By Vatsal Srivastava

New Delhi, Feb 17 (IANS): Once a darling of the investor community, emerging market (EM) equities are currently one of the most disliked themes among them. Emerging market stocks have had a poor start to 2014 due to fears of a sharp slowdown in China, the US Federal Reserve's decision to taper down its bond purchases programme (through quantitative easing-QE) and more recently the collapse in many of the emerging market currencies to multi-year lows.

The EM under-performance relative to their developed market (DM) peers is a trend that has established itself over the past three years. Emerging market equities have under-performed developed market equities by nearly 35 percent since November 2010. It should be noted that during this time period the relative earnings of the EM corporates were down by only 15 percent as compared to the DM corporates, according to research by Barclays global equity strategy team.

However, at current levels, emerging market equities seem to be trading at valuations which have historically turned out to be the bottom for EM equities. Further, according to Barclays, the current magnitude of the earnings yield gap between EM and DM equities has never resulted in the emerging market space under-perform the DM space over the subsequent 12 months.

The discount embedded with EM equities versus DM equities, as gauged by the difference between the earnings yield between emerging market and developed market stocks, is very high. Such occasions have turned out to be great buying opportunities for the contrarian investor.

The price/book ratio for emerging market stocks is now below 1.5 according to Barclays equity research analysts. These are crisis level valuations -- last time we witnessed the P/B ratio (price-to-book ratio, which is the comparison of a company's current market price to its book value) for EM stocks below 1.5 was during the Asian financial crisis, 9/11 terrorist attacks in the US and the global financial crisis of 2008. Again, these periods turned out to be a bargain buying opportunity.

It is also encouraging that although retail investors have been net sellers of EM equities since 2009, institutional holdings have been surprisingly resilient.

Crisis level valuations for EM stocks also point out that the US Fed induced liquidity has not been greatly beneficial. In fact, there is little correlation between US treasury yields across various maturities and the performance of EM stocks according to Barclays research.

In the first half of 2013, when the third round of quantitative easing (QE3) was in full throttle and there was minimal talk of "tapering" down, EM equities under-performed even when US bond yields were falling. This has played out this year as well as disappointing jobs data (which may be weather related) has pushed 10-year US bond yields down from their recent high of 3 percent to about 2.7 percent. But EM stocks have still under-performed DM stocks.

As the Barclays equity research team notes, it is the slow economic growth, and not the Fed monetary policy, which has been the main driver of the EM under-performance. However, along with an acceleration in global growth, the earnings growth in emerging markets is expected to be 10 percent in 2014 and 13 percent in 2015.

We could be in a situation similar to one in early 2004, when the sell off in emerging market equities was incorrectly pricing in a contraction in earnings and exports.

Fundamentals will soon catch up with the depressed equity prices if the above growth prospects materialize. Of course, there will be relative out-performers within the emerging market space. If historical valuations serve as a good guide, this is the ideal time to start picking stocks in the EM space using a bottom up approach.