Emerging-Market Stocks Are Battered. That Doesn’t Mean It’s Time to Buy.

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A ferry crosses Victoria Harbor in Hong Kong.

Bertha Wang/AFP via Getty Images

Emerging-market stocks have gotten crushed. And given the potential downside for Chinese stocks, buying the dip isn’t yet a sure bet. 

The MSCI Emerging Markets Index is down almost 8% since its February peak. Much of that is due to trouble in China, given that many components of the index are reliant on strong demand there.

China’s nonmanufacturing and manufacturing purchasing managers indexes, which measure levels of economic activity, have declined sharply from early in the year, according to Citigroup economists. A renewed surge in cases of Covid-19 has hit growth. And for much of the year, the People’s Bank of China’s monetary policy was less supportive of expansion than it had been. 

Citi’s global equity strategists advise holding off on buying emerging-market shares. Chinese stocks account for roughly 35% of the total market capitalization of the emerging market index, and they still look expensive, according to Citigroup.

Stock prices haven’t yet reflected the full extent of the economic slowdown, according to the bank. The average stock on the MSCI China Index is trading at 13 times the per-share earnings expected for the coming year. While that is down from 18 times in February, it is still 7% higher than the average multiple on the emerging-market index, excluding Chinese names, Citi’s data show.

Historically, Chinese stocks trade at an average 5% valuation premium to their emerging-market peers. “So, even after the recent sell-off, Chinese equity valuations do not look especially cheap,” wrote Robert Buckland, Citi’s global equity strategist. “We are not yet tempted to buy the dip and remain Underweight EM equities.”

Still, buying at current levels is hardly a bad idea. Economic growth in China may soon improve, as the Chinese central bank has recently said it wants policy to support the economy. Already, growth in Chinese gross domestic growth is expected to be above 5% for the next two years, according to FactSet data.

Don’t forget, it is hard to time the bottom of a sell-off, and the emerging markets index has already begun to rise. It is up 7.5% from the low point it reached in late August.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com