Morgan Stanley sees boom in emerging-markets stocks

Emerging-markets stocks may rise 39% by the end of next year, spurred by a “soft landing” for China’s economy, earnings growth and cheap valuations, according to Morgan Stanley.

The MSCI Emerging Markets Index may jump to 1,355 by the end of 2012, from the 900-1,000 range it has been hovering at this month, said Jonathan Garner, Morgan Stanley’s chief emerging-markets and Asia strategist. The U.S. brokerage firm has joined UBS AG in favoring Chinese stocks for next year, bolstered by confidence that the government will loosen monetary policies to support Asia’s biggest economy.

“Inflation is probably going to fall going forward and we hope for a soft landing in growth,” said Hong Kong-based Mr. Garner, whose Asian research team was second-ranked by Institutional Investor magazine this year. “We should be in a better environment for the stock market.”

As of Tuesday, the MSCI developing-nation index had rallied 9.46% from this year’s low Oct. 4, as policymakers from China to Indonesia moved to support economic growth by refraining from raising borrowing costs, or by lowering them. The emerging-markets gauge trades at 10.4 times estimated earnings, compared with 12 times for the MSCI World Index, according to data compiled by Bloomberg.

“We suspect the rally has already begun from the low in early October,” Mr. Garner said.

CHINA RALLY

Morgan Stanley favors China and its consumer companies most among the Asian emerging markets. Also as of Tuesday, the Shanghai Composite Index had risen 4.12% from this year’s low Oct. 21 as inflation slowed and the government announced measures to help small businesses through easier access to bank loans. As of Tuesday, the Hang Seng China Enterprises Index of Chinese companies listed in Hong Kong had climbed 5.7% since Oct. 21.

China’s consumer price gains slowed to 5.5% last month, from a three-year high of 6.5% in July, giving the government greater scope to unwind monetary tightening as Europe’s debt crisis hurts exports.

“Earnings growth should hold up very well in this environment,” Mr. Garner said. “We think the market is too cheap,” he said, noting that China may cut interest rates in the first half next year.

RISK PREMIUM

The Shanghai Composite’s 12.5% drop this year, following a 14% slide in 2010, has driven down reported price earnings to 13.2 times, compared with 26.4 times at the start of trading last year, according to weekly data compiled by Bloomberg. China’s central bank has raised interest rates three times this year and lifted the reserve requirement ratio to curb asset bubbles.

UBS also prefers China, along with Brazil and India, among emerging markets for next year. Developing-nation stocks may rise 13% next year, with gains dependent on the “normalization of the equity risk premium,” the brokerage firm said in a report.

Morgan Stanley will avoid Indian equities, along with Taiwanese stocks, next year because of a “deteriorating” return on equity.

Estimates for Indian corporate earnings may be downgraded as Asia’s third-largest economy slows, said N. Krishnan, head of India research at CLSA Asia-Pacific Markets.

“There is still some downside to next year’s earnings, as well, even though the cuts have been coming in,” said Mr. Krishnan, whose team was ranked first for India research in a poll by Institutional Investor this year.

“We are in the midst of a broader slowdown in economic growth. Earnings could see some degree of cuts.”