Are clients concerned about the recent volatility in the emerging markets? Here’s a take from my colleague Justin Leverenz, Director of Emerging Market Equities.
Anxiety about emerging markets (EM) continues following a difficult year for the asset class in 2013. Emerging markets have been troubled by several big issues happening concurrently, resulting in a near perfect storm for investors. Three extraordinary global influences have been affecting growth prospects in the emerging world.
First, the Federal Reserve tapering of quantitative easing has resulted in a global liquidity tightening and the backup in yields in emerging markets. We have warned at length in the past about potential unintended consequences of financial repression and the unsustainable levels of emerging market debt spreads.
Second, we have seen extremely negative and completely misplaced sentiment about the sustainability of China’s growth. And finally, there has been broad growth disappointment throughout EM economies driven by lower commodity prices and weakness in commodity country currencies caused by balance of payment pressures.
Bullish on Emerging Markets
So why would we invest in EM with all this happening? Well, opportunities will always be the biggest when controversy is the loudest. The reality is that EM equity prices have embedded much of investors’ fears as evidenced by the 45% cumulative underperformance of the MSCI Emerging Markets Index vs. the MSCI World Index over the last three years in U.S. dollar terms. The correction in EM bond yields has normalized costs of capital while local currency depreciation leaves little room for further decline. Prices of many fundamentally sound companies have finally reached levels that excite us.
We are actually extremely bullish on EM at the moment. We see that the structural case for strong growth remains intact. If you look at the world in totality, the emerging markets continue to outperform the developed world by about 300 to 400 basis points a year in terms of economic growth. We believe the recovery in developed market economies promotes global trade which EM economies can broadly leverage. Of course, the world is not homogeneous, and the EM world is no exception. Fragile economies like Turkey and Ukraine plague investors’ view on many countries on the cusp of massive economic and political reforms such as Mexico, India, Russia and China.
Misconceptions Lead to Opportunities
Yes, China. Over my investment career, I have seen misconceptions about China being played out in uncountable ways. It is not as if China doesn’t have issues. All countries have issues. While the issues that you read about China in the press are not insignificant, they are unable to derail the world’s largest growth story. In my mind, there are going to be major reforms in China, which means that the current disconnect between output growth and asset prices should be corrected. Moreover, there is a convenient disregard of China’s extraordinary productivity expansion in the last decade which we believe will continue driving growth in the next decade. I think if investors choose to ignore the heterogeneity of emerging markets, they are missing out on, in my opinion, some opportunities of a lifetime.
The easiest — but strangely enough, often overlooked — theme is a structural growth story associated with low penetration rates and high government support, such as in the EM health care sector. Then there is the Internet and e-commerce boom, which have revolutionized the way we interact and shop. We own some of the fastest growing Internet companies in the world, which will continue shaping the development of this sector. In addition, there is rolled up consolidation around the strongest players across a variety of industries and sectors, as is the case with the Brazilian education and Russian retail sectors. Furthermore, there are European multinational companies with deep EM exposure, which are commonly misunderstood and have been recently mispriced.
We have emphasized for many years our focus on great companies, not countries. When the macro noises are deafening, we see numerous opportunities present themselves at extremely attractive prices.
The MSCI Emerging Markets Index is designed to measure global emerging market equity performance. The MSCI World Index is designed to measure global developed market equity performance. Each index is unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. Past performance does not guarantee future results.
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Feb. 4, 2014 RPL0000.201.0214