Emerging markets: The world’s great engines of growth
Leighton Riley, Investment Director, explains why he and the team are optimistic about the outlook for emerging market equities.
However, there are a few things we know for certain. Firstly, EM fundamentals look very strong relative both to history and to developed markets (DM). Secondly, China has clearly underperformed this year, but we’re now seeing green shoots that suggest we’ve reached the bottom. And thirdly, it seems like interest rates have peaked for this cycle, with some EM central banks starting to cut.
Strong EM fundamentals
But it’s not just their economies that look attractive. From a stock market valuation perspective, the cyclically adjusted P/E ratio for the MSCI EM Index (a measure of stock prices against earnings throughout the business cycle) is trading at 10.7x, approximately one third of the level of the S&P 500 Index (29.5x). This means that EM equities are not only presented with the most fertile growth conditions for a decade, but they are also very attractively priced relative to DM (in aggregate).
The government recently stepped up its response to its ongoing property sector woes, announcing a raft of stimulus measures. China is a policy-driven economy that relies on policies, symbols and nudges to achieve its goals. These announcements are a meaningful step in the right direction, with the central government ‘tone from the top’ particularly important. We have seen encouraging early signs, though we do recognise it’s still too early to infer causality.
The government has also continued to focus on ‘activating’ the capital market in China. This will be important for reinvigorating Chinese investor confidence in equities. Finally, these concerns should be put in the context of the opportunities for the country: China is the world’s second largest economy and will remain so for some time to come, regardless of geopolitical tensions, with domestic consumption continuing to increase. Chinese GDP per capita has increased by 14-fold, from 2% of US GDP per capita in 1980 to 28% today. If it were to achieve the same level of prosperity as Poland, for example (46%), over the next 20 years, its GDP per capita would double. We don’t try to forecast macroeconomic data, but this gap would suggest that there is a long way for China to run before it catches up to its emerging European peers – a not outrageous expectation.
Peak interest rates
Globalisation, but not as we know it
What does this mean for investors? In our view, it means that global trade and economic growth may be less dependent on the fortunes of these two nations, and more dependent on cross-border investment between countries, which could be very positive for EM in aggregate. Already, the share of trade between EM countries is more than 40% of total EM exports. Emerging markets constitute the world’s last great engines of growth: they have vast, young populations; they’re well educated and entrepreneurial; they’re rapidly growing their wealth; they benefit from inbound and domestic capital investment; and they are increasingly run by fiscally conservative, stable governments. Greater integration of EM economies helps support this growth and reduce reliance on the slower-growing developed world. Furthermore, the historically strong negative correlation between EM equities and the US dollar may be weakening, allowing the attractive fundamentals of these countries to shine.
Ripe conditions for EM
The value of active minds: independent thinking
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