Emerging market growth story dies

Last updated: July 26, 2013 11:44 am

Emerging market growth story dies

By Jonathan Wheatley

An uncomfortable truth is making itself felt around the world of emerging market investors: the emerging market growth story is dead. This is not to say that emerging economies will no longer grow. Nor even that emerging market assets will no longer deliver attractive returns. But the days are long gone when “emerging markets” could be seen as a single asset class. More than that: as David Lubin, head of emerging market economics at Citigroup puts it, the very “foundation myth” of the emerging markets no longer holds true. “The EM story is based on rapid growth, led by exports, which delivers large current account surpluses, which leads to the accumulation of foreign exchange reserves and the expansion of domestic credit,” he says. “Every single element of that story is no longer true.”Mr Lubin says the recent street protests in Turkey,Brazil and elsewhere show that growth in those economies can no longer keep pace with popular aspirations that were raised during periods of rapid growth before and after the 2008-09 crisis. And he says the end of the EM growth story can be read in the performance of EM equities.

“Stock markets often give much truer signals than other markets,” he says. “The underperformance of EM equities in the past 18 months shows they have captured the idea of change in the global economy, and that it is rebalancing in favour of developed markets.”

Indeed, from the beginning of 2002 to their peak in late 2007, EM equities (measured by the MSCI Emerging Markets index) gained 320 per cent, while global equities (the MSCI World index) gained 67 per cent. From then to their post-crisis peak in April 2011, EM equities lost a tenth of their value while global equities lost nearly a fifth.

Since then, however, in spite of the floods of liquidity provided by quantitative easing in the US and elsewhere, EM equities have lost another fifth of their value, while global equities have gained about 12 per cent.

Michael Gavin, head of emerging market strategy at Barclays, sees little chance of improvement in the foreseeable future.

“A few years ago, you would invest in emerging markets because you expected growth,” he says. “Now not only do we have much weaker growth, we’ve had a strong demonstration that top down macro growth does not drive returns on EM assets.”

One example of how things have changed is Brazil, which Mr Gavin describes as “the poster child of equity underperformance”. Brazil’s government would have investors believe that the country’s huge gains in prosperity over the past 15 years were a result of a transformation in policy that created a predictable environment of low inflation, good governance and steady growth.

Policy makers deserve their share of credit but many analysts now say Brazil’s growth was caused primarily by the commodities supercycle, cheap money before the crisis and more cheap money after it – circumstances unlikely to be repeated. More recently, policy has been much less investor friendly.

“Brazil’s authorities have a dirigiste view of development. They think you control prices by leaning on utilities and you generate growth by leaning on the central bank. Is Brazil a buy at today’s prices? Maybe, but not as a growth story. Maybe as a policy turnround story if you think that will happen,” says Mr Gavin.

Even emerging market perma-bulls find it hard to defend the broad emerging market case.

“There will be markets that will disappoint,” says Julie Dickson, product manager for equities at Ashmore Group, a dedicated emerging market investment company. “It is time to get a lot smarter.”

Getting smarter, of course, means getting a lot more selective. “We are active stock pickers,” says Ms Dickson. “There are definitely some gems out there that will surprise on the upside against a difficult backdrop.”

She says “market dislocation” in recent months has delivered disappointing returns for asset managers because companies that are performing well have done just as poorly in share price terms as companies that are doing badly. But this, she says, has the effect of broadening valuations, “so you can distinguish the really cheap from the truly expensive.”

She favours small-cap companies in emerging and frontier markets that get most of their earnings from their own markets, over large-caps that are more exposed to global conditions. She says Ashmore has invested in discretionary consumer stocks such as retailers and automakers and in a range of tech stocks from mobile technology to robotics. She is avoiding markets that are too expensive, such as the Philippines, but has found opportunities elsewhere in Asia and in Peru and Mexico.

Despite her emphasis on selection, however, Ms Dickson says she believes in a broader EM recovery, “not just because we’re in this space but because there is a lot more going for emerging markets than against them.”

That is an increasingly lonely position.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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