EM equities to outperform global peers in the next decade: Morgan Stanley

Morgan Stanley expects emerging market (EM) equities to outperform their global peers in the next 10 years, with a return of 9.6 per cent per annum (20 basis points higher than their long-term average). 

By comparison, Morgan Stanley expects the S&P 500 to return 4.9 per cent per annum, MSCI Europe to see a 6.3 per cent nominal return per annum and Japanese equities' return at 6.1 per cent per annum during this period. 

That said, it expects annual return from a traditional fund in the US — split 60 per cent equities and 40 per cent fixed income — at 2.8 per cent per annum over that time, about half the average over the last two decades. The assumption is based on the S&P 500 Index returning 4.9 per cent per annum and 10-year Treasuries handing investors 2.1 per cent a year for a dollar-denominated investor.

Equity risk premium in the EMs, according to the global research and brokerage house, is pegged at 6.6 per cent and remains elevated compared to the historical average of 4.2 per cent. This level, it said, is close to the highs seen in the first quarter of 2016 (Q1-2016).

“Equity expected returns are still mostly below long-run averages except for EM and Japan. However, equity risk premiums don't look compressed, given yields still close to historical lows. The drivers of mediocre equity expected returns are mainly low inflation expectations and valuations, especially for the US,” wrote analysts at Morgan Stanley in a recent co-authored report, “What Will Markets Return? 2019 Edition”.

The report pegs the MSCI ACWI long-run expected return at 6.3 per cent per annum, just below the 20-year average of 7 per cent. However, equity risk premium remains elevated at 3.5 per cent, close to levels seen at the start of the year and early 2016. The MSCI ACWI is a market capitalisation weighted index comprises stocks from 23 developed countries and 24 emerging markets and is designed to provide a broad measure of equity-market performance throughout globally.

As regards debt, Morgan Stanley sees risk-free government bonds' expected returns at near record low, as yields have trended lower in the last 12 months. Given this backdrop, Morgan Stanley expects portfolio weight for government bonds to be lower than the allocation made over the last three decades.

“Our framework projects 10-year US Treasuries to return 2.8 per cent per annum over the next decade, and German Bunds 0.3 per cent per annum. The story is similar for 5-year US treasury, which is expected to see a return of 2.1 per cent per year,” the report says.

As regards equities, analysts at Jefferies, however, have a contrasting view and suggest EM debt to be a better bet than equities as things stand. 

“Most EMs have adhered to far more orthodox monetary and fiscal policies than their developed world counterparts in the past ten years. Given the pursuit of unconventional monetary policy in the G7 world in the past decade that reality is much less reflected in sovereign credit ratings. This is why there is a much better secular case to be overweight emerging market sovereign debt than there is to be overweight emerging market equities; most particularly given the negative bond yield phenomenon in the developed world,” Wood wrote in GREED & fear, his latest weekly note to investors.