Emerging Markets and Small Companies Stand Out

Roadmap Read time 3mins

09 Apr 2024

By Tim Rocks

Now Reading: Emerging Markets and Small Companies Stand Out

Equities have experienced remarkably strong returns since October 2023 when investors started to consider interest rate cuts by the US Federal Reserve.

Households have had excess savings since COVID and these are now being put to work more aggressively. Large US tech companies have been disproportionate winners. There have been some other areas of strength (Japan, India) and some laggards (emerging markets and smaller companies).

Rebalancing focus

Our strategy from here is to reduce weights to areas where gains have been strong and valuations are now stretched. There are a number of risks that could affect sentiment in the second half of the year. This includes some lingering inflation pressure, concerns about commercial property valuations and political uncertainty heading into the US presidential election. At the same time, there are some areas where valuations are not stretched and could benefit from ongoing high liquidity levels and resilience in the global economy.

Small caps less stretched

The US has the most stretched valuations and is now the most vulnerable to correction as interest rate concerns re-emerge. This is particularly the case for the big tech stocks that rode the AI wave to extreme valuations. Our preference is for smaller companies only. They have not seen the same valuation rerating as the mega-caps.

Emerging standout

Emerging markets are the standout global region for now. All eyes have been on China where the post-COVID recovery has disappointed. Consumer confidence is weak due to concerns over the property sector. However, a range of stimulus measures have been announced and these are starting to have an impact. Other emerging markets also have good prospects. Taiwan and Korea will be large winners from AI equipment while Mexico and south Asia are beneficiaries of manufacturing relocation.

A tale of two halves

Europe is facing more challenges. The industrial north is suffering from a manufacturing recession but this has been offset by the benefit of returning tourism to the southern nations. In the short term there are still risks from energy shortages and rising interest rates. We do not recommend increasing exposure to Europe at this time but we will be monitoring the situation as its equity markets are not expensive.

Currency concerns

Equity investors need to be more aware of the potential for currencies to drive relative performance going forward. It has been a remarkable run for the $US over the past decade driven by US corporate dominance and structural challenges in Europe. This has left the currency overextended and vulnerable to reversal over the next cycle.

US Valuations by Size

US and World ex US Valuations

Emerging Markets Price/Book

Tim Rocks

Chief Investment Officer

Important Disclosures

This document was prepared by Evans and Partners Pty Ltd (ABN 85 125 338 785, AFSL 318075) (“Evans and Partners”). Evans and Partners is a wholly owned subsidiary of E&P Financial Group Limited (ABN 54 609 913 457) (E&P Financial Group) and related bodies corporate.

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