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Emerging markets will walk the walk
With low risk levels, emerging markets remain attractive even after the subprime crisis has plagued the rest of the globe.
- By Mark Mobius, Special to Gulf News
- Published: 23:12 January 18, 2008
2007 was another positive year for emerging markets equities. Despite problems brought on by the subprime crisis, the MSCI Emerging Markets index gained 40 per cent (in US dollars), bringing emerging markets returns for the last five years to close to 400 per cent. Most stock markets were supported by a robust macro-economic environment, surging money supply, rising commodity prices, stronger emerging market currencies, improved corporate earnings and significant fund inflows.
Despite the strong overall market performances, the latter half of the year was plagued with increased volatility. Investors remained nervous due to widespread concerns over the impact on the global economy of the credit market crisis in the US. This uncertainty is expected to continue in the near term or at least until the full extent of the subprime is clear. Thus far, however, the subprime issue in the US has had a limited impact on emerging markets.
Within this environment, emerging markets still look attractive because they offer superior growth opportunities at historically low risk levels due to factors such as, but not limited to: privatisation and deregulation of key industries; appropriate fiscal and monetary policies; stable political environments; improving corporate governance; enhancement of competitiveness through removal of subsidies and reduction of trade barriers; increasing productivity thanks to a young and increasingly well-trained labour force; and a huge domestic consumer base.
Despite their rapid growth, a number of emerging market companies are undervalued when compared to their peers in developed markets. Moreover, as a result of the growth in stock markets, liquidity has also improved significantly. Yet we continue to find undervalued stocks in most emerging markets.
Asia
Asia is the largest emerging markets region and home to some of the fastest growing economies globally. In fact, more than 50 per cent of the world's population lives in Asia, providing the region with a major consumer base.
One of the key supporting factors for investing in Asia is its robust economic growth. The region is home to two of the fastest growing major economies in the world - China and India. Developing Asian economies are expected by the International Monetary Fund (IMF) to grow 8.8 per cent in 2008, four times more than the 2.2 per cent growth expected for developed markets.
In addition to strong economic growth, per capita incomes have been rising and reforms continue, thus improving the region's business and investment environment. And, in line with that economic growth, earnings growth is expected to be much stronger than in the developed world this year.
Middle East
In addition to the 'traditional' emerging markets in Asia, Latin America and Eastern Europe, we have been impressed by the Middle East's economic performance.
We also believe that the potential for economic growth and development in this region remains considerable, especially if the current trend toward political and economic reforms remains on course. The Middle East, therefore, will be the focus of continued research. In fact, we recently opened a new research office in Dubai to allow us to capture growing opportunities in the region.
Eastern Europe
In Eastern Europe over the past several years, we have seen improved corporate governance, robust earnings growth, industry consolidation and heightened M&A activity as a result of convergence with the European Union, a reduction in sovereign risk and a stronger macroeconomic environment. These factors have all contributed to the stock price appreciation and re-rating of Eastern European equities over the last five years, and are expected to remain in place for some time.
Despite short-term pullbacks, the long-term outlook for the region remains very good, with Eastern European markets expected to continue to benefit from EU convergence, access to funds, labour costs that are lower than in western Europe, business-friendly tax laws, cost competitiveness, relatively high GDP growth and foreign direct investment inflows.
Africa
The African continent has abundant natural resources such as gold, copper, platinum, iron ore, bauxite, coal, oil and gas, as well as soft commodities like cocoa, coffee and sugar. Africa has benefited tremendously from rising prices fuelled by the rapid growth in other emerging commodity-importing economies. This, combined with large-scale debt relief programmes, has enabled governments to embark upon structural and regulatory reforms to place the continent on a path to long-term sustained growth.
Thus, markets such as Botswana, Mauritius, Nigeria and the BRVM (Bourse Régionale des Valeurs Mobilières, a regional stock exchange serving the West African countries of Benin, Burkina Faso, Guinea Bissau, Côte d'Ivoire, Mali, Niger, Senegal and Togo) recorded returns ranging from 40 per cent to more than 90 per cent in 2007.
"Frontier markets", which are currently smaller and less developed than other emerging markets but could also in the future, grow into tomorrow's emerging markets. However, one must not get carried away with the excitement and abandon a bargain-oriented strategy.
For example, while we believe that the Vietnamese market has good potential, valuations three currently are quite high, although we continue to monitor opportunities. Some other frontier markets such as Slovenia, Romania, Croatia, Kazakhstan and Ukraine are also beginning to look interesting. Any of them could become tomorrow's major emerging market.
Our investment approach enables us to invest not only in large companies but also smaller ones. Each has different factors in their favour. Small companies have great growth and development potential, while large caps continue to benefit from the strong macroeconomic environment they are operating in and economies of scale.
BRIC
All four BRIC (Brazil, Russia, India, China) economies are registering good GDP growth rates, with China, and (possibly) India recording double-digit growth rates. Falling interest rates in Brazil and Russia should continue to fuel economic activity. Inflation, while a concern in India and China, remains under control. All four countries continue to build up vast foreign exchange reserves. China's reserves are now in excess of $1.4 trillion, while India has about $400 billion in reserves, while Brazil and Russia's have surpassed the $200 billion mark.
Collectively, the BRIC markets account for about 30 per cent of world GDP and over 40 per cent of the world's population, making them large and increasingly important markets. The BRIC economies are expected to continue to grow strongly this year and per capita growth should continue to rise.
Domestic consumption is becoming an increasingly important factor in all four markets. Thus, we remain optimistic about the long-term future of the BRIC markets.
Latin America
Growth perspectives for Latin America continue to be good. Strong commodities prices associated with solid domestic demand for goods and services are the key drivers of such a boom in each Latin American economy. Despite recent corrections, the Latin American stock markets have put in a sturdy performance in 2007. A smooth transition of political power in democratic elections in most countries in the region has supported Latin America's economic growth in recent years, so that it is stronger now than at the beginning of this decade.
One major factor in the performance of Latin American stock markets has been the lowering of interest rates and the decline in sovereign and corporate debt. A few years ago, the region had debt/GDP ratios that were reflected in high sovereign debt spreads of the different Latin American countries. But the fall in Latin American indebtedness means that spreads have narrowed considerably. At the same time as many countries have experienced strong growth, inflation has remained reasonable.
Outlook
The long-term outlook for emerging markets remains good. In the short term, however, we can expect volatility to continue, particularly with the continued unwinding of the subprime situation in America. We could even see corrections in equity markets, including emerging markets, if global economic growth slows.
The good news is that bear markets tend to be much shorter in duration than bull markets and bear markets declines are shallower than bull market increases. This is why one must invest with a long-term perspective.
Current risks include but are not limited to a major slowdown in the United States economy, instability in the Middle East and South Asia, rising inflation globally, economic overheating in China and India, as well as highly volatile exchange rates and commodity prices.
Emerging markets are not fully insulated from the subprime problem since a significant portion of their exports still goes to the United States, the world's largest economy. A slowdown in the United States economy could lead to a reduction in that country's domestic demand, with unavoidable repercussions for emerging market exports. However, with increased globalisation, the impact of developed economies on emerging markets has, in general, lessened.
Indeed, emerging markets have also begun to have some impact on developed markets. For example, China's growth and demand for commodities has impacted economies globally.
We continue to take a long-term view to investing in emerging markets just as we did when our first emerging markets fund was launched over 20 years ago, in 1987. Emerging markets' underlying fundamentals remain intact and prospects for the future are good.
- The writer is managing director of Templeton Asset Management Ltd.
(Opinions expressed by the portfolio manager are subject to change without notice and do not constitute investment advice.)
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