Emerging markets gain strength despite intricate links with the developed world and the resultant volatility - but growth in the region offers myriad stockpicking opportunities.
In the run-up to the 2008/09 financial crisis, there was much speculation about the decoupling of global emerging markets from their developed counterparts. The emerging markets, went the argument, were no longer simply high-beta plays on global growth, but free to blaze their own trail.
However, today’s globalised world is too complex and interconnected to be captured in a simplistic on/off image. Emerging markets are less dependent on the developed world than they were, but in some ways they are also more closely connected. And these connections are not just one-way relationships. So, while emerging market companies are much less dependent on the West for growth than they have been in the past, many western and Japanese firms rely on the emerging-market consumer to fuel their own growth.
What happened during the post-Lehman Brothers crisis? The only obvious decoupling was in the performance of emerging market economies on the one hand and equity markets on the other. The former proved resilient to the global recession, with China, India and many other Asian economies avoiding recession altogether – although growth generally decelerated. Meanwhile, many other emerging nations experienced only relatively shallow recessions. But emerging market equity indices plummeted. Emerging market stocks did, however, recover more rapidly too. Essentially, though, risk appetite, rather than economic health, was what drove stockmarket returns at that time. The pattern was similar to that in developed markets, but more exaggerated – indicative of the high correlation between all equity markets during extreme sell-offs.
The economic resilience of the emerging market countries was largely a function of their healthy balance sheets at sovereign, corporate and household levels. In addition, China did not simply weather the post-Lehmans storm but deployed enormous fiscal stimulus packages to ward it off. It could do this because it had plenty of capacity to borrow, having maintained a healthy fiscal position in the years leading up to the crisis. (Strategy continues below)
Today, with Europe engulfed in another debt crisis, the prudent management of the emerging market economies holds real attractions for investors. Despite all the global macroeconomic turmoil, emerging market sovereign bonds have performed strongly this year, ensuring that Asian and Latin American governments can continue to borrow cheaply, even as European countries struggle with debt and deficit.
So far, however, that endorsement has not been extended to emerging market equities. In 2011, emerging market stockmarkets have again been subject to renewed risk on/risk off oscillations and have had an even rougher ride than developed markets. Once more, risk appetite has been the decisive factor here. Ultimately, though, despite successive crises and risk-driven sell-offs, the emerging market asset class has still performed better than developed markets over the past decade.
There are no signs, then, of emerging market stockmarkets decoupling, but for investors who can put up with heightened volatility, they have offered superior long-term returns. In a globalised world, the threats to equity markets are generally global shocks – which can stem from emerging markets as well as developed ones. But that should not obscure the outstanding opportunities within the emerging markets asset class. Emerging economies are likely to be the engine of global growth.
That will not translate directly to benchmark equity returns; the relationship between growth and index performance is tenuous. But it does mean that the developing world will offer a richer variety of growth opportunities.
”Some emerging market firms are continuing to benefit from developed world demand despite – or even because of – the problems in the West”
Those opportunities lie in companies that fulfill domestic demand, or in other emerging markets. China’s Lenovo, which gained prominence following its purchase of IBM’s PC business, is benefiting from booming demand for PCs. It has become the world’s third-largest PC firm by focusing its efforts in emerging markets. And that focus continues to pay off: in a year in which global PC shipments will be more or less flat, Lenovo is likely to achieve over 25% growth. Its China sales alone should rise by 30% this year.
Many emerging market firms will prosper because they offer services or products that are still hugely underpenetrated. Telecoms firms, such as Mexico’s America Móvil and TIM Brasil are harnessing pent-up demand for mobile technology in Latin America.
And some emerging market firms continue to benefit from developed world demand despite – or even because of – the problems in the West. India’s Infosys Technology is profiting from demand for outsourced operations in developed markets. As European companies slash budgets, cost-effective outsourcing firms will benefit.
Emerging markets will not decouple from developed markets. Our increasingly globalised world makes that impossible. But with intra-regional trade between emerging counties an important part of the global economy, the region will offer more stockpicking opportunities for many decades.
Kim Catechis is the manager of the Martin Currie Emerging Markets fund.