The strategic argument for exposure to emerging economies remains very much in place.
Emerging economies still have the most to benefit from likely continuing trends in globalisation, with their comparatively greater export orientation and growing share of world trade. Alongside this, rapid population growth (while both a burden and a benefit), still suggests a faster level of absolute GDP growth for emerging economies than their developed peers.
However, equity markets are all about how reality measures up to expectations and, for some time, the bar has been set higher for emerging economies and equity markets buoyed by a decade or more of dynamic acronyms and increasingly subjective commentary.
Some of this froth has faded over the last year or so, with the marked underperformance of emerging equities versus their developed peer group’s. So is it time to bite the bullet and add a tactical overweight to our strategic call?
The valuation argument is perhaps not as clean cut as it looks. Certainly at the regional level, valuations look undemanding relative to trend and may indicate a greater valuation tailwind than might be enjoyed by developed markets right now. However, if you start looking below the hood and examine the sectors that are dragging those valuation multiples lower, much of this discount to recent history is harder to dispute. Sectors such as Chinese banks (over a third of the Hang Seng and 5% of overall MSCI emerging market capitalisation), where you can have little faith in the current earnings projections, materials and even energy all have good reason to be lowly rated at the moment.
Much of the energy sector in emerging markets remains under the umbrella of the state and suffers accordingly; while the materials sector’s high dependence on Chinese capital spending suggests some caution is merited. Conversely, those sectors that speak directly to the emerging consumer do not look as obviously inexpensive, relative to history, as you might expect.
The more profound near-term influence on the performance of emerging market indices is likely to be their allure relative to their developed markets counterparts. On this count, we retain a preference for the latter and, in particular, the US and Europe ex UK. It is these two regions that have suffered the most from the crisis of investor confidence over the last few years and, therefore, it is still these two regions that have the most to gain from a resurgence in that confidence. In a world with less money to chase all of these assets we suspect that it will still be these two regions that win the beauty parade for the moment.
Favourite emerging exposure…
For those investors keen to gain direct access to emerging equity markets, we still believe that the most attractive indices are those that are most closely linked to the US economic cycle – Korea, Taiwan, Mexico and even Poland are all names that come up regularly in association with this theme.
China is our favourite long-term play, but investors may well need to be patient. The link between GDP and corporate profits is not always clear cut and this is particularly the case in China where a high level of government ownership further muddies the picture. That said, the likely next move for us with regards to our tactical allocation to emerging markets is up rather than down. For the moment our convictions still lie in the areas where expectations remain fractionally easier to beat.
:: Andrew Miller, Barclays Wealth and Investment Management, Newcastle