Emerging market equities seen to deliver flat-to-negative returns in 2014

Will things ever go right?

According to Bank of America Merrill Lynch, after being tactically bullish on equities since mid-Aug, it has changed its minds. It now believes Emerging Market (EM) equities may deliver flat-to-negative returns in 2014.

Here's more:

Still, tactical opportunities are likely just as in this gone summer. In our view, the divergence between EM growth stocks (internet, gaming, staples) and undervalued SOEs is big enough to view these as two distinct equity markets.

Three pockets we are BUYing

However, we do see pockets of neglect, revulsion and value - SOEs, Korea's semis and autos, and India's beaten-down "Policy Ignition" themes.

In a tough world, positive free cash flow companies/countries, with external surpluses and reasonable valuations are preferred - Korea, Russia and China.

We upgrade Turkey from U/W to O/W (EPS revisions are curling up, free liquidity is improving, foreign ownership is low); South Africa from neutral to mild O/W (though expensive, looks good on EPS growth, ROEs and price momentum); and Brazil from neutral to mild O/W (cheap, improving earnings revisions).

Downgrade India to Neutral from O/W (not deep value now, up 28% in US$ since its August low).

Challenges ahead, but things could go right too

Although we see 10 clear challenges for EM Market equities (see below), a weak USD, and low bond yields reflecting another round of global QE or any drop in US/Europe/Asia policy uncertainty would be a boost to multiples for EM high-flying growth stocks. China, India and Mexico's focus on reforms could be an upside catalyst.