffs could increase exports.

The free trade proposal among major Asia-Pacific nations and the United States (but not China) came one step closer to reality on Wednesday when the U.S. Senate passed a "fast-track" bill that gave President Barack Obama more authority in negotiating the deal.

"I think the TPP is an underappreciated positive for Japan and the one clear "trade" on the trade deal getting done, which we think is likely," Kleintop said in an email. "The decline in the yen combined with the TPP should offer an economic boost."

In its mid-year outlook, Charles Schwab also favored Japan.

Barclays is bullish on the country for recent structural changes in local corporations that increases share buybacks. Those benefits to shareholders are "not fully realized," Kantor said.

Within those markets, the analysts recommend cyclical assets such as financials versus defensive sectors such as consumer staples.

While those sectors may still perform well in the United States, overall domestic "growth is simply too slow to justify higher returns," said Barclays Head of U.S. Equity Strategy Research Jonathan Glionna.

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Still, looking at domestic sector allocations he likes financials for their yield of 2 percent and, more importantly, dividend growth of 10 percent.

"The place to get that profile is in the financials sector," Glionna said.