The title of Shakespeare’s sixteenth century play “Much ado about nothing” is now a common phrase that translates to making a big fuss out of something insubstantial. How might this relate to current market noise on emerging markets?
Emerging markets (or EM) continue to face volatility in today’s investment environment, but these swings are perennial and far from unique. Current “speed bumps” in the asset class are caused by the technical features of shifting market events, rather than depleting health in the underlying fundamentals of EM.
The fundamentals make the most difference when it comes to predicting the long-term sustainability of any asset class. These are among the core reasons to stay invested in any asset for long periods of time, in our view.
Take a look at the fundamental health of emerging economies, and you will notice that these countries remain relatively robust. Emerging countries that were labeled the Fragile Five a few years ago are starting to bounce back. The Fragile Five refer to Brazil, India, Indonesia, Turkey and South Africa, and were given this moniker because they were seen as the countries in greatest turmoil.
Compared to the summer of 2013, all five of these countries are in much better financial shape today, having experienced growth in relative bond yields, real interest rates and/or current account balances as a percentage of gross domestic product (or GDP).
Market Realist – Market gyrations seem to have spooked investors away from emerging markets (FEO). Emerging market equities have been bleeding money for more than a year now. Emerging market ETFs (VWO) (EEM) saw outflows of $7.2 billion in the 12 months that ended on September 30, 2015 (Source: EPFR, Financial Post). The specter of a Fed rate hike later this year, coupled with concerns about the economic slump in China (FXI), has been weighing down investor sentiment for the asset class. A Fed rate hike usually leads to a stronger dollar, which doesn’t bode well for emerging markets. But the tide seems to be turning. Last month saw inflows into emerging market funds (ABE) after an excruciatingly long hiatus. Do fundamentals support the recent turn in investor sentiment? We think so.
Despite the carnage, EM fundamentals look healthy. Emerging markets continue to grow at almost double the rate of the developed world. The International Monetary Fund (or IMF) forecasts the growth rate for advanced economies to come in at 2.36% for 2015. On the other hand, emerging and developing nations are estimated to grow at 4.26% in 2015. This trend is likely to persist over the next five years. According to IMF calculations, the developed world is likely to grow by 1.95% in 2020. Emerging markets, in contrast, are estimated to grow at 5.27% in 2020. The long-term outlook for emerging markets continues to look very optimistic.
As we explained above, the “Fragile Five” seem to have largely recovered from the weakness displayed in 2013. In fact, India (IFN) (EPI) is likely to surpass China (GCH) in terms of economic growth by 2016. The IMF estimates India to grow at 7.5% in 2016 while China is estimated to grow at 6.3% next year. The current account balances of all the “Fragile Five,” except Brazil (EWZ), have improved over the past two years, as you can see in the above graph.
In this series, we’ll explore why emerging markets may still be an attractive opportunity for investors.