Equity Outlook  |  Q2 2020

A bullish case for emerging markets

Brian S. Freiwald, CFA, Portfolio Manager, Putnam Emerging Markets Equity Fund

A bullish case for emerging markets

In an environment where bullish forecasts are relatively rare, I am optimistic about the prospects for emerging-market equities. Much is still unknown about the economic impact of COVID-19 across global economies, and there is a wide range of potential outcomes. However, in terms of equities, we believe the negative effects of the global pandemic will be less intense for emerging markets, particularly relative to U.S. and European stocks. In our view, emerging-market equities in most regions offer an attractive absolute and relative risk/reward profile. Lower global interest rates could also provide a tailwind for emerging-market equities.

Attractive valuation opportunities

As of mid-April, the price/earnings multiple for the MSCI Emerging Markets Index had de-rated to just 11 times forward earnings, and it offered a dividend yield of 3.5% — a 10-year high. The index is trading at its lowest price-to-book ratio in 10 years as well as its lowest cyclically adjusted p/e multiple.

Outlook brightens for China

In China, Korea, and Taiwan, we believe the worst of the COVID-19 crisis has passed and the virus is largely contained. Together, these three markets account for approximately 60% of the MSCI Emerging Markets Index. As of mid-March, most production plants in China were back to nearly 100% utilization, and restaurants and malls had reopened across the nation. Specific examples of rebounds include Louis Vuitton, which reported a double-digit acceleration in sales growth in China during the first two weeks of April. Also, Yum China Holdings and Nike reported significant increases in consumption trends. For our portfolio, within China, we are focused on the e-commerce and internet industries. We are maintaining overweight positions in both, based on our belief that they will be longterm beneficiaries of the current disruption.

Buying opportunities beyond China

Outside of China, we are seeing opportunities in more fragile economies such as Brazil, where the benchmark Bovespa Index was the world's worst-performing major equity market in the first quarter. We are using the decline to add to our favorite positions in the health-care and technology sectors, which have net cash positions and will emerge from the crisis even stronger, in our view.

"In our view, emerging-market equities in most regions offer an attractive absolute and relative risk/reward profile."

Within our portfolio, our focus on strong balance sheets has been beneficial, as we had limited exposure to financially levered companies. By sector, we are maintaining underweight exposure to the financial and commodity sectors, which we believe will be most negatively affected by the economic impact of COVID-19. We continue to seek companies that we believe can compound their earnings regardless of the macroeconomic backdrop.

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