Emerging markets look inexpensive next to the U.S. The MSCI EM index is priced at a bit below 9 times expected earnings over the coming year, while the S&P 500 sits near 19 times. That puts EM at a 53% markdown, the biggest on record since Bloomberg began tracking it in 2006.
Why so cheap? Earnings forecasts have been sprinting ahead of prices. Over the past 12 months, multiples slid even as the EM gauge gained about 15, because the earnings side of the ratio moved up faster.
More recently, with the rally losing steam, lower share prices have also helped push valuations down. Even with the latest dip, the EM gauge is up 15% for the year, a lead over the S&P 500 of roughly 3 percentage points.
The story under the hood is AI. While U.S. hyperscalers pour capital into artificial intelligence, many developing-nation tech firms sell the semiconductors, parts and hardware that buildout requires. That demand has analysts marking up EM tech earnings, even as worries about lofty AI valuations cool broader investor appetite for the sector.
In Singapore, Bank Julius Baer's head of Asia research, Mark Matthews, said, "There is no pullback in the prices of the things the Asian tech companies make, namely semiconductors and associated hardware." "US technology companies have generally been raising their earnings guidance to analysts. They are the biggest customers of the Asian semiconductor and associated hardware companies."
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Company-level profit outlooks are surging. The blended 12-month-forward estimate for average earnings across the MSCI EM universe has surged 70% this year, hitting new records. Asia is doing most of the heavy lifting with an 87% jump in EPS projections.
Latin America adds 28%. Emerging Europe, the Middle East and Africa - a region facing conflicts and debt distress - trails with 8.6% growth.
Tech stands out. The EM information technology subindex has climbed 63% this year versus a 23% gain for the S&P 500 Information Technology Index, and profit forecasts for the EM tech group are up 128%. Taiwan Semiconductor Manufacturing Co. offered an outlook that topped expectations, prompting further analyst upgrades, yet the stock has slipped since as investors exit an overcrowded AI trade.
According to Robert Naess of Nordea Investment Management, who serves as a portfolio manager, "There are clearly growing concerns about the sustainability of AI investments." "However, what I find particularly interesting is that earnings estimates remain extremely strong, while share prices have collapsed."
At Ninety One, emerging-markets equity portfolio manager Varun Laijawalla said, "The discount makes EM an attractive opportunity for long-term investors." "Historically, when the valuation gap between EM and developed markets has been this stretched, EM has gone on to outperform over the following five years."
The bottom line: EM is cheaper because expected profits have surged and, lately, some prices have softened. For a portfolio, that sets up a rare valuation gap driven by earnings momentum in AI's upstream suppliers - with managers noting how similar gaps have preceded multi-year EM outperformance.
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