Business

Saturday November 14, 2009

The rise of emerging markets

By TEE LIN SAY


Developing countries are chief contributors to global growth

CHANGING perceptions is never easy, and more often than not resisted.

Nonetheless, investors may need getting used to economic revelations that are shifting faster than the tectonic plates under Mother Earth.

Allan Conway ... ‘The world is seeing one of the biggest structural changes.’

Firstly, developed economies are no longer safe havens.

Secondly, emerging markets are today’s safe havens.

Thirdly, developed economies are the submerging economies and are fundamentally getting weaker.

On a less dramatic note, the US’ power has peaked and is now shifting to China and India. Convinced?

Well, Schroders global head of emerging market equities Allan Conway is a firm believer that all roads now lead to emerging markets.

“I am very convinced that when economic historians look back 100 years from now, they will look at this period and say it was a turning point. It was a point where the US’ position as a super power peaked and shifted to China and India. This is also perpetrated by the 2.8 billion consumers in China and India.”

He says the world is seeing one of the biggest structural changes in the globe since the 19th century industrial revolution.

“Forty years ago, emerging markets were contributing 20% of the world’s market growth and were mostly exporting nations.

“This year, emerging markets contributed 100% of global growth. Next year, even with an anaemic recovery in the developed world appearing increasingly likely, we still expect 70%-75% of global growth to come from these developing economies,” says Conway.

The fact is this: Emerging markets used to rely on developed countries. Now developed countries depend on emerging markets.

Conway says that emerging markets have been consistently growing 3 to 5 percentage points faster than developed nations. A large proportion of these markets’ growth are also contributed by domestic demand rather than exports.

“A significant portion of China’s growth comes from its domestic demand. Emerging markets have created a momentum on their own. They now export more to China than to the US. China too, exports more to emerging markets than it does to the G7 countries,” he says.

Notably, this crisis period has seen emerging markets escaping relatively unscathed.

“If we had looked simply at history, we would think that emerging markets were going to be in big trouble with this crisis. But emerging markets are now stronger, not weaker. Their balance sheets are stronger, they have high savings rates and they don’t take on debt the way developed economies do,” he says.

On decoupling

Conway says emerging economies have significantly decoupled from the developed world. He says this is also true of the stock market.

“If you look at the MSCI All Country World Index over the last 10 years up to December 2008, the US has given returns of (minus 2%). Whereas emerging markets are up 145% even after the 50% drop in markets!” he says.

“The decoupling of stock markets are keeping pace. It was only in 2008 that the decoupling theory for emerging markets did not hold. That was because investors got worried and wanted to raise their cash levels.”

“Hence they took money out where they had profits – typically from emerging rather than developed markets. The sell-off was not about the fundamentals,” he says.

Conway says what is happening now is a major re-appraisal of risk.

“We should not be talking about developed economies. Emerging market’s are today’s strong economies. They are the safe havens. Developed economies are the submerging economies. Its economic fundamentals are worse from all the debt they have taken on.”

Conway says the US has avoided a depression, but the cost of this is that it will take years to cope with it.

Meanwhile, emerging markets have seen very strong returns and to date, are up 70% from a very oversold position.

“Valuations were ridiculously cheap last year. Now they have reached reasonable levels, but it is not expensive. Over the short term (next one to three months), we see some setbacks for financial markets, but this is purely technical,” Conway says.

He explains that the recent rally in markets was because people were predicting a U-shape recovery. Conway believes it will be a W-shaped for developed economies.

Hence there will be a double dip in the developed economies but not for emerging markets.

Emerging markets will see a V-shaped recovery, not a U recovery. There may be a setback over the next month or two, but this is an opportunity to buy.

“The double dip in the US is because its recovery has been manufactured. Firstly, there’s been massive fiscal stimulation.”

“There’s been quantitative easing and now there is inventory rebuilding. The potency of these measures over time, will reduce.”

Conway adds that consumers in the US aren’t returning until the second half of the year. They are rebuilding their balance sheets and managing their debts.

“The strength of the long-term case for emerging markets is undeniable – these economies are developing a momentum of their own, based on sustainable growth drivers and strong fundamentals. In our view, the journey has just begun,” says Conway.

A bubble in the making

With the huge amounts of liquidity injected by global central Banks, Conway sees a bubble forming, in the next one to two years.

Nonetheless, he does not see a drop in liquidity, especially when there are already anticipations of a double dip in the market.

He opines that with governments having gone through huge amounts of trouble to avoid a depression, they would rather take a risk with inflation rather than growth.

“In the past, institutional funds saw emerging markets as tactical strategies. They did not need to have them. Now, they are re-appraising their attitudes. Emerging markets are now seen as strategic investments,” Conway says, adding that he sees more money coming in this area.

For a fund manager to be neutrally weighted in emerging markets, he needs a 13.5% weightage in the MSCI Emerging Markets Index.

Schroders is neutrally weighted on Malaysia for valuation reasons. It is however positive on Malaysian plantation companies.

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