“We think the commodity rally may be a little more solid fundamentally than the equity one and have broadened our [overweight] in commodities to all sectors," the firm wrote in a recent research note to clients.
"This also makes us more bullish on bombed out [emerging market] asset classes like equities, where the same EPS growth expectations as in [developed] markets trade for a 27% price-to-earnings discount.”
The firm believes that a reflation wave following the Chinese easing, a dovish Fed stance, a soft dollar and commodity supply restraint have provided support to risk appetite and pushed stocks of emerging markets back to the top ranges, but their valuations remain cheap.
“We think these developments warrant a more constructive stance on EM assets after so many years of underperformance and very poor sentiment on the asset class. For example, recent economic momentum and surprises have been to the upside in [emerging markets] relative to [developed market] economies, yet relative equity market performance languishes close to a six- year low.”
The firm said it expects local EM currency moves to remain fairly stable into mid-2017, which should also benefit their equity markets.
“We factor in that by June 2017, US Treasury rates are going to be slightly higher and US Federal Reserve funds at 1.0%. While the EM adjustment is, probably, somewhat incomplete, we do not anticipate a meaningful move in EMFX. Rather, we expect a gradual depreciation in [the Chinese yuan] and, with it, a moderate depreciation in most EMFX.”
The firm has concerns about the developed markets, such as Europe and the US.
“Fading quantitative easing euphoria in Europe, rich valuations in Europe and the US, and margin pressures make us more cautious [on] these markets.”
The recent rally in developed market equities can persist for a while, the firm said. But caution remains given fundamental concerns about global growth and the lack of inflation.
Citi's positive stance on emerging markets follows other analysts. Falcon Private Bank believes that sentiment has turned in favour of emerging markets. Old Mutual Global Investors said it was overweight in selective emerging market local currency bonds after a strong Q1 perrformance.
Over the last twelve months, the EM equity index has been trading in similar pattern to the developed market index. But the chart suggests EM equities are undervalued.
Source: FE Analytics