Time to view emerging markets as a contrarian trade?

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As sentiment continues to weaken towards emerging markets, the investment case for them could be stronger on a contrarian view, according to Bank of America Merrill Lynch.

According to BofA ML’s August Global Fund Manager Survey, asset allocators continue to have a bear view of emerging markets with a net 19 per cent of global investors now underweight towards them.

This marks the lowest exposure in 12 years as investors continue to prefer developed markets which are showing more positive data.

The significant pullback from emerging markets have prompted BofA ML to highlight them as a potentially attractive contrarian trade, alongisde gold and shorting the US.

With net exposure dropping, the survey recognises emerging market assets as appearing “inexpensive”. Three-quarters of  emerging market fund managers now see the asset class as undervalued.

BofA ML says: “We believe the secular bull case for EM now rests on the ability of interest rates to continue their decline of the past 15 years from high double digits to single digits.

”If economic weakness can force politicians in emerging markets to return to policies of disinflation, fiscal discipline and central bank independence, then the longer-term case for emerging markets improves.

“After all, emerging markets continues to have a substantial yield advantage relative to developed markets, and ageing populations in the west will keep the need for income high.”

Additionally, emerging markets have shown signs of recent improvement with Chinese data strengthening in July. For instance, export and import grew to 5.1 per cent and 10.9 per cent for the month. The export and import numbers beat market expectations by 2 and 1 per cent respectively, while industrial output rose 9.7 per cent year on year.

Emerging markets may benefit as investors may be impacted from upcoming difficulties facing developed markets – with BlackRock chief investment strategist Russ Koesterich recently saying investors should prepare for a “September swoon” in the UK, the US, Germany and Japan.

Koesterich points to the Federal Reserve’s upcoming September committee meeting, Germany’s federal elections and the ongoing US budget debates in Congress as sources of volatility for investors to consider.