It’s rare for emerging markets to be a haven during a global selloff, yet they’ve defied those expectations in the most recent rout.
While the S&P 500 Index has slid 15 percent over the past three months and is approaching bear market territory, MSCI’s gauge of developing-nation shares declined just 7.2 percent. Several factors have recently turned favorable for emerging markets, according to Jim Paulsen, chief investment strategist at Leuthold Weeden Capital Management LLC in Minneapolis.
For one, the fact that defensive stocks are leading S&P gains could signal a weaker U.S. growth outlook, while the outperformance of cyclical stocks in the developing world suggests improving economic momentum there, he said. Secondly, valuations 'strongly favor' emerging markets as do technicals: the majority of the asset class is under-owned. The prospect of a U.S.-China trade truce and a weaker dollar next year will also be supportive.
'Who knew that during a stock-market correction based on recession fears, it would be best to tilt economically-sensitive exposures toward EM?' Paulsen wrote in a note to clients on Thursday. 'EM stocks have shown they can play defense as well as offense.'
A scenario in which the world economy is headed for an imminent recession would surely be disastrous for emerging markets, yet it’s quite possible for the asset class to lead global gains in the event that the economic recovery hangs on for a few more years, according to Paulsen. He says cyclical shares are key. Since 1995, cyclical sectors have trailed defensive names in every major stretch of emerging-market underperformance, whereas cyclical-stock leadership has been the hallmark of each episode of outperformance.
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