Asia ex-Japan equities lagged the MSCI World index by 30% between 2010 and 2015. This is a sad state of affairs for a region which was, at one point, leading the world’s growth. Indeed, between 2003 and 2008 earnings at Asian companies ex-Japan grew at a rate of around 20% per annum yet between 2010 and 2015 earnings growth has stalled, averaging around 1% per annum.

A report published by UBS earlier this week compiled by the Swiss bank’s global macro strategist Niall MacLeod, considers this strange trend and asks if emerging markets are about to take up the growth gauntlet once again?

Asian companies set to return to growth in the next decade?

Emerging markets have been a hot commodity among investors this year. In the hunt for growth and yield, investors have ploughed money into emerging market equity and debt funds after shunning these markets for the past few years.

Niall MacLeod believes that investors could be making the right decision to head into emerging markets now. Even though earnings growth in these regions has been sluggish since 2010, analysis from UBS shows that 7% annual EPS growth is realistic over the next three years in Asia ex-Japan.

Asian companies set to return to growth in the next decade?

Asian companies set to return to growth in the next 10 years?

There is one swing factor here, however, and that’s non-performing loans. Non-performing loans at banks across Asia are on the rise, and if this continues, it could threaten earnings growth for the region. Nonetheless, barring any significant financial crisis even an increase in non-performing loans will only impact the financial sector and drag down average EPS growth figures. Other sectors should continue to grow.

The bad news is that after the recent rally in emerging market equity prices, UBS believes that EPS growth of 7% per annum for the next few years is already baked into valuations.

“Backing out of current valuations the implied earnings growth for the next three years, we think Asia ex-Japan equities are pricing in around 8% EPS growth a year – broadly in line with our expectations. But not the sort of stuff that bull markets are likely made of. It contrasts markedly with the early 2000s, when Asian equities were implying 7% growth but delivered 20%+.”

“In 2004, markets were pricing in 8% growth, while it delivered 20%. In 2010, markets were implying 10% growth, while actual growth was 1% with returns being pedestrian”

Where does this leave us? Niall MacLeod concludes that based on current valuations, Asia ex-Japan equities can deliver high single digit per annum returns going forward if earnings growth meets the 7% target.