With the global emerging markets (including Asia) being home to three quarters of the world's popula...
With the global emerging markets (including Asia) being home to three quarters of the world's population, the investment potential for these countries is tremendous.
For 2006, real GDP for global emerging markets growth is more than 6% compared to 3% in advanced economies. Aggregate current account surplus is greater than 1.7% of GDP compared to -1.7% in advanced economies. Fiscal deficit is just -0.6% of GDP compared to -3.1% in advanced economies and inflation has fallen from a 1988-97 average of 53.5% to 5.4%.
The acceleration of industrialisation in China and India, domestic deregulation and reduced trade tariffs have all been crucial for this change. The prolonged period of low interest rates and high real GDP growth globally and higher commodity prices since 2002 have also helped tremendously.
Of course, investors have not been blind to these changes. The MSCI Emerging Markets index has returned 206% since March 2003 lifting the asset class out of the bargain basement box. Today the index is valued at 2.2 times price to book and 13 times price to earnings.
However, trouble is looming. The US economy is decelerating fast as its consumers feel the pinch from high oil prices, stagnating house prices and higher interest rates. Within the global emerging markets universe itself, the pace of expansion is moderating, leading indicators in China have started a downward descent and the Brazilian Central Bank is guiding lower GDP growth.
Despite the unprecedented positive changes to fundamentals, the region is not immune to global economic cycles. Investors need to be aware of the large bias within emerging markets towards cyclical earnings streams; the energy, materials, information technology and consumer discretionary sectors represent 54% of the MSCI index versus 36% for the MSCI World.
Other worries are the full pricing of risky assets evident in financial markets today, a consensus ownership of emerging markets and continued analyst optimism towards earnings increases in 2007 and 2008 (+17% and +10%). Caution should therefore be reserved towards earnings-based valuation matrix and, consequently, towards expected short-term performance.
Emerging markets are, bluntly, vulnerable to a correction of 15%-25%. Yet this does not signal the end. Emerging market equities should continue to benefit from many of the themes discussed for years. Indeed, following the coming cyclical shake-out in earnings expectations and share prices, global emerging markets should ascend to all-time highs.
A re-test of the previous peak price to book multiple (3.2 times, recorded in 1995), would result in a 44% absolute return. Relative to global equities, global emerging markets today trade at a 16% discount despite higher returns on equities. This indicates approximately 50% upside to their previous peak.
Investors who have long-term confidence in the prospects for the emerging markets and are not overly concerned that short-to-mid-term price volatility will stay long. Others might consider investment vehicles which have the ability to protect against cyclical retracements in prices while maintaining a structural long-biased view on the market. key points
Emerging markets performing well on industrialisation growth
A US slowdown represents a threat to emerging markets
Long-term growth opportunities for those not worried about short-term volatility
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