The world’s powerhouse economies are reeling. The U.S., Europe and Japan are all mired in deep recessions, and the World Bank is predicting paltry 0.9 percent global GDP growth for 2009. Investors have reacted with understandable trepidation, sending stock markets down to levels not seen since early this decade. Although the declines are painful, investors should not let them get in the way of truly compelling opportunities, such as those we see in emerging markets.
As highlighted in our firm’s latest white paper, emerging-markets economies, despite their current difficulties, will generally prove resilient during this downturn. The World Bank forecasts that the GDP of developing countries will grow 4.5 percent this year — down from 6.3 percent in 2008, but growth nonetheless.
High foreign exchange reserves and lower foreign debt levels should act as firewalls for emerging markets against the global slowdown. During the past ten years, reserves have grown sixfold, to more than $4 trillion. Emerging-markets countries also have improved their credit ratings. According to Merrill Lynch & Co., 40 percent of emerging-markets debt is now investment grade, compared with just 3 percent a decade ago. This in part reflects the ability of governments in developing countries to implement more sound monetary and fiscal policies. Stronger balance sheets enable them to execute these policies, such as China’s nearly $600 billion two-year infrastructure investment, which help stimulate their economies.
Our research also shows that emerging-markets equities can buck conventional wisdom and perform well regardless of what happens to commodity prices. From 1987 to 1992, emerging-markets equities nearly tripled in value, while commodity prices fell. Commodities and equities again moved separately for long periods in 2006 and 2007. In addition, commodities now account for just 15 percent of total emerging-markets exports.
In many emerging markets, domestic demand plays a larger role in GDP growth than do exports. This helps to partially insulate their economies from the slowing demand from developed markets. In early 2007 exports between emerging markets equaled exports to developed markets for the first time. By the second quarter of 2008, intra-emerging-markets exports surpassed developed markets exports, 52 percent versus 48 percent, making emerging economies less reliant on the health of developed nations to prosper.
During the past decade emerging-markets companies have produced higher profits (expanding by double digits annually) with lower leverage, highlighting prudent corporate practices. Stronger balance sheets have enabled companies to focus on growth opportunities, unlike during previous crises, when they had to focus on their own financial viability. Companies’ return on equity has steadily increased over the past ten years, doubling to more than 16 percent on a trailing 12-month basis.
The average price-earnings ratio for emerging-markets companies was 8.1 in mid-January, more than 50 percent below the historical average. These low valuations have been caused, in large part, by indiscriminate investor selling and a desire for liquidity regardless of company or country fundamentals. Indeed, investor outflows in 2008 equaled more than one third of the total inflows into emerging-markets equity funds during the previous five years. But even with further stress-testing of earnings growth and investors’ profitability expectations, investment opportunities remain very attractive.
Clearly, and particularly in the current market environment, investing in emerging markets involves risks. With the global financial crisis still in progress, patience and rigorous analysis are required. There will be winners and losers, and even the winners may take time to appear. Those countries and companies that took advantage of booming times and invested prudently are expected not only to survive but also to prosper, while those that consumed the gains generated over the past economic cycle are likely to suffer the most.
Emerging markets continue to benefit from positive secular and cyclical drivers. Prudent fiscal and monetary policies have improved the ability of emerging-markets countries to withstand global macro shocks, reducing historical economic vulnerability and contributing to the resilience that we expect to support an upward revaluation of equities. When investor sentiment catches up to fundamentals, emerging-markets equities will again shine. Investors who ignore them will do so to their detriment.
Marko Dimitrijevi´c is founder and CIO of Everest Capital. With offices in Bermuda, Geneva, Miami, Shanghai and Singapore, the firm manages $1.5 billion in global theme-driven investment strategies incorporating bottom-up fundamental research.
