EMs will outperform US over seven years despite Trump fears, GMO

EMs on a 'whopping' 30% discount

Daniel Flynn
clock • 2 min read

Emerging market equities and bonds will outperform US assets over the next seven years, according to forecasts from GMO, which believes the current sell-off in developing country stocks on fears over the potential impact of Donald Trump's presidency are unjustified in the long term.

According to the investment firm's Seven-year asset class real return forecasts, emerging market stocks will generate an annual return over seven years of 4.4%, far outperforming a projected 3.1% annual loss across the same period for US large caps, and a 2.1% loss for US small caps.

Likewise, US high quality stocks are expected to generate a meagre annual return of 0.6%, while international large caps look set to generate just 0.1% per annum and international small caps are forecast to remain flat.

The poor expected returns across US stocks compare to a long-term historical US equity return of 6.5% per annum.

Emerging markets are also expected to outperform the US in GMO's fixed income forecasts, with emerging market debt set to generate an annual return of 1.5% over seven years, versus a loss of 0.6% for US bonds, a return of 0.1% for US inflation-linked bonds, and a flat performance for US cash.

Meanwhile, GMO expects hedged international bonds to fall 3% per annum over the next seven years.

Binu George, portfolio strategist for GMO's emerging markets equity team, said: "The rise of the middle class in emerging markets and its associated consumption wave will drive domestic demand in emerging markets.

"Investors have much to gain if they look through the noise of short-term volatility in emerging markets to focus on the secular forces behind domestic demand."

'A recipe for economic uncertainty': The market implications of a Trump presidency

Rick Friedman, a member of GMO's asset allocation team, said: "While falling relative return on equity may lead some investors to sell emerging market equities, we believe they should trade at a discount to their developed brethren because of their higher levels of fundamental risk. 

"Developed countries separate themselves from emerging countries based on the durability of their institutions. Strong, weak, dynamic, or dull leaders come and go, but the countries' key institutions live on. 

"Emerging countries do not offer such consistency and are prone to chaotic and highly dilutive events.  As such, a discount of about 10% seems appropriate to us, but today that discount has swelled to a whopping 30%.

"Recently, investors have rightly been concerned about a variety of issues in the emerging markets, most significantly the radiating effects from slower than expected growth in China;  the election of Donald Trump has further intensified these anxieties.

"Importantly, it is unlikely any one administration in the US can dramatically alter the long-term earnings power for emerging companies. Yes, the short-term earnings of some countries/companies may be impaired, but as equity owners our horizon extends out for decades, not the length of any single administration. 

"The question all investors should be asking is not, ‘Is it risky?' but rather, ‘How is that risk being priced?' While the absolute valuations of emerging equities are nothing to get too excited about, we believe the relative valuations are most definitely attractive."

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