Global emerging markets have been through seven turbulent years, beginning with the Mexican crisis i...
Global emerging markets have been through seven turbulent years, beginning with the Mexican crisis in 1994. This was followed by the 1997 Asian currency crisis, devaluation in Brazil, the Russian crisis, debt problems in Argentina and Turkey, and the recent attacks on the US. In spite of all the problems, the key reason for investing in emerging markets continues to be intact ' these markets are growing significantly faster than markets in Europe and the US.
Over the past 10 years, emerging markets grew about 5.6% a year compared with 2.8% in the developed world and this trend is expected to continue. Investors are able to buy stocks in emerging Asia that are not only cheaper than stocks in Europe and the US, but less risky too. The volatility of the US and European markets now equals, or surpasses, that of the emerging markets. Global bond markets have already been signaling this for some time. Until recently, because of the renewed concern for Argentina, we have seen emerging market bond yield spreads over US treasuries fall. The spread has fallen from 1,700bp in 1988 to less than 1,000bp today. Over the same period, US BAA corporate bond yield spreads have moved in the opposite direction.
Most emerging markets firms are undervalued compared with their US peers. At the end of September 2001, the average p/e ratio for the emerging markets was 10.8x compared with 22.4x for the US. A high dividend yield can often be an indication that a stock is undervalued. The average dividend yield for the emerging markets was 3.1% compared with 2% for the US. We see tremendous upside in many emerging markets. For example, after the Asian financial crisis, the Thai market fell to a low in August 1998, losing some 90%. Therefore, the market has good upside potential. For the market to reach its peak (as at end-1993), it would have to gain some 900%.
Many emerging market currencies are also undervalued. This helps local firms lower production costs and increase exports, and it also enables us to invest cheaply. According to purchasing power parity studies, as of end October, the Brazilian real was undervalued by about 45%, the Mexican peso by 36% and the Indonesian rupiah by about 47%. However, emerging markets are by definition constantly evolving and growing, and therefore imperfections exist. Only when good corporate governance standards prevail will confidence in these markets fully return, and only then, will we all benefit fully from the potential that is in the global markets.
There is a misconception that risk is higher in emerging markets. But it is just as high in developed markets. The complexity of emerging markets often provides an opportunity for profit if investors are able to take advantage of the market irregularities.
It is important to distinguish between poor fundamentals and poor sentiment. We agree recent sentiments towards investing in emerging markets have been bearish but this does not destroy opportunities. The markets do not suit everybody, but more sophisticated investors with longer-term horizons and well-diversified portfolios would benefit from allocating some of their assets in emerging markets.
Cheap valuations in emerging Asia.
Low prices relative to historical performance.
Currencies look undervalued.
A question of selectivity
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