Mixed views on emerging markets

21st May 2013

Following a period of disappointing emerging market returns, investors are crossing their fingers for a return to form across the world’s developing markets writes Philip Scott.

Economic growth has pulled back in some emerging markets, with China, the world’s second largest economy, after the US, the most talked about in this regards. But ultimately, emerging market GDP is still growing at a rate developed markets cannot touch, while China’s rate has pulled back from some 10% per annum to a still envitable 7.7%.

Developed stock markets, such as the US, the UK and Japan, were once left in the shade by the returns delivered to investors global by emerging markets but that gap has narrowed markedly in recent years. For example, back in 2007, before the onset of the financial crisis, the MSCI Emerging Markets index, which is designed to measure the performance of the largest companies across a plethora of developing markets, rose by 37% over the 12 month period. In contrast, the MSCI World Index, which measures 24 developed markets, returned just 7%.

But in 2012, emerging markets achieved 13% against 11% from developed markets. While many investment experts argue that perhaps the easy money has been made in emerging markets such as China, Russia and India, experts are generally confident that, although there will be volatility along the way, there have more to go, given the fundamentals that emerging markets typically boast, growing urbanisation, forcing the need to improve infrastructure, as well as an abundance of mineral reserves and commodities. Perhaps most importantly, the rising affluence and growing middle classes with more spending power.

Mark Burgess, chief investment officer at fund management group, Threadneedle Investments, says: “Sluggish demand and slowing growth in China weigh heavily on sentiment and commodity prices and emerging markets remain under some pressure underperforming the developed world. Only in the US does the macro data suggest that the economy is gently improving, particularly from a jobs perspective.”

In contrast part Legal & General Investment Management sees steady and superior growth in emerging markets with policy makers maintaining a benign environment as well as relatively valuations.

Fund managers assert that earnings weaknesses which have dampened emerging market equity performance has been as a result of cyclical as opposed to more secular and fundamental reasons. JP Morgan Asset Management for example, points out that stock valuations have been reasonably cheap for emerging market equities over the past two years but broadly disappointing earnings have created negative momentum, leading investors to question when and whether better earnings will pave the path to improvement.

In addition, key economic indicators and market signals, the pace of moderate economic recovery across EM globally remains intact according to the group. Notably, China PMIs have turned upwards, inflation has abated and policymakers are cutting interest rates.

From a macro, or broad point of view, JPMAM analysis suggests from a valuation and earnings momentum perspective, it believes financials are an attractive play on the domestic growth story in emerging markets – and a cheaper way to play the consumer story than consumer staples, which on balance look expensive.

In terms of regions, investors should look to own companies that are attractively valued but poised to benefit from improving momentum. Richard Titherington, chief investment officer for J.P. Morgan’s emerging market equities team, says: “Defensive markets now look expensive, but we remain positive on China and Russia. The recovery in investor expectations and better data will help China, assuming inflation stays contained. We are sticking with Russia because significant dividend payouts from Russian companies are coming up; this will support the market and reduce investor scepticism.”

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