Since the markets have started to price out a an early “Fed-Tapering”, the troubled emerging markets have started a release rally. Investors, however, still need to be patient and to have strong nerves. The risks...
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Mikio Kumada, Global Strategist at LGT Capital Management
of temporary setbacks due to disappointing fundamental data is still significant.
Exit from the ultra-expansive monetary policy delayed
Because of the US budget debate that might regain attention in the beginning of next year and the nomination of the very dovish Janet Yellen as Bernanke’s successor the exit from the ultra-expansive monetary policy is likely to be further delayed. The gradual pricing out of the immediate “Tapering”-fear has supported riskier assets like those emerging equity markets that suffered most from the capital flight in the summer.
Even without “Tapering” the environment remains tough for emerging markets
Despite the recent release rally of EM equities and the prospect of an ongoing ultra-expansive monetary policy, there is no reason for exaggerated emerging markets euphoria. The relative weakness of EM equities amplified after Ben Bernanke’s announcement about a possible “tapering” of the Federal Reserve’s asset purchasing program. However, we should bear in mind that emerging markets have already been struggling with macroeconomic imbalances long before any debate about a possible Fed exit. The growth differential between emerging and developed markets is still remarkable, but has been shrinking from almost 7% to just above 3% over the last years.
The cyclical turnaround has not yet arrived
More important than the past growth numbers is the recent economic outlook. And even though the prospects for emerging markets are still attractive over a longer period, they do not look too bright for the short term. Even the International Monetary Fund (IMF) that is normally well-disposed towards emerging markets, has downgraded their growth outlook several times and now also forecasts a shrinking growth differential between EM and DM over the next years.
Markets have downgraded EM growth prospects, too
Financial markets have downgraded the growth outlook for emerging markets significantly. Valuation, which implies the expected growth, is responsible for 2/3 of the 50% underperformance of EM equities vis-à-vis US equities since September 2010 whereas the actual earnings growth only accounts for 1/3. While the P/E ratio for US equities recovered, it has been falling for EM stocks. Equity valuations for emerging markets at recent levels are attractive for long term orientated investors. In the short term, however, the valuations could fall even further in case leading indicators should continue to disappoint.
Their ability to decouple has been overestimated
Our EM surprise indicator shows, that expectations about a possible EM decoupling from the western crisis have been exaggerated. The rising China euphoria might be responsible for the excessive growth fantasies. For the first time in history, an emerging country was able to react with such a big growth stimulus that investments could compensate for the declining exports and that real growth rates reaccelerated to over 10%. As a consequence, many analysts expected that emerging markets would be able to decouple to a reasonable degree from the structural problems in the Western hemisphere. However, it has become clear over the years that the growth stimulus which was financed by a large amount of credit is not sustainable and that a decoupling of EM is not a realistic scenario yet. Nevertheless, the massive Chinese stimulus showed the enormous power of the new World, which can be interpreted as a bullish sign for EM over the long term.
Source: ETFWorld – LGT Capital Management
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