Emerging market equities Seek Exposure to US Economy - UBS

• We stress a defensive stance in our emerging market country allocation. We advise investors to avoid expensive markets such as Indonesia.
• We believe ongoing rotation into countries with high exposure to the US economy still has upside potential. Therefore, we add Mexico and Korea to our list of preferred countries.

Emerging market country recommendations
Current most favored markets : China Russia Taiwan Korea Mexico
Current least favored markets : India, Indonesia, Malaysia, Thailand

Valuation gives first signs of caution
Price-to-book (P/B) ratio, which measures the market price of the balance-sheet equity of a single company or a market as a whole, is a useful indicator of overheating stock markets. The indicator advantageously removes the cyclical element of earnings indicators based on income statements.

Current valuation levels are not yet extreme and do not justify an immediate sale on valuation grounds alone. Investors should, however, consider leaving crowded markets and switching to attractively valued ones to minimize downside risk in case of setbacks.

Adding our macroeconomic picture of inflation concerns and a scenario of further interest rate hikes in emerging markets, we can identify a few countries that are likely to provide less appealing returns over the medium term. Indonesia and Thailand are candidates deserving more caution. On pure valuation measures, India always trades at elevated P/B values due to higher profitability, but ongoing food inflation and rising interest rates are likely to weigh on profitability and asset prices, in our view.