Investing.com -- Wells Fargo told investors in a note Tuesday that it sees an opportune moment to cut exposure to emerging markets equities following recent outperformance, calling it “an attractive opportunity” if investors are overallocated to the asset class.
Despite a strong start to the year for the MSCI Emerging Markets Index, which gained 6.9% year to date compared to a 3.3% decline in the S&P 500 Index, Wells Fargo remains unconvinced.
“We are skeptical,” analysts wrote. “The long-term EM equity track record has been uninspiring. EM earnings have barely budged since 2007, and index levels remain roughly 15% below their pre-global financial crisis highs.”
The firm points to structural issues in emerging markets, including “political and economic instability, corporate governance concerns, variable regulatory risks, as well as China’s excessive debt, slumping property sector, and slowing growth.”
While Wells Fargo acknowledges the rally was driven by “modestly better-than-expected EM economic data prints, signs of bottoming consensus earnings expectations, China stimulus measures, and a broadly weaker U.S. dollar,” it warns that “the EM sentiment pendulum has swung too far positive.”
Trade tensions are another concern. “In our view, trade frictions only add to the headwinds these markets will face,” the note said.
Wells Fargo favors developed markets, noting that “DM have the benefit of a more stable and predictable regulatory environment, while recent news of increased fiscal spending in Europe is likely to remain a tailwind to investor opinion and returns.”
“We favor reallocating to U.S. Large Cap, U.S. Mid Cap, or Developed Market (DM) ex-U.S. Equities to maintain overall equity exposure,” said Wells Fargo.
For risk reduction, “investors could look to Commodities or select fixed-income investments to reduce equity allocations.”