Clearly, this year has been challenging for investors in emerging markets, which have generally underperformed developed markets. However, we have seen recent data showing the trend of asset outflows may be reversing as more investors are putting their money back to work in emerging markets. This is encouraging to us, but even if the type of volatility we saw this summer flares up again, by no means do we feel it’s time to abandon the asset class. We consider many of the factors driving recent volatility in emerging markets to be temporary and compounded by typically low summer liquidity—thus we believe we have grounds to be optimistic longer term. Emerging Markets Can’t Be Ignored In our view, regardless of short-term investor shifts in sentiment, emerging markets simply can’t be ignored. They are a significant part of the global economy today in terms of world land mass, population, gross domestic product (GDP) and equity market capitalization. It is true that emerging markets’ economic growth in general has been slower this year than perhaps it was in the past, but we don’t see systemic risk present in emerging markets. There are pockets of vulnerability in some countries, but by and large, we don’t see an asset-class-wide doomsday situation. Foreign reserves and public debt as a percentage of GDP generally appear to be at healthy levels, and GDP growth overall remains more robust than for developed markets. Broadly speaking, we aren’t seeing an emerging market equity crisis brewing. Most investors globally remain underinvested in emerging markets so in our view the question is not whether to invest in emerging markets or not—the question is which companies in which markets to invest in? We believe emerging markets remain growth drivers of the world. Two Main Factors Impacting Emerging Markets: The Fed and China In our view, there have been two main factors contributing to emerging markets’ performance this year: possible monetary policy tightening ahead from the US Federal Reserve (Fed) and concern about slowing economic growth in China. We think the markets have overreacted to potential US rate increases ahead. It is interesting to note that a number of central banks in emerging markets have actually called on the Fed to raise rates to end the uncertainty. Historically, we have seen similar sharp market gyrations (typically downward) in both emerging-market currencies and equities in advance of Fed tightening. However, during the actual implementation of previous US rate-rising cycles, equities have been able to rebound—illustrating our belief that markets tend to price in a worst-case scenario prior to the event. Looking at the MSCI Emerging Markets Index, the average one-year performance following a Fed interest rate increase was 12.4%.1 You can see in the chart below that following the initiation of the last three periods of Fed tightening in 1994, 1999 and 2004, the market did not collapse. If the Fed aggressively raises rates in a series of moves, we do see that as bearish for emerging markets, but that scenario doesn’t seem likely to us. US multinational companies (and thus the broader US economy) depend vastly more upon emerging market countries (most notably Asia) for growth than they did during previous rate rise cycles. Hence, a greater feedback mechanism exists now, whereby declines in emerging market growth and currencies have a far larger direct impact upon US economic growth and, in turn, influence the freedom of the Fed to raise rates. We also must not forget that other central banks outside the United States have been adding liquidity via quantitative easing or interest rate cuts, including in Europe, Japan and China. In terms of the impact of slowing growth in China, again we feel there has been unwarranted investor panic. While China’s equity market volatility and the government’s ineffectual attempt to intervene directly to support prices have dominated headlines this past summer, we remain confident that the government’s efforts to effect a broad economic rebalancing will succeed. While news of China’s market ups and downs makes for splashy headlines, we expect the impact of recent declines in mainland share indexes to have limited impact on the broader economy due to the low level of household wealth allocated to equities in China (less than 20%, according to our research). As household exposure to local equities is very low, we believe there would not be a profound wealth effect even if we saw a market crash in China. The government is also systematically addressing the structural weaknesses in the economy—most notably concerning debt—with the mandated transfer of banks’ bad loans to asset management companies, higher non-performing loan (NPL) provisioning at banks, and the development of local government debt markets. Furthermore, while aggregate levels of debt are relatively high, given China’s level of economic development, the country also has a uniquely vast level of state assets, including foreign exchange reserves and state-owned enterprises that provide balance. Continued rapid rises in wages and dramatic increases in the number of service jobs (typically in the private sector) in our view also help counter the housing slowdown and manufacturing job losses. The increased flexibility in the renminbi represents another welcome move towards financial market liberalization. Asian Economies Appear in Good Shape Overall On a host of measures, from current account deficits to foreign exchange reserves to the proportion of debt that has been issued in local currency versus in US dollars, many Asian economies appear to us to be more resilient than they have been historically. A particular example is India, which illustrates the disassociation of sentiment from economic fundamentals. Its currency has declined about 5% versus the US dollar,2 but while this decline may parallel the decline and volatility in 2013 that was associated with the announcement of Fed tapering, India today is far stronger from a macroeconomic perspective. India’s commercial debt of US$185 billion3 is very manageable in our view, and historically, even during turbulent periods, refinancing has not been a major problem. More importantly, since late 2013, India’s current account deficit has improved from US$88 billion...
Investment Adventures in Emerging Markets - Notes from Mark Mobius
Mark Mobius, Ph.D., executive chairman of Templeton Emerging Markets Group, joined Templeton in 1987. Currently, he directs the Templeton research team based in 15 global emerging markets offices and manages emerging markets portfolios. As he spans the globe in search of investment opportunities, his “Investment Adventures in Emerging Markets” blog gives readers a taste for what he does, when, where, why and how. Dr. Mobius has written several books, including “Trading with China,” “The Investor’s Guide to Emerging Markets,” “Mobius on Emerging Markets,” “Passport to Profits,” “Equities—An Introduction to the Core Concepts,” “Mutual Funds—An Introduction to the Core Concepts,” ”The Little Book of Emerging Markets,” and “Mark Mobius: An Illustrated Biography."
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