Emerging market equities have seen their earnings expectations continue to surge, pushing their valuations relative to US peers to historic lows and potentially offering long-term investors a buying opportunity.
The MSCI Emerging Markets Index currently trades at a forward price-to-earnings ratio of just under 9 times, based on expected earnings over the next 12 months, while the corresponding valuation for S&P 500 constituents stands at approximately 19 times. The valuation discount of emerging market stocks relative to US equities has reached 53%, the widest level since Bloomberg began compiling this data in 2006. So far this year, the emerging markets index has still gained 15%, outperforming the S&P 500 by about 3 percentage points. Earnings forecasts have been revised upward at a much faster pace than share price gains during the year, thereby compressing valuation levels.
Artificial intelligence companies have contributed the bulk of emerging market earnings upgrades. While US hyperscale cloud providers are investing heavily in AI development, technology companies in developing economies are largely the recipients of this spending, supplying chips, components, and hardware for AI infrastructure.
Emerging market stocks becoming increasingly cheap has prompted analysts to raise earnings expectations for emerging market technology shares, even as concerns over AI valuations more broadly drive investors away from the sector. Mark Matthews, head of Asia research at Bank Julius Baer in Singapore, said: "The prices of the products that Asian tech companies make, namely semiconductors and related hardware, have not come down." "US tech companies have generally been raising their earnings guidance to analysts. They are the largest customers of Asian semiconductor and related hardware companies."
Profit outlook remains bright
The composite forward 12-month earnings estimate for companies in the MSCI Emerging Markets Index has surged 70% this year alone, repeatedly hitting new highs. Asia leads with an 87% upgrade in earnings per share expectations, Latin America contributes 28%, while emerging Europe, the Middle East, and Africa, a region at the center of multiple conflicts and debt troubles, lags behind with an 8.6% increase.
Asian markets lead the way, with the emerging markets information technology sub-index having risen 63% this year, compared to a 23% gain for the S&P 500 information technology index. The profit expectations for this emerging markets index have also been revised up by 128%. Despite capital flows and market dominance shifting away from AI stocks, technology companies continue to demonstrate strong earnings momentum. Taiwan Semiconductor Manufacturing Co Ltd (TSM.US) delivered a better-than-expected earnings outlook, encouraging analysts to further raise their forecasts. But since the update, the stock price has fallen as investors flee the overcrowded AI sector. Robert Naess, a portfolio manager at Nordea Investment Management, said: "Clearly, concerns about the sustainability of AI investment are growing." "However, what particularly interests me is that earnings expectations remain extremely strong while share prices have collapsed."
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