UBS turns bullish on Emerging Markets equities amid macro tailwinds, valuation

Investing.com -- UBS has upgraded Emerging Markets (EM) equities to Overweight from Benchmark, citing a combination of macro tailwinds, attractive valuations, and supportive policy backdrops.

The bank emphasized that this is a tactical call for now, though many such upgrades in the past have evolved into more strategic positions.

The bank highlighted that a weaker dollar, expected declines in U.S. short-term rates, and a strong China credit impulse create a favorable environment for EM assets.

“Historically, when the dollar weakens 10%, then EM outperform by 9%,” UBS strategist Andrew Garthwaite wrote, noting that EM is particularly sensitive to falling rates and looser financial conditions.

Garthwaite also pointed to EM trading on a 30% price-to-earnings (P/E) discount versus global markets, a wider gap than the historical average, while dividend yields stand nearly two standard deviations above norms.

On a relative basis, EM valuations compared with developed markets (DM) are close to levels last seen during the Asian financial crisis.

Garthwaite argues that many EM countries are better positioned than developed peers on inflation and fiscal sustainability. Inflation is just 2.4% excluding China, allowing central banks across much of the bloc to cut rates. 

"In general, EM have a better fiscal position than DM,” he said, adding that shorter debt maturities amplify the benefits of lower global yields.

Investor positioning also remains light, with UBS data showing EM at their most under-owned level relative to the U.S. in nearly a decade.

On a country level, UBS favors China, Brazil, Indonesia, and the Philippines. China is seen benefiting from capital discipline, excess liquidity, and underweight foreign ownership.

Brazil screens cheap on valuation, with inflation-adjusted short rates around 10% expected to fall sharply in coming years.

India, while moved back to benchmark, remains one of the strongest structural growth stories and stands to gain from lower oil prices.

UBS also sees high-beta opportunities in deficit countries such as Indonesia and the Philippines if the dollar weakens further.

Risks to the call include slower Chinese nominal GDP growth, tariff disputes with the U.S., and ongoing earnings downgrades. However, Garthwaite believes that policy flexibility and political bargaining power could cushion the impact.

The strategist also notes that EM equities are already pricing in a significant amount of bad news, with valuations near crisis-era levels.

At the portfolio level, UBS is overweight Continental Europe and EM, underweight Japan, and neutral on the U.S.