The vulnerabilities—or rather, perceived vulnerabilities—of emerging markets have been the focus of heightened discussions over the past few months. Concerns about the health of emerging markets came on the heels of political upheavals in Egypt, economic deceleration in China and protest demonstrations in Brazil and Turkey this summer.
I think too many investors have failed to put those events and developments in the proper context. Rather, they have come to the conclusion that emerging markets are finished, particularly, they say, as the US Federal Reserve (Fed) is expected to turn off the money tap, depriving emerging markets of needed liquidity to protect their weakening currencies and pay their debts. For the time being, the Fed has decided to keep the tap flowing, removing one immediate investor fear. But I think there are also other reasons why investors who doubt the emerging markets’ story need better context.
Inherent in this kind of doomsday thinking are a number of misconceptions. First of all, some emerging market currencies have been getting stronger, not weaker. Good examples of this are China and Thailand, where their currencies have become stronger against the US dollar over the past few years. The fact is that many emerging markets are not dependent on the support of the West and the developed world. Proponents of the idea that emerging markets are dependent on the developed market countries say that money from the US, Europe and Japan has allowed the emerging market countries to live beyond their means! Ironically, others say that a slowdown in the emerging world will have a negative impact on developed nations.
But if you look at the global debt picture, many developed market countries have more debt in relation to their respective levels of GDP, have higher government deficits, and are more dependent on investors from all over the world buying their bonds. Additionally, the emerging market countries generally have far higher foreign reserves than the developed market countries.
There is a pattern of thinking among many economists and commentators that the emerging market countries are not capable of handling their economies and they need the guidance of the developed market countries. Many in the developed markets lectured Asian nations on fiscal discipline during the 1997 Asian crisis. Then, the emerging markets world watched as the disaster of the US and European financial systems unfolded in 2008–09 while many emerging countries themselves generally continued to not only survive, but prosper. The reality is that the emerging market countries have experienced, and we believe should continue to experience, the most dramatic increases in incomes at the national and individual levels. Their adoption of market economic models and acquisition of productivity-enhancing technology have engineered this positive result.
Asian Emerging Markets: Challenges and Opportunities
The largest of the emerging markets, China, always gets its fair share of attention. There’s been much speculation about worrisome issues in China, including a potential housing bubble, debt problems, and so on. But growth in China has continued at a rapid pace. In September, my team and I visited a large housing development in Beijing, and this particular development was 70% sold out in a matter of weeks. I saw the same thing in other cities I visited, a clear demonstration to me that the demand for property in China remains strong.
Of course there will be some developments in China that will fail, and some problems with debtors. But generally speaking, we think that China has the potential to grow at a strong pace, particularly when compared with most developed markets. China’s economy is now the second-largest single economy in the world, so growth is likely to naturally slow a bit from double-digits of the past. For an economy this size, growth in the range of 7% – 8%, which many forecasters are projecting, should hardly be disconcerting.
Elsewhere in Asia, of course Japan is pumping money out at a pretty rapid rate. We expect a lot of this money could find its way into Southeast Asia. Countries including Vietnam, the Philippines, Thailand, Cambodia, Malaysia, Singapore and Indonesia could potentially benefit.
There’s been a fair share of negativity about India recently, but despite all the problems, the current growth trajectory this year still looks good to us. The International Monetary Fund projects growth of more than 5% in 20131, which is still above most developed countries. We believe India’s elections in the spring of 2014 could bring solutions to some of the country’s problems. From our perspective, challenges often present investment opportunities, and not always where you might expect. For example, you might think weakness in India’s currency would be a very negative thing for the stock market, but there are companies that can potentially benefit. One example would be an outsourcing company that does most of its business outside of India and has costs in rupees, but income in US dollars. A weak rupee and stronger dollar could be very good for this company.
A Global Recovery Story
Even in the throes of a debt crisis a couple years ago, I felt Europe would eventually recover. I expected the process would likely be slow, with a lot of careful thought, but a recovery would come. We believe we are now seeing that in Europe. In the emerging markets in Eastern Europe, a growth slowdown tied to the crisis brought changes and reforms, in some cases quite dramatic. We think Eastern Europe could do well going forward, and if oil prices continue moving up, Russia, of course, could benefit as the largest emerging economy in the region.
It’s not just large countries that are experiencing change. In September, I traveled to Georgia, a small country in Eastern Europe undergoing rapid change. Corruption had been a problem there, but it’s been largely reduced. I saw construction all over the country, and people seemed to be very upbeat about the future there.
Looking at the global picture, we are quite optimistic. The recovery in Europe appears to be underway; in the US, the Fed’s continuation of its QE program should drive growth in many other parts of the world; and Japan is determined to ramp up activity in its economy with its own ambitious monetary policy regime. We believe many emerging markets globally should likely benefit as liquidity currently remains plentiful. For example, in Latin America, countries such as Brazil, Chile and Colombia, which have widening current account deficits, may benefit from needed investment inflows. Mexico also appears well positioned to potentially benefit from greater trade and capital inflows due to its proximity to the US economy.
We recognize that it hasn’t been smooth sailing for emerging markets investors this year. Late in the second quarter and into the third, there was a move away from both emerging markets equity and debt markets. However, we believe the recent outflows are likely to prove temporary. Not only is there still plenty of liquidity in the system, but, given the outflows that occurred, we believe many investors have reduced their weightings to emerging markets. I’m not saying everyone will or should increase their allocations to emerging markets, but I think that many could very well rebalance their portfolios as market sentiment should improve.