GovernanceMacroeconomicsEmerging markets: challenge or opportunity

Emerging markets: challenge or opportunity

Julian Roche explores the prospect of emerging markets, the golden decades and how their trends are impacting investor opinion.

Six years ago, HSBC told us that: ‘in the future, there will be no markets waiting to emerge’. Even if an approximation to the truth, if this trend continues it will make the next three decades very special. They could be referred to as ‘the golden decades’. These years are surmised as the last time that it is feasible to invest in markets that are not crippled by political risk while offering high returns in a range of products and services.

Astute firms ranging from multinationals to entrepreneurs, along with government and international agencies – can exploit these opportunities with a potential for high profits but an equal risk of loss. Following that (if HSBC is correct) the whole concept of emerging markets will start to unravel.


As unique as this time may be, there are still concerns and there is widespread agreement on what those risks are.

  • Market volatility
    This remains much higher in emerging markets. The iShares MSCI Emerging Markets ETF (EEM) rose from $11 per share in April 2003 to almost $56 per share in October 2007, before plunging below $20 per share in the financial crisis. This is a concern for investors.
  • Emerging economies are still heavily dependent on commodity exports
    Investment values and commodity prices are highly correlated: when commodity prices fall, so will investments. Goldman Sachs closed its BRIC investment fund in late 2015 after its assets fell in value a disastrous 88% from their 2010 highpoint following the collapse in oil and other commodity prices at that time.
  • The US dollar and other developed country investors face currency risk
    Both Egypt and Nigeria devalued by over a third when commodity prices fell this decade. However successful local investments are, they cannot overcome such drastic change in their value in developed country currencies.
  • There is the risk of economic nationalism and a trade war, especially in the current political environment
    While some countries such as Argentina find themselves in a familiar credit crisis, others such as the Philippines worry about a fall in remittances from overseas workers.
  • Corruption and the failure of economic progress
    As developing countries grow richer, the real divide in the golden decades will shift from developed vs. developing, to urban vs. rural, and poor vs. rich, which an anti-corruption campaign cannot reverse. Higher wages in China have curbed the country’s manufacturing growth. The World Bank argues that a colossal 68% of all existing jobs in India and 77% in China are at risk from automation, as even basic service jobs are not immune.
  • History has taught investors that markets opportunities are never uniform                                                                                                    Take the BRIC countries. Although their trajectory has slowed over the past decade, they went from accounting for 11% of the world’s GDP in 1990 to almost 30% twenty-five years later. During the same period, economies like Indonesia and Russia made huge strides, whilst Zimbabwe and Venezuela collapsed.

The lure of gold

The macro picture is encouraging. Favored emerging markets such as Indonesia have made significant strides towards fiscal consolidation. They have reduced their large current account deficits, successfully fought inflation and have been able to reduce inflation-adjusted interest rates. This has led to capital inflows. Others countries including Zimbabwe and South Africa have made sensible moves towards political renewal.

Forecasters are predicting continued European growth. Even though Russia has been dealing with sanctions, their economy continues to impress, with higher oil prices providing additional impetus. The Indian economy, notwithstanding the jolt caused by demonetization and the introduction of GST, is expected to continue to outperform its neighbors, excluding Sri Lanka and potentially China. Finally, Chinese and Indian domestic markets are still growing at over 6% year-on-year and are now of tremendous importance for manufacturing and service exporters in emerging markets.

Investment bank Morgan Stanley highlights that emerging markets’ economies outside China (EMXC) contributed 36% of global growth in 2017, which closely parallels the MSCI Emerging Markets index rise of 37.5% (Asia ex-Japan reached 42%). The gap is forecasted to increase to 3.2% in 2019, which partly explains why Morgan Stanley argues that EMXC economies will contribute 41% to global growth in 2018 and 43% in 2019. If the correlation holds, EM equities, as well as EM sovereign debt, will continue to benefit.

Optimistic fund managers like T. Rowe note that emerging market valuations are still at historic lows – the MSCI Emerging Markets index is trading around 12.8x forward price-to-earnings ratio, a discount of 24% compared to the MSCI World index, which compares to typical discounts of two third of that.

Short-term investors in countries, especially those favoring ETFs and equity index products as well as debt derivatives, will be influenced by recommendations from Morgan Stanley and Schroders. Overall, fund managers conclude that 2018 will see continued high returns in EMs, albeit not to the level seen in 2017.

How long will the good times last?

Fund managers, as well as private equity investors, must be concerned about the medium-term prospects for emerging markets. Global agencies are optimistic: after a half-decade of decline, the IMF now expects GDP in emerging market economies to accelerate every year through 2021, the standard exit timeframe for private equity.

Capex growth in emerging market economies, after several years of negative trends, is another encouraging sign for investors basing their decisions on economic fundamentals. To add to the positive fundamentals in emerging markets, medium-term forecasts for commodity markets are now higher than even at the end of 2017.

Fund managers such as Janus who have underperformed the MSCI benchmark due to heavy exposure to commodity-dependent markets could now recover as energy and commodity prices exhibit a modest rebound.

Technical investors such as MIRA likewise draw on evidence from the six bull cycles of emerging markets over the past five decades to argue that equities are in the early stages of a multi-year recovery. If the past is any guide, however, emerging markets will fail to maintain these advantages and the bull cycle will fade away as the new decade gathers pace.

The race is on

In the long-term, if HSBC is correct in their predictions that by 2050 19 of the 30 largest global economies are in countries we still call ’emerging’, the disparity between valuations in those markets and in OECD countries will have almost evaporated. This will make for more accurate comparative valuations in general as the pool of comparable companies will be greater, but it will reduce opportunities for arbitrage between advanced and emerging markets.

As that begins in global equities, the need for greater understanding of individual national markets and specific companies within them will dominate the historical combination of a macro-overview and reliance on the price of commodities. Apart from the effects of devaluation with more synchronicity in global markets, stock picks will dominate over market choice once and for all. For instance, almost 60% of the world’s active mobile money accounts are in Sub-Saharan Africa alone, while Tesla cars drive around in Abuja and India is moving to a cashless economy.

Franklin Templeton Emerging Markets Equity may be premature in claiming that emerging markets are now at the forefront of the latest technological developments, from mobile banking and shopping to robotics and healthcare. However, their remarks should serve as a wake-up call to fund managers. The race is now on to determine how emerging markets will be affected by the next wave of technological developments.

The biggest winners in the golden decades may be the advisers that leverage their local knowledge and global brands to provide credible analysis for private equity and fund managers alike in disparate markets across the world.

Someone sold that Tesla in Abuja after all.

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