Emerging market equities have taken a hammering over the past 12 months, largely as a result of high inflation, high domestic interest-rates, growing uncertainty about the eurozone and, to a lesser extent, doubts over the US recovery. The iShares MSCI emerging markets index tumbled by 20.6% in the year to December 31, 2011, versus a flat performance for the S&P 500.
Byron Wien, chairman of the advisory services unit at Blackstone, the world's largest asset management group, believes emerging market equities will rebound by 10% to 15%, experiencing a real surge in value during 2012. However, the run down over the past year has been so severe that even this would leave emerging market indices below their January 2011 level.
In his closely watched annual “10 Surprises” list Wien said the MSCI emerging market index’s price-earnings ratio of 10.8 will enhance stocks propensity to rise in 2012. He said: “The emerging markets finally have a good year. Growth slows somewhat but favorable valuations enable China, India and Brazil indexes to appreciate.”
Adrian Mowat, chief Asia and emerging equity strategist at JP Morgan believes that, as emerging market inflation falls on the back of tumbling commodity and food prices, and as emerging market central banks reduce interest rates in 2012, bearishness will turn to bullishness, at least by the second half of the year. Predicting that financials, consumer discretionary stocks and late cyclical stocks will be the main beneficiaries, Mowat told CNBC-TV18 that:
“When you move into this policy environment where they are trying to encourage growth, it tends to end the de-rating in emerging market equities...”
One reason for the failure of emerging markets to perform in 2011 was that the Holy Grail of “decoupling” from the developed world continued to prove so elusive. European recession, deep uncertainty about the future of the eurozone and doubts over the US recovery acted as brakes on emerging market growth in 2011. It’s difficult to get away from the fact that, despite rising intra-regional trade, many emerging market players remain extremely dependent on exports to the developed world.
Among the more bearish commentators, John Greenwood, chief economist at asset management firm Invesco believes that the developed world, with its necessary focus on debt repayment in 2012, will continue to act as a brake on emerging market growth over the next 12 months.
Pimco’s Rahman suggests that emerging markets are as vulnerable as ever to sudden outflows of “hot money”. This would happen in the event that global investors take fright. Others have warned that, if the euro implodes in a disorderly fashion, then “all bets are off”. In such a context, the more “decoupled” markets are clearly going to be the least traumatized.
Indonesia may therefore be a good bet. Milan Zavadjil, the IMF’s resident representative, recently said: “[In Jakarta] consumer and business confidence are near all-time highs. Fitch has just upgraded Indonesia to investment grade, citing resiliency to external shocks … Indonesia is a large ship, well suited for turbulent waters.”
The longer term outlook for emerging markets is much stronger than that for developed markets. In its latest report on emerging markets, investment bank Goldman Sachs stresses the importance of grasping just how much overall emerging market capitalisation is going to grow relative to developed market capitalisation by 2030.
“We believe EM market cap will rise to $80 trillion in fixed US dollar terms taking 2010 as the baseline,” Goldman Sachs says.
By way of contrast, developed market cap will be “just” $66 trillion. That’s quite a turnaround from 2010 when the market cap for emerging market countries was a mere $14 trillion, versus $30 trillion for the developed markets.
Moreover, according to Goldman Sachs’s figures, the rise is expected to be steady and inexorable, decade by decade, unless something wildly unforeseen happens. In the current decade the capitalisation of all emerging market stocks will have more than doubled to $37 trillion by 2020, whereas the developed world market cap will have achieved a paltry 0.5% growth rate, to reach £46 trillion.
By 2030, says Goldman, China will account for some 28% of world GDP, with North America as a whole coming in at 25% and Europe weighing in at just 14%.
Brazil, which recently overtook the UK to become the world’s sixth largest economy, will be 3% of global GDP with Russia at 4%. The BRICs’ share of world equity cap by 2020 is likely to be 30%, rising to 41% by 2030, versus just 18% today.
This analysis has major implications for investment strategies, Goldman says. Not least, pension funds and developed market “savings pools” generally will need to own a lot more EM equity.
“We estimate that developed market institutional asset managers currently hold 6% in EM equities within their total equity portfolio,” Goldman says. This will need to rise to 18% by 2030 on any “balanced portfolio” view, implying that developed world institutional managers need to shift some $4 trillion of investment into emerging market equities by 2030!
If even a fraction of these inflows start to happen in 2012, it will further buoy the asset class. But there will inevitably be a fair amount of plenty of volatility along the way, especially given Rahman’s warning.
Further reading on the outlook for emerging markets:
- Lessons from Russia by Bruce Misamore
- Is the West mispricing emerging market assets by Anthony Harrington
- The final decoupling is going to be a painful wake-up call for the West by Bruce Stout
- Fidelity is confident its MINTS won’t suck by Ian Fraser
Tags: banking , China , Chinese equities , economic recovery , emerging economies , emerging markets , equities , financial crisis , India , Indonesia , JP Morgan Global Emerging Markets Income Trust