Over the next few months and quarters, the manner in which the US Federal Reserve handles an eventual increase in US interest rates will be very important. If rates are pushed up aggressively and by more than expected, it will likely have a negative impact on all markets around the world, not only emerging markets. We do not expect that to be the case, since the Fed has repeatedly indicated that a rate rise, if any, will be gradual and data-dependent. But the uncertainty is what makes investors wary and hesitant.
There’s no denying it -- emerging markets, as an asset class, have had a tough time in recent years. However, that is not to say that ALL emerging markets have declined. Markets such as the United Arab Emirates, Qatar, the Philippines, China and India have all reported positive returns in the three year period ended September 2015. Emerging market equities, as represented by the MSCI Emerging Markets Index, however, look on track to record a third consecutive year of decline. The last time this happened was in the 2000-2002 period. But what followed then was five years of solid double digit performances in 2003-2007. Are we going to see more years of poor emerging market performance or will there be a recovery in the coming year? Our view is on the positive side for a number of reasons.
Emerging economies in general have experienced stronger economic growth trends than developed markets. This has been a consistent long term theme, one we expect to continue in the foreseeable future. Even with major economies like Brazil and Russia in recession, emerging markets’ growth in 2015 is expected to be comfortably in excess of that achieved by developed markets, with China and India driving Asia to particularly strong growth. In the current year, emerging markets as a whole are estimated to be on course to grow by about 4.0% against 2.0% for developed markets. Emerging markets currently account for 37% of the world’s GDP, with developed markets making up the remaining 63%; we expect this gap to narrow as emerging markets growth continues to exceed that in developed markets going forward.
While it is true that growth and stock market performance can be divergent at times, there is no question that growth matters, since company earnings depend on general economic growth. Economic growth on a year-by-year basis may not necessarily result in high stock market performance, but over time, improving growth should be reflected in corporate earnings. The market tends to be forward thinking, while economic statistics are backward looking, sometimes leading to a mismatch.
LOW DEBT, STRONG RESERVES
In addition, what also makes emerging markets attractive is the fact that emerging market governments generally have much less debt and hold significant foreign reserves compared with developed markets. In recent years, foreign currency reserves in emerging markets have been on a rising trend so that they now stand well above the reserves held by developed markets. Reserves in emerging markets total $7.6tr compared to $4.2tr for developed markets. Moreover, public debt in emerging markets on average is well below that in developed markets at just over 30% at end-2014 versus just over 100% in developed markets. This does not mean that some emerging market governments do not have too much debt but as a group the debt is very low in relation to GDP.
Further, emerging markets possess some of the world’s largest and lowest-cost sources of key commodities, including oil and gas, metals, minerals and agricultural products. These are cyclical industries due to long lead times and high upfront development costs. Prices are currently under pressure as a result of negative sentiment but there is continuing demand for them and that demand is expected to grow as a result of the current low prices as well as the cut back in supply by the high cost producers. We continue to see demand for many commodities from emerging markets since infrastructure development requires hard commodities, energy demand remains high, thus oil, gas and coal are required, even metals such as platinum and palladium benefit from greater demand from the auto industry, for example. It should also be noted that some emerging markets (such as China and India) benefit from lower oil prices as they are net importers and allowed governments to reduce oil and gas subsidies, freeing up funds for other uses such as infrastructure development and investment.
Looking at the global oil supply and demand growth trends over the last 10 years to the end of August 2015, the average annual production growth rate was 1.2%. This compared to a 1.1% average annual consumption growth rate. And despite lower commodity prices, we believe that low cost producers can continue to profit in this environment, especially as demand continues and high cost and more inefficient companies shut down. We also believe that many of these companies are trading at attractive valuations, have solid fundamentals and should be more resilient during downturns.
FRONTIER MARKETS RISING
Another attractive investment opportunity at the moment is frontier markets. Frontier markets are geographically and economically diverse and are found all over the world -- in Latin America, Africa, Central and Eastern Europe, and Asia. The list of frontier market countries is long and includes such nations as Nigeria, Kenya, Saudi Arabia, Kazakhstan, Bangladesh, Vietnam, United Arab Emirates, Qatar, Egypt, Ukraine, Romania, Argentina, and many more.
As a subset of emerging markets they share the characteristics of emerging markets which are generally evidenced by faster economic growth. The potential growth is also great. The International Monetary Fund projected that during the next five years, 19 of the 20 fastest growing economies will be in frontier markets with the last one rounding up the 20 being India.
These markets could grow into tomorrow’s fully-fledged emerging markets. They are where many emerging markets were say 15 or 20 years ago. Thus, frontier markets today can provide investors with a very attractive investment opportunity, comparable to emerging markets in the late 1980s. Frontier markets are going to develop into emerging markets and investors should not miss the opportunity to take advantage of their growth.
Lastly, we have noted that many investors are still underweight emerging markets. Emerging market equities represent just over 30% of the world market capitalization, yet investors generally have a much lower weighting in this asset class in their portfolio. About one-third of investors surveyed in the Merrill Lynch Fund Manager’s Survey are underweight emerging markets equities. Thus, I strongly believe that a large number of investors are missing out on benefiting from investing in the fastest growing economies.
Mark Mobius is executive chairman of Templeton Emerging Markets Group and currently directs the Templeton research team which is based in 18 global emerging markets offices, and manages emerging markets portfolios.