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A correction in emerging market equities is increasingly likely, according to Jonathan Garner, global emerging markets strategist at Morgan Stanley.
“Contagion from the deteriorating environment in subprime and leveraged loans is one possible trigger [for a correction], via the impact of rising credit spreads,” said Mr Garner.
“Profit-taking after such strong gains is another.”
The MSCI emerging markets index has risen by 36 per cent since its trough on March 5.
“Valuations are another concern,” says Mr Garner, who points out that emerging markets are trading at a premium to the MSCI World index for only the third time in history using a trailing price/earnings valuation.
“The last time that emerging market equities were trading above the current multiple of 18 times was in August 2000.”
The oil sector accounts for 15 per cent of the MSCI emerging markets index and high oil and base metals prices have been an important driver of performance.
However, Mr Garner says the re-rating for the MSCI emerging markets index has now exceeded the levels that are warranted by fundamentals.
“Having been aggressive buyers [of emerging market equities] when sentiment was more cautious earlier in the year, it seems inappropriate not to warn that conditions are very different now,” says Mr Garner.