Emerging markets have been on an incredible performance run in 2017. Can the drivers of these results continue for another year? That’s the question we hear many people asking.
Understanding the Shifting Valuation Landscape
With strong gains, it becomes important to look at the underlying drivers and any changes in valuation that might impact these drivers in the future. While valuation alone may not be the best predictor of an upcoming correction, we’ve found that the more extended the valuations become, the tougher it becomes to generate similarly high future returns.1
Information Technology—particularly a handful of Chinese Information Technology firms—has gotten a lot of attention in 2017 and has performed strongly. The sector is up 66.3%. In the sector, the Internet and software industry is up 82.9% (this is the industry to which firms such as Tencent, Alibaba and Baidu—up 116.02%, 114.13% and 50.25%, respectively—belong).2
Energy, on the other hand, has been a rougher experience: It is the third worst performing sector in 2017, returning 18.78%. If people are trying to find single-digit P/E ratios in emerging markets, this sector is not a bad place to look, with more than one-third of the weight of the Energy exposure in the MSCI Emerging Markets Index benchmark having a trailing P/E ratio below 10x.3
The divergence in performance and valuation between the Information Technology sector and the Energy sector in emerging markets gives us a great deal of market context—for one thing, it gives us a starting point to understand why growth-oriented strategies have done so much better than value-oriented strategies in 2017.
Massive Performance Divergence Has Led to Massive Valuation Divergence
Energy: The price-to-book value ratio of the MSCI Emerging Markets Energy Sector has reached a level that is equal to approximately half that of the broad Index, trending toward the lowest relative level seen over more than 20 years. We can all step back knowing two things: 1) Yes, the price of a barrel of oil is at a much lower level than what we saw only a few years ago, and 2) there remains a very large demand for petroleum and petroleum-related products. If people are seeking an area of emerging market equities where prices might be too low compared to fundamentals, Energy may not be a bad place to look.
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