July 2017
IV. Opportunities in Emerging Market Equities
Emerging market currencies have re-priced and no longer appear vulnerable to Fed hikes currently. Global reflation, improvement in trade and the potential for EM
yields to decline from here should set up a sustainable bull market.
• Since 2010, emerging market equities have underperformed the broader
market with annualized returns close to 1% vs the MSCI ACWI at ~8.3%.
• A stronger dollar has been a headwind for emerging markets as much of
their companies’ financing costs are tied to the currency.
• Declining commodity prices over the last five years have negatively
impacted emerging markets’ economic growth.
• History shows that regional leadership tends to rotate over multi-year
periods. The rotation to EM might have started in the middle of 2016.
Investment Thesis
• Emerging markets have underperformed for the last 5 years, but could
now enter a new era of outperformance. The reason: Global growth is
improving, commodity prices are stabilizing, and the dollar is behaving.
We are already seeing signals of this shift as EM has outperformed the
S&P 500 by ~9% this year.
• Despite recent outperformance, valuations remain attractive. The MSCI
Emerging Markets Index is priced at a 26% discount to the MSCI World
Index (developed markets) based on next 12 months’ earnings.
• Real yields are at multi-year highs for emerging markets. We believe EM
has the potential to outperform as real yield differentials will tend to
converge closer to zero.
• The EM Purchasing Managers’ Index, which measures the health of the
manufacturing sector, is now above 50 for the 11th month in a row,
signifying a sustained improvement in EM growth.
• Earnings troughed in February 2016 along with oil prices and are now
increasing from their lows.
Emerging Markets Trading at a 26% Discount to Developed Markets
As of June 30, 2017
21
Forward P/E Ratio
Context
17.3
16
12.8
11
6
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
MSCI Emerging Markets Index
MSCI World Index
Real Rate Differentials in Emerging Markets Remain Attractive
As of May 31, 2017
5.0%
EM10 ex-China Real Rate Differential
4.0%
3.5%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
2003
2005
2007
2009
2011
2013
2015
2017
Source: Bloomberg, FactSet, Morgan Stanley Wealth Management GIC
Past performance is no guarantee of future results. Estimates of future performance are based on assumptions that may not be realized. This material is not a solicitation of any offer to buy or sell any security or other financial
instrument or to participate in any trading strategy. Please refer to important information, disclosures and qualifications at the end of this material.
GLOBAL INVESTMENT COMMITTEE
Page 1
July 2017
IV. Opportunities in Emerging Market Equities
Investment Ideas
• Due to the uncertainty around trade policy, we prefer an active vs
passive approach to EM equities.
• We see opportunities for active management focused on
domestically oriented companies in Indonesia, India, Taiwan,
Korea and China (through H-shares).
Earnings Growth Has Inflected Upward
As of June 30, 2017
1400
110
100
1200
90
1000
80
800
600
2010
Key Risks
• China's successful soft landing becomes uncontrollable,
deflationary risks increase, and the currency depreciates sharply
• Financial conditions tighten considerably
• Trump’s protectionist policies impact global trade with EM
economies
• The dollar appreciates significantly to levels that stress EM
financing costs
• A growth scare turns into a recession and macro data collapses
70
60
2011
2012
2013
2014
2015
2016
MSCI EM Index Price (Left Axis)
Forward Earnings Estimates (Right Axis)
2017
Morgan Stanley Global Trade Leading Indicator Making New Highs
As of May 31, 2017
1
0.5
0
-0.5
-1
2010
2011
2012
2013
2014
2015
2016
2017
Source: Bloomberg, FactSet, Morgan Stanley Wealth Management GIC
Past performance is no guarantee of future results. Estimates of future performance are based on assumptions that may not be realized. This material is not a solicitation of any offer to buy or sell any security or other financial
instrument or to participate in any trading strategy. Please refer to important information, disclosures and qualifications at the end of this material.
GLOBAL INVESTMENT COMMITTEE
Page 2
July 2017
For index, indicator and survey definitions referenced in this report please visit the following: http://www.morganstanleyfa.com/public/projectfiles/id.pdf
Risk Considerations
International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk
of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.
Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
Investing in currency involves additional special risks such as credit, interest rate fluctuations, derivative investment risk, and domestic and foreign inflation rates, which can be volatile and may be less
liquid than other securities and more sensitive to the effect of varied economic conditions. In addition, international investing entails greater risk, as well as greater potential rewards compared to U.S.
investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these
countries may have relatively unstable governments and less established markets and economies.
Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.
The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment.
The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes. Morgan Stanley Smith Barney LLC retains the right to change
representative indices at any time.
Disclosures
Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes
only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. Past performance is not necessarily a guide
to future performance.
The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances
and objectives. Morgan Stanley Wealth Management recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial
advisor.
This material is based on public information as of the specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We and our third-party data
providers make no representation or warranty with respect to the accuracy or completeness of this material. Past performance is no guarantee of future results.
This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for
any investment decisions that you may make. Morgan Stanley Wealth Management is not acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under
section 4975 of the Internal Revenue Code of 1986 as amended in providing this material.
Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice. Each client should always consult his/her personal tax and/or legal
advisor for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation.
This material is disseminated in the United States of America by Morgan Stanley Smith Barney LLC.
Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of
any kind relating to such data.
This material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney LLC.
© 2017 Morgan Stanley Smith Barney LLC. Member SIPC.
Past performance is no guarantee of future results. Estimates of future performance are based on assumptions that may not be realized. This material is not a solicitation of any offer to buy or sell any security or other financial
instrument or to participate in any trading strategy. Please refer to important information, disclosures and qualifications at the end of this material.
GLOBAL INVESTMENT COMMITTEE
Page 3