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| Table: Emerging Market Funds (CLICK TO VIEW) |
The MSCI Emerging Markets index shed one fifth of its value during 2011 in the face of inflationary fears and the European sovereign debt turmoil. However, these markets are still growing at a healthy clip compared with their developed peers while the US, their major consumer, may be staging a recovery.
Inflationary pressure mounted as commodity prices fluctuated violently, especially oil, amid political upheaval in the Mena (Middle East and North Africa) region, and adverse weather conditions forced up food prices, which comprise up to 50 per cent of emerging market cost-of-living baskets. Developing nations, which are seen as high beta and are very sensitive to global risk appetite, were hit by the flight to safety as global markets faced multiple headwinds.
“It is well documented that emerging markets had a disappointing year, underperforming the developed world by about 10 per cent, and we think next year will be another challenging year for emerging markets, and for equities as a whole,” says Brian O’Reilly, head of wealth management research UK at UBS.
“The most serious risk is how much they are impacted by Europe, which after all is the world’s largest economic block,” he adds.
Although the European crisis remains the ‘elephant in the room’, Mr O’Reilly believes emerging market equities could return 5-10 per cent in the latter half of 2012, if a resolution can be found.
Many commentators have been surprised at the lack of political will among European leaders to ring-fence this crisis, however, and fear a repeat of 2008. Europe’s peripheral countries face funding costs at near record highs, despite a series of measures that have been hammered together to restore investor confidence in the eurozone. More than €457bn of eurozone government debt must be repaid in the first quarter of 2012, according to Citigroup. Italy alone for example has to repay around €113bn.
Chinese stockmarkets also fell heavily last year with Hong Kong’s Hang Seng index losing 20 per cent and the Shanghai Composite down 22 per cent, according to Bloomberg, yet few have lost faith in Asia’s long-term structural story. Drivers of growth such as the development of infrastructure, still huge in Brazil for example, the long-term development of consumer markets and an abundance of raw materials that increasingly industrialised countries want to access are not a one-year horizon stories.
A DIFFERENT WORLD
Confidence can also be taken from the behaviour of developing nation economies in 2008 compared with historical crises. “2008 was different from any other crisis because emerging markets fared well compared with other markets,” says Nordea Investment Funds’ head of global distribution, Christophe Girondel.
“It’s clear the world has changed when European officials are going to Asia to raise money. And these countries are good at favouring growth and adapting their interest rate policies, particularly the Chinese.”
Big changes in The Communist Party of China could herald a more expansive monetary policy as food price inflation begins to moderate.
“A housing collapse remains the key risk in the Middle Kingdom, but China has an ambitious social housing policy with plans to build 36m affordable homes by 2015,” says Mr O’Reilly at UBS. “In addition, unlike indebted nations in the West, China still has $3,000bn in reserve so they should be able to engineer a soft landing.”
A lot of negativity has been priced into Chinese equities squeezing valuations to 8.6 times forward earnings, even for companies generating a 70 per cent return on capital employed and dividend yields of 3 per cent.
Property developers are more exposed than the domestic householder in the housing market, and there are plenty of banks that are not overexposed to this sector, such as Russia’s Sberbank, which has a solid Tier 1 capital ratio and makes a 6 per cent net interest margin. Arguably, low valuations in the telecoms sector are also ample compensation for risks, and the data growth in handheld devices and laptops coupled with low fixed line coverage makes for a wonderful combination in developing regions.
Fund managers are particularly drawn to Chinese stocks in the small to mid cap sector that have been punished excessively.
“The government's pro-growth policies should make smaller and medium-sized companies, particularly the latter, deserving of renewed interest going into 2012,” says Agnes Deng, investment manager of Baring’s Hong Kong China Fund.
“Recently the People’s Bank of China cut the bank reserve requirement ratio by 50 basis points, the first reduction since December 2008. This could encourage banks to lend additional money and should provide strong support to economic growth.”
China’s dynamism may have been undersold. The International Monetary Fund estimates economic growth came in at 9 per cent in 2012, more than double the predicted global growth rate of 4 per cent.
