Emerging markets are now by the far the most popular area with investors having been the least favoured at the start of the year, according to the latest FE Trustnet poll, which shows many investors have all but given up on Europe after previously voting it as their favourite region in January. 
Our latest poll, in which more than 2,000 of you voted, shows that 30 per cent of readers believe emerging markets – which have rallied substantially of late due to various factors – offer the best investment opportunities for the remainder of 2016.
However, in a similar poll conducted in January when some 2,500 of you voted – a time when the developing world was seemingly plagued with headwinds – just 9 per cent thought emerging markets would be the best performing market area of the year.
Source: FE Trustnet
In an another significant change in trend, just 7 per cent of readers now believe European equities to be the best hunting ground for 2016 (putting it bottom of the list) while in January 29 per cent thought it was the most attractive region out there.
When analysing the performance of those major equity market regions, though, the picture becomes a little clearer.
Indeed, due to headwinds such as China’s growth slowdown (as well as its stock market crash and currency devaluation), falling commodity prices and uncertainty over US interest rates, the MSCI Emerging Market index lost 9.99 per cent during 2015.
However, while the index certainly had a turbulent first few weeks of 2016 – with the Chinese stock market closure and another drop in the oil price – it is up a hefty 25.17 per cent in sterling terms due to signs of stabilisation in China, more dovish tones from the US Federal Reserve and Brexit-induced pound weakness.
Though Europe wasn’t a stellar performer last year, the consensual view this time eight or so months ago was that 2016 would be a good one for continental equities.
Certainly, there was the belief that Europe was cheap and – unlike in the US – the central bank was going to stand by with a massive quantitative easing programme. However, the potential impact of Brexit, numerous terror attacks and political uncertainty (as well as the fact it has been the worst performing region so far this year) has seemingly weighed on investor sentiment.
Performance of indices in 2015 and 2016
Source: FE Analytics
This trend can also been seen in the other major developed markets.
FE Trustnet readers are, for example, now more bullish on US equities now than at the start of the year despite the upcoming presidential election. The S&P 500 made 6.58 per cent last year, but is up 20.28 per cent in 2016 so far (in sterling terms).
On the other hand, Japanese equities have returned less this year so far than in 2015 – and investors have since cooled on the prospects for Japan; though it must be noted monetary policy from the Bank of Japan has become far more extreme over recent months.
Probably the biggest surprise, however, is that investors are now more positive on the domestic market even though the UK voted to leave the EU last month. Again, though, the FTSE All Share has rallied significantly since the Leave camp’s victory and is now up 8.14 per cent year-to-date – compared to its meagre 0.98 per cent gain last year.
Ben Conway, fund manager at Hawksmoor, says the results of the poll (and the fact may investors have completely changed their tune in the space of six months) show the inherent fickleness within the investment community.
“It is absolutely a trait of human behaviour when it comes to investment that they prefer funds that have recently done well. It’s also completely nonsensical. You should like a region more if it falls price (all other things being equal) because it has got cheaper,” Conway said.
His views are supported by Rob Morgan, pensions and investment analyst at Charles Stanley Direct.
In relation to the poll, he said: “That is quite a swing, and yes it certainly seems to show investors have largely missed the success story of the year so far.”
That being said, Conway agrees that European equities look a poor choice in the current environment.
“Sentiment towards Europe has cratered this year. There is good reason for this,” Conway said.
“The construct of the European Union has come under huge pressure following our referendum and the flaws of the eurozone area, which everyone has always known was not an ‘Optimal Currency Area’, are more apparent than ever. Without fiscal transfers from countries doing well (Germany) to those in dire need (Italy and their banks), growth in the region will be seriously constrained and regional inequality will only grow.”
“This is a good reason to be circumspect on the region. We have certainly cooled our interest in European equities. The margin catch up story with the US is just not materialising and valuations are just not cheap enough given the lack of earnings growth.”
Ben Willis, head of research at Whitechurch, is one expert is another who has turned against Europe since the EU referendum.
Performance of indices since Brexit vote
Source: FE Analytics
“Our overweight to the region has been markedly cut back since the result as the outlook for Europe now remains unclear and uncertain,” Willis said.
However, Conway isn’t positive on emerging markets either. While emerging market equities have rallied back strongly in 2016, the index is still 70 percentage points behind the developed world index over five years.
Performance of indices over 5yrs
Source: FE Analytics
Conway says there are good reasons for this and drivers that suggest a massive reversal in the developing world’s fortunes isn’t around the corner. While he likes emerging market debt, he says developing world equity returns will now be far harder to come by following the recent rally.
“We are not so keen on emerging market equities, which are simply too expensive – the headline P/E ratio doesn’t tell you anything since the sector mix in emerging markets is totally different to developed world indices.”
Morgan says that though the longer term outlook for emerging markets is positive, he warns that those buying in now could well be in for a rough short-term ride.
“I think much of the good performance we have seen has been predicated on the weakening of the US dollar and a stabilisation in commodity prices. It is possible these supportive trends could reverse,” Morgan said.
“With very few US interest rate rises now priced in, even a slightly more hawkish tone from the Fed would likely weigh on the sector, particularly as there is relatively little to cheer in terms of economic growth or structural reform. However, overall valuations across emerging markets look fairly attractive, especially in Asia, so although there could be volatility I agree with your readers that the long term prospects are decent.”
Simon Evan-Cook, senior investment manager at Premier, says long-term investors really should be allocating to emerging markets now, though.
He has been upping his exposure to the developing world for much of the past 12 months and says a short-term rally doesn’t jeopardise future returns.
“We were buying emerging market and Asia funds at the start of the year which was a contrarian call. We still like emerging markets but, clearly, it is no longer that contrarian,” Evan-Cook said.
His preferred emerging markets are in Latin America, an index which is dominated by Brazil. The country has been plagued by political headwinds as well as weakening iron ore price, but with those trends starting to reverse (and because it is deemed cheap), he thinks the future is bright for Latin American equities.
