Many pension funds and insurance companies as well as governments — such as those in Europe and Japan — have been focusing on long-maturity bonds.
As a result, prices of those bonds have spiked, far outpacing the price increases in equities. For example, the 15-year UK government bond has surged 30 percent in price so far this year, although it only offers one percent return.
This has led to some smart investors taking profits on the bonds and shifting funds to the equity market.
It’s a fairly sensible strategy, given the danger that bond prices could fall as quickly as they rose. If bond investors sit and do nothing and the prices crash, it could take several years to recoup the losses.
Currently, the US stock market is already at a record high, and therefore there is limited upside there.
Financial stocks might catch up if the Fed hikes interest rates and the US economic recovery remains on track. However, it’s doubtful if they will propel the market much higher in the short term.
Amid this situation, emerging markets have become attractive again as investment bets. Some funds have already pulled money out of developed markets and turned to the emerging ones.
The current valuation of emerging markets represents 20 percent discount to developed markets. That makes the former a good destination in the relay game.
The price-to-book ratio of emerging markets is around 1.4, below the 20-year average of 1.8. And the 12-month forward price-to-earning ratio of emerging markets is at 12.3, compared with 15.7 in developed markets.
Emerging markets stocks and bonds have followed a rebound in oil and commodity prices. The return on equity in emerging markets has started to pick up since April this year, and already exceeds slightly that in developed markets.
It’s widely expected that there will be only one rate hike from the Fed this year. Meanwhile, Europe, Japan and China are all expanding their monetary easing programs.
All this should benefit emerging market equities.
Adapted from an article that appeared in the Hong Kong Economic Journal on Sept. 1.
Translation by Julie Zhu
[Chinese version 中文版]
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