Time to look at the emerging markets again?

Does the almost 60% underperformance of the MSCI emerging markets index against the MSCI world index since the end of 2010 create a contrarian investment opportunity?

The answer is broadly, no, according to J P Morgan Asset Management (JPMAM) in its latest Weekly Strategy Report (16 March).

JPMAM said the emerging markets (EM) asset class in general "will continue to struggle as EM growth rates decelerate further, as earnings are revised still lower and as valuations erode, given challenging growth and policy backdrops."

But there are variations across the emerging markets. For instance, "strong external positions are allowing policymakers in Asia to cut interest rates to support growth while their counterparts in Europe, the Middle East, Africa and Latin America have much reduced flexibility."

JPMAM noted that recent currency declines have largely corrected the overvaluations of many EM currencies, with the Brazilian real, the Mexican peso, the Russian rouble and the South African rand all showing up as cheap on a real effective exchange rate basis.

But "equity valuations do not yet tell a convincing contrarian story." Aggregate valuations are biased downwards by large constituent exposures (China, Korea, Russia and Brazil), which tend to be lowly rated for a reason (highly economically sensitive, poor corporate governance, etc). Valuations elsewhere (India, Mexico, South Africa) are at the upper end of their ranges, suggesting little further upside.

So, argued JPMAM, "it is difficult to justify a more positive stance on EM equities, in our view, without a stronger growth backdrop, better earnings outlook or cheaper valuation starting point."

Of the five BRICS (Brazil, Russia, India, China and South Africa) that account for 50% of the EM equity index, only India ranks well in the asset manager's assessment. "Given this index composition, it is difficult to see why the underperformance of emerging markets against developed market equities should suddenly reverse."

There may "idiosyncratic opportunities" at the individual stock and country level, but "we see better opportunities elsewhere," concluded JPMAM.

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