Earnings growth in the emerging markets is currently being revised down for many countries, as analysts absorb the currency falls and effects of tapering QE that have dominated the last year.Newman says that there could still be some pain to come for investors in the sector in the short-term, but once earnings are revised upward it will be a strong buy signal.
“Market forecasts are for double-digit earnings growth this year. This may be, but earnings revisions are still negative. Perhaps not as negative as they have been,” he said.
“When earnings revisions get into positive territory, at that point global investors will be willing to believe the cheap valuations.”
“There are some signs that earnings revisions have stabilised, but I think there’s a chance the change will take place this year,” he added.
Newman, head of emerging market equities at Invesco Perpetual, has steered the £128m Invesco Emerging Countries fund to positive returns over the last three years, which is a rare achievement in the battered sector.
The fund has made 1.13 per cent over this time while the sector has lost 8.64 per cent.
Performance of fund vs sector over 3yrs
Source: FE Analytics
Emerging markets stocks have struggled for a number of years, but it was last year’s sell-off after the US authorities decided to taper bond-buying that saw a dramatic fall in the market.
Performance of indices over 3yrs
Source: FE Analytics
Newman reaffirms the message being trumpeted by many analysts that valuations on emerging markets are now very attractive.
The P/E [price/earnings] ratio on emerging markets is just 10.2 times for 2014, he says, compared with 13.6 times for the global market.
However the return on equity on the markets is the same, at 13.3 per cent.
Return on equity represents the profits made as a proportion of market cap and is a basic measure of profitability.
Earnings growth forecasts for this year are also similar, he says, even if they are being revised downwards.
Analysts often say that earnings forecasts at the start of the year tend to be on the optimistic side and are then revised down.
More interesting is the trailing price/book measure, which relates the share price to the assets on the balance sheet rather than to earnings.
“This is an interesting long-term tool for looking at valuation, a more fundamental way of looking at inherent value,” Newman continued.
“Emerging markets are very much at the bottom end of their 10-year range. They are not at their very lowest as they were in 2003 or in 2008, but I would say that compared with 2003, profitability has improved significantly over the period, so a higher price/book is probably warranted.”
Taking a shorter term view, Newman says that the relative strength index, a momentum-based technical measure that tracks the speed and change of price movements on the index, suggests that the sector is oversold.
However, he says that the key to timing an entry point is to look at earnings revisions.
When these start to turn positive, investors are likely to pile back in and share prices should rebound.
Newman has run the Invesco Perpetual Emerging Countries fund since April 2007.
Data from FE Analytics shows it has produced better-than-average returns over that time of 42.58 per cent. The average global emerging markets fund has made 33.4 per cent.
Performance of fund vs sector since Apr 2007
Source: FE Analytics
Newman explains that he has been reducing his weighting to Latin America in recent months, in particular to Mexico where he believes prices are too high.
In this he is following the same course as Will Landers, manager of the BlackRock Latin American trust, who has also been reducing his weighting to that country.
On the other hand, Newman is overweight eastern Europe, including Poland, Turkey and Russia.
In the latter country he admits investors have to be brave, but says there are good stocks available on cheap valuations.
“In eastern Europe most countries are still showing reasonable economic growth,” he said.
The manager says that investors shouldn’t view tapering as an ongoing negative influence this year.
“Tapering policy is more or less discounted into equity market valuations,” he said.
“However, this doesn’t mean we won’t have wobbles through this year as tapering progresses.”
“If tapering is happening that’s because growth is returning in the US and the developed world, which is good for emerging markets because they ultimately need growth.”
Newman says he feels no need to change course in the current environment and is selectively adding to his stocks on weakness. The fund has ongoing charges of 1.76 per cent and requires a minimum initial investment of £500.
