Emerging market stocks rose a record 75 per cent last year as banks in these regions avoided most credit-related losses and investors speculated economic growth would outstrip developed nations. But while emerging markets are still thought to represent excellent opportunities over the mid to long-term, there is uncertainty in the near future.
“Looking ahead, liquidity remains ample and risk appetite healthy, given low interest rates in the developed world,” says Devan Kaloo, head of global emerging markets at Aberdeen Asset Management.
“Emerging markets are thus likely to remain well supported in the short-term, though valuations are starting to appear more expensive. Under these circumstances, we will continue to be vigilant, looking to take profits should valuations move higher.”
Changing circumstances
One concern is that emerging market shares could fall as central banks begin tightening their policies in response to the recovery. They dipped for instance in early January after China’s central bank raised the interest rate on its three-month bills in a bid to curb lending growth.
Interest rates will also rise this year in Brazil, India and other developing countries as policy makers withdraw stimulus measures and look to control inflation during the recovery.
The tremendous run these markets have already enjoyed from their lows in 2008 also limits progress. “Valuations have closed up from the wide gaps at the beginning of the year, and with the possible exception of Turkey and Russia, there will not be significant rerating from here,” says Claire Simmonds, client portfolio manager for emerging market equities at JPMorgan.
However, a certain nervousness about the sector in the short-term is matched by equal optimism about long-term backdrop, namely the urbanisation of a young, well-educated and growing workforce, hungry for all things western. Consumer spending accounts for 60-70 per cent of most countries’ GDP, and China’s headcount is expected to grow by a massive 150 per cent in the next 30 years.
“Of the 6.7bn people in the world, 80 per cent live in emerging markets,” says Nick Price, portfolio manager at Fidelity. “If you take current population growth rates, by 2040 there will be 2bn more people, or 9bn in total, and the vast majority of that growth will be in emerging markets,” he explains.
“There is a direct link between a healthy consumer base and growing GDP,” adds Mr Price. “Japan is the classic posterchild of an ageing demographic. Its elderly are a huge burden on the working population and have a lower propensity to consume. Japan’s systematic failure to recover is a result, and a good route map for where Europe is heading. A high dependency ratio and ageing workforce are very long themes and don’t show up discernibly year to year, but they are still a very important force in the background.”
The growth potential for consumer goods and services is immense, he believes, whether in mobile phones or cement. “If you measure beer consumption in Kenya for example, the beer consumed per head per year is 7 litres compared with 138 litres in Germany. This is the same in every single area of consumption; the poorer countries are still functioning at a basic level,” adds Mr Price.
He cites as an example a foam mattress company in Nigeria, initially spun off from British Foam, which is enjoying sales of 20 per cent plus per year because the rural population is only now switching from mats to foam mattresses.
Stocks that play straight into rising consumer prosperity, such as healthcare, personal care and telecoms, are sought after by most fund managers, with additional value put on companies that make or market repeatable purchases such as soap and toiletries. The credit growth story is a favoured one, as financial services have been oversold along with western banks, and savings rates across these regions are high while the public’s propensity to borrow has not yet been tapped.
Chinese manufacturing
Mobile penetration is no longer quite the universal mantra it once was, as the youngest economies slowly catch up and more mature countries such as Russia, Korea and Taiwan begin to boast a penetration comparable with the developed world.
In terms of tech manufacture, however, most of the world’s supply is now made in China and a handful of other Asian nations. Domestic spending on technology should grow not only from innovations in the consumer market such as the iPhone, e-Reader, Apple Tablet PC, GSP systems and the Nintendo DSi, but from businesses looking to gain productivity and replace existing computers. The average PC in an emerging economy business is estimated to be five years old, compared with the normal 3.5 year life of corporate computers in developed markets. The demands of Windows 7 could also help make it a good year for corporate spending on PCs.
